Budget 2012 – The “Hockey Stick” Budget

Don’t you just love accountants?  I’m serious.  Every year accountants are given the thankless task of preparing “The Budget” and every year, bless their little number crunching hearts, they deliver—only to see their hard work go off the rails and into the ditch in less than 8 seconds.

The derailment process starts when the “higher ups” see the budget and react in horror and disbelief.  In the corporate world the “higher ups” know they can’t take that budget to the board of directors without risking the board (and the shareholders) concluding that management are incompetent spendthrifts.   In the political world, the Premier and her Cabinet know they can’t table a budget that fuels the Wildrose argument that the Torys are reckless money managers or attracts censure from the Liberals, NDP, and Alberta Party for sacrificing the most vulnerable Albertans on the altar of big business.  It has to a Goldilocks budget—not to big, not too small, just right—at least until after the election when the Premier and her party are safely ensconced in the Legislature for another 4 years.

The dialogue between the “higher ups” and the accountants invariably focuses on the assumptions underlying the numbers.  (This makes sense because assumptions are not laws of physics and can be changed with a stroke of the pen.)  The debate usually goes like this: “What do you mean [insert appropriate sacred cow] won’t hold from here to eternity?” or “What do you mean [insert extremely optimistic forecast] isn’t appropriate in these circumstances?

The Redford/Liepert 2012 budget includes some critical assumptions that deserve further scrutiny.  These are:

  • Oil prices will be $99/bbl.  Oil prices are influenced by the global economy which shows no signs of finding its feet any time soon.  There’s a 40% chance that the US economy will stumble and if that happens, oil prices will drop to the $90/bbl range.* A $1 drop in the price of oil results in a $223 million drop in revenues—do the math.
  • Natural gas prices will hold at $3 per gigajoule.  The market is flooded with natural gas, production is declining and new demand from industrial, power and LNG markets takes time to develop.  Bottom line: don’t expect a boost in natural gas royalties any time soon.
  • The Canadian dollar will remain in the 98.6 cent range against the US dollar.  The Cdn dollar and the US dollar shudder when someone sneezes.  If the loonie goes to par with the US dollar the impact is a $600 million drop in revenue.

Depending on how these assumptions play out we could be looking down the barrel of a $1 billion shortfall.

While some industry associations like SEPAC and CAPP**are prepared to support these assumptions, financial experts like FirstEnergy Capital Corp and BMO Capital Markets call them (delicately) a little optimistic.  And the big players in the industry are sending out mixed signals.  Husky expects a “lumpy” year and Nexen describes 2012 as “pivotal”.***

Given that resource revenue makes up about 30% (27.8% to be precise) of the budgeted revenue of $40 billion one would hope (pray actually) that the government didn’t resort to an overly “aggressive” approach to developing these assumptions.  Or to put it another way, in these uncertain times the assumptions should err on the side of caution, not wild-eyed optimism.  This is especially true when you consider that in order to achieve the dramatic turnaround from deficit to surplus the government must raid the Sustainability Fund.   By 2015 the Fund will have dropped from $14.9 billion to $2.4 billion.  That gives the government very little wiggle room if they got it wrong.

A CEO delivers a “bad news” budget to his board of directors by presenting a chart known as the “hockey stick”.  The blade of the hockey stick sits down in the lower left hand corner of the chart…this is the god-awful-horrible-results quadrant.  The stick then swoops up hard and fast to the top right quadrant where revenues flow into the corporate coffers, everyone collects their bonuses and goes home happy.  A smart director will ask for details about the assumptions to understand why these assumptions will drive the rapid rise up the hockey stick.  If the CEO doesn’t have a rational answer or, heaven forbid, the directors saw this very same hockey stick last year and the year before that, smart directors will fire the CEO before the shareholders dump their stock.

The Redford/Liepert “hockey stick” starts with an $886 million deficit (the god-awful corner of the chart), next year it turns the corner with a $952 million surplus and in 2 years it soars to the nirvana quadrant with a $5.19 billion surplus.  Like smart directors we need to ask ourselves:  Is the hockey stick based on a realistic assumption about resource revenues?  What’s Plan B if the resource revenue assumption fails to materialize?  And most importantly, how many times must we see this “hockey stick” before we do the political equivalent of firing the CEO and dumping the stock?  Think about it when you mark your ballot this spring.

*Craig Alexander, SVP and Chief Economist, TD Bank Group

**Small Explorers and Producers Association of Canada and Canadian Association of Petroleum Producers

***Calgary Herald, Feb 10, 2012, A10, D7, D4

This entry was posted in Energy & Natural Resources, Politics and Government and tagged , . Bookmark the permalink.

2 Responses to Budget 2012 – The “Hockey Stick” Budget

  1. Carlos Beca says:

    Another election budget and another carrot for the next election. Imagine Liepert and his caring government giving a raise to those on social assistance. It must be his goodbye assistance gift.

    I agree with everyone that the assumptions are obviously optimistic. All it takes is for Greece to default and the whole economic framework could quickly go down the drain and cause major consequences all over the world. This scenario is way more possible than many people think. For those in Wall Street and their friends it does not matter because many of them are actually making millions on the possibility of that happening. For the rest of us the situation is different and an economic panic could be very painful. Greece is right now in the process of reducing minimum salaries about 22%. According to the agreement they will have to reduce 5 billion dollars of their anual budget. I have to say that I am not in any way defending the Greeks because I have to confess that not just them but the whole world is living way beyond their real means, but this is their reality and I doubt this whole affair is going to end well. A political/social collapse is very possible with the obvious consequences for everyone.

    Like you wrote, once the 4 years are in the bag then the situation changes and no one really knows.

    Yes it is deplorable.

    • Yes you’re absolutely right. It’s been difficult keeping up with the PCs on this one. As acting Finance Minister Lloyd Snelgrove said Alberta’s finances were in good shape. Then Redford in her faux throne speech (as Brian Mason wittily called it) said the global economy was weighing heavy on our economy and Albertans had to be cautious. Ron Liepert said the same thing. But a few short months later Alberta’s financial position is looking rosy again…and there’s an election coming. Hardly a coincidence!
      Thanks Carlos.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s