Alberta's addiction to oil royalties leading to record deficit

It's no great secret that the ups and downs of Alberta's finances are tied to the price of energy.

For betteror for worse, the province has ridden that roller coaster for decades posting surpluses in times of plenty andrunning deficits when energy prices drop.

Alberta is about to record its worst financial year ever. In October, the province pegged the current year deficit at $6.1 billion, which, not coincidentally, is just about the exact drop in energy royalties for the year.

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That $6 billion figure, however, might be a little optimisticbased on assumptions of $50 US a barrel for oil. For every $1 drop in the price of oil, the provincial coffers take a hit of $170 million Cdn.

Right through the end of 2015, most of the government price assumptions held up. West Texas Intermediate averaged $48.60 US a barrel in 2015, andthe Canadian dollar averaged 78 cents US.The heavy/light oil differential came in a little better than expected,and natural gas prices were only slightly lower.

The better way to do it is what any sensible person would do with a variable income.You would calculate the amount of revenue that you can count on come hell or high water.- Ron Kneebone, University of Calgary

So far, 2016 has been a different story, with oiltradingconsistently under $40 US a barrel. The assumption for 2016-17 was for the price of oil to average $61 a barrel,double what crude is trading at today.

Ron Kneebone, an economist with the University of Calgary's school of public policy, says the province will be lucky to show a deficit of $6 billion Cdn this year and will likely post one ofroughly$8 billion in 2016/2017.

Blowing through$14Bin 2years

"Doyou understand how big that is?," asked Kneebone. "The Heritage Fund is worth about $17billion; we're going to blow through an amount nearly equivalent to the Heritage Fund in two years."

Alberta has faced a lot of criticism for the way it has handled its natural resource revenue over the years. It hasn't saved most of it, like Norway, nor has it stashed away as much as Alaska.

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Instead,Alberta has found waysto spend that oil revenue.

Kneebonesaidit's too easy to increase spending when there's no political cost, when you don't have to ask taxpayers for more money, when building a new hospital or raising the wages of public sector employees.

"They don't have to raise tax rates on anybody, which gets people mad,"said Kneebone. "So they spend royalty incomevery easily, and this is why Alberta tends to have very high levels of spending relative to other provinces."

A few years of discipline

You can see from the chart that Alberta had a pretty solid run through the 2000s, posting surpluses as high as $8.5 billion. That had a lot to do with natural gas prices, which were often above $6 per gigajoule, a level only dreamed of today.

That was the era of Ralph bucks, the $400 given to each Albertan in 2006 under the government of premier Ralph Klein. That was also a time when the provincial government tried to impose some discipline on itself, according to Kneebone.

"For a few years in the early 2000s, they had a rule that said that they would only allow themselves to spend $3.5 billion worth of natural resources royalties, and they would have to save the rest." said Kneebone.

"The problem was that politicians were allowed to control that number, and the very next year, they pushed it up to $4 billion that they were allowed to spend and they after that it went up to $4.75 billion, theyear after that $5 billion, and the year after about $6 billion, and theyear after that they said, 'to hell with it, we'll just spend it all.'"

Out ofpoliticians' reach

Kneebone suggested putting the majority of energy revenues out of the reach of politicians.

"The better way to do it is what any sensible person would do, with a variable income," said Kneebone.

"You would calculate the amount of revenue that you can count on come hell or high water."

Kneebone suggests calculatingthe royalty revenue received when oil tradesat a modest price say$30 USa barrel, using thatrevenue to fundeducation and health care, while saving the rest.

"It removes that volatility from the government's budget, because now all they get to spend is the revenue from $30 oil. It prevents the government from going on these big spending binges when oil prices are high and then having to cut everyone's salaries and closing hospitals when oil prices go down."

Kneebone said that royalty revenue should be replaced by a less variable source, such as a provincial sales tax, something that has been dismissed by the government.

Without that, he expects a $30 billion deficit by the end of current government's mandate and then a massive round of cuts in the years to follow.

"If you remember Ralph Klein, we're going to repeat that, and it's really sad that we keep doing this, but that's what's going to happen again."