Alberta's Budget Provides Look at Oil, Gas Trends

Abstract: This week's budget in Alberta gives some useful information on oil and gas production trends in the Canadian province. It also provides context to help understand the knotty relationship between Alberta and the federal government.

Analysis: Reading government budgets, unless you're an accountant or tax lawyer, is usually a good cure for insomnia, but the annual number-crunching exercise from Alberta deserves a cup of coffee and a second look.

This week's budget provides insight into where the Canadian energy industry is headed, and it helps explain some of the dynamics that influence the often testy relationship between Alberta and the federal government in Ottawa.

Since Alberta is home to most of Canada's oil and gas production, it's no surprise energy royalties fuel the provincial economy. Premier Ralph Klein's government expects to collect C$4.8 billion in fiscal 2003/04 from non-renewable resource revenues.

The biggest chunk by far, at C$3.5 billion, will come from gas. Conventional crude, synthetic crude, and bitumen (a type of extra heavy oil) are expected to contribute C$605 million. Land sales, coal royalties, and other fees make up the remainder.

The revenue split shows why cold winter days in the U.S. Northeast, which usually result in New York Mercantile Exchange traders bidding up gas contracts, warm the hearts of provincial auditors.

Alberta based its budget on oil averaging $23.30 per barrel this fiscal year and gas fetching C$4.05 per thousand cubic feet (mcf).

The forecast for gas will likely turn out to be low, especially since U.S. storage operators have to rebuild inventories from a record low of 636 bcf. Spot gas prices averaged C$8.17 per mcf between January and March, and the 12-month forward strip currently hovers around C$6.75.

The conservative nature of the budget was especially apparent when looking a little more into the future. Alberta expects prices will drop to C$3.50 per mcf in 2004/05, even though output in the province, which produces about 85 percent of this country's gas, is forecast to slip to 13.5 bcf/d in 2004/05 from 13.8 billion in the current fiscal year. The likelihood of prices dropping that low is about the same as pop singer Britney Spears dressing demurely in a music video.

On the other hand, the dart tossing on oil prices could be high. OPEC members said this week a glut is the biggest problem facing crude markets, a problem that could worsen with the U.S. military victory in Iraq.

An eye-catching figure in the deluge of numbers was the province's expectation oil production will increase about five percent annually over the next three years. The higher volumes are due almost entirely to the multibillion-dollar boom in oilsands projects.

Total crude output is forecast to climb to 1.67 million barrels per day (mmbbls/d) in the current fiscal year, up from 1.56 million in 2002/03. Daily production is projected to reach 1.76 mmbbls in 2004/05 and 1.84 million in 2005/06.

The budget illustrated the importance of the exchange rate to the Canadian petroleum sector, a fact sometimes overlooked by U.S. audiences.

If the price of West Texas Intermediate crude averages $22.30 per barrel instead of the forecast of $23.30, the decline reduces Alberta's revenue by C$76 million. A one cent gain by the Canadian dollar, now trading around 68 cents, takes C$125 million out of the province's pocket. The sensitivity helps explain why many Canadian executives, analysts, and investors focus on currency swings like a dog straining its leash to reach a dropped burger patty.

Besides underpinning Alberta's economy, the province's geological riches also color federal-provincial relationships.

Ottawa supports less fortunate provinces at the expense of wealthier ones. The process, which involves a series of economic tests, results in what are called transfer payments.

Newfoundland, which is reaping higher energy revenues because of increased offshore oil production from Hibernia and Terra Nova, expects transfer payments to fund almost 40 percent of its 2003/04 budget. Energy royalties of C$137 million are expected to provide only three percent of Newfoundland's budget expenditures, compared with almost 22 percent in Alberta.

Since Canada was founded in 1867, only one province has switched from collecting transfer payments to contributing toward them--Alberta.

This means the provincial government in Edmonton can afford to be much more confrontational with Ottawa than other members of the confederation.

Sometimes the belligerence is more show than go, since running against the federal government is a proven vote-getting tactic. Other times the hostility is real, such as Alberta's deep opposition to Prime Minister Jean Chretien's decision last December to ratify the Kyoto Protocol.

The bitterness was exacerbated when Ontario, a near-fortress for the Liberals in the past three elections because of vote-splitting by right-leaning parties, won exemptions from Kyoto for its important automotive industry.

Kyoto has entered the realm of popular myth in this province, feeding the dreams of would-be separatists who argue energy makes Alberta strong enough to stand on its own. While these ideologues are as misguided as a troop of Boy Scouts lost in the woods without a compass, lingering resentment means most Liberal election candidates in Alberta generally do as well as Michael Dukakis in the 1988 presidential race.

The unwillingness to elect more than a handful of politicians from the Liberal Party, which has governed Canada for 20 of the last 30 years, contributes to Ottawa's occasional deafness on energy, agriculture, and transportation, issues which are vital to Alberta.

As long as oil and gas royalties fill up Alberta's spending tank, the province is going to worry more about a warm winter in the U.S. than taking a stand that offends a prime minister in distant Ottawa.

Alberta will continue to be more sympathetic to U.S. goals, since its economic well-being depends on enhancing the flow of oil and gas exports to the world's largest energy market, than the federal government.

This means it will be a warm January in Novosibirsk before the relationship between Alberta and Ottawa improves substantially.