The 2016 budget season ended with the release of the Saskatchewan budget yesterday. The Saskatchewan Party, led by Premier Brad Wall, won its third consecutive majority at the April 4th elections. In contrast to his two previous 4-year terms however, this one starts with the tough challenge: lower oil and potash prices. Depressed potash prices, hovering near US$200 per tonne today compared to US$900 eight years ago, are due to both a slumping global demand and overcapacity which resulted from the arrival of new foreign competitors in recent years. Meanwhile, the shale revolution in the U.S., lower-than-expected oil consumption in China and OPEC’s November 2014 decision not to cut production are the most significant factors explaining why oil prices are now half of what there were in mid-2014.
The economic and fiscal consequences for the Province of Saskatchewan, the largest potash producer in the world and the second largest oil producer in Canada, are very negative. For instance, at only $1.5B, fiscal non-renewable resource revenue is projected to be at its lowest level since FY 2003-04. This is considerably less than the usual $2-3B range seen in previous years and is clearly insufficient to support $14.5B in spending. This led Finance Minister Kevin Doherty to unveil a budget including a $434M deficit for FY 2016-17. On the positive side, this projected deficit is manageable as it represents only 0.6% of NGDP, far from the larger deficit-to-NGDP figures presented by Alberta and N&L notably. On the negative side, it marks a significant deterioration from the $260M shortfall predicted just a few months ago in February. The projected deficit, combined with the highest amount ever attributed to capital spending projects in one single year ($1.8B more precisely), will contribute to increase the Province’s debt level. Thus, borrowing requirements are projected at $2.045B in FY 2016-17 (similar to last year’s tally of $2.285B).
This being said, the government remains committed to balancing the books in FY 2017-18. In order to do so, additional savings in program spending will have to be found; this will help to restrain the pace of total spending to a soft 1.1%. Fiscal discipline is expected to remain on the front burner beyond FY 2017-18 as the government is about to begin a “transformational change” aimed at making more efficient the delivery of public services.
Given our above-consensus call on oil prices, the LBS Economic Research and Strategy team estimates that the government actually has a very good chance to be able to eliminate the deficit next year. Our forecast is that the new equilibrium price of oil over the next few years will be significantly higher than that of the consensus and that budgeted by the Saskatchewan Ministry of Finance. Our rationale is based on the on-going pullback in non-OPEC production (especially in U.S. oil shale plays) and the robust increase in global demand. These factors should allow excess global oil inventories to clear more rapidly than anticipated by the consensus. As a result, we forecast WTI prices to end 2016 at US$68 per barrel and to average US$75 in 2017. As a result, and as mentioned in our Alberta and N&L budget write-ups (available on our web site http://www.lb-securities.ca/EconomicResearch), the wind could be turning for the better financially for oil-producing provinces as early as next year.
Yet, the oil outlook still remains very much uncertain. While the global crude oil supply is currently suffering from significant outages due to wildfires in Northern Alberta, economic turmoil in Venezuela and political unrest in Nigeria, the oil market is still coping, at least for a few more months, with excess supply and the building of already large inventories. With such imponderables, governments are better off making prudent assumptions about oil prices for budget planning purposes. And it is exactly this approach which is reflected in the latest Saskatchewan budget documents: WTI crude oil prices are projected to increase modestly, from an average US$40.50 per barrel in 2016, to US$51 in 2017 and to US$60 in 2018. Note that the oil assumptions are in fact slightly more conservative than the one used in the Alberta budget while marginally above those of the N&L budget.
Conclusion
The past decline in crude oil prices have contributed to create deficits that were not initially in the cards for Saskatchewan. The good news now is that the pendulum has started to swing the other way. The recent uptrend in crude oil prices, which is not over in our view (although we still expect short-term weaknesses and high volatility), could lead to positive surprises throughout the year and the next as Finance Minister Kevin Doherty releases fiscal updates. Combined with the responsible management of the public purse, this prudent approach is likely to prevent credit agencies from considering a cut to the Province’s long-term debt rating (Moody’s: Aaa; Dominion: AA; S&P’s: AAA with a negative outlook).
All in all, this budget did not contain tax hikes or deep spending cuts; and our assessment is that the government may not need to go down this route to restore fiscal balance over the medium-term horizon (if not sooner). The Province of Saskatchewan may end up registering two modest deficits in FY 2015-16 and in FY 2016-17, only representing roughly 0.6% of NGDP. This is contrasting with the situation prevailing in the two other oil-producing jurisdictions, Alberta and N&L - where large deficits are projected far into the future - and in some other provinces registering deficits every single year since the financial crisis started in 2008-09. The bottom line is that, relative to several of its peers, Saskatchewan’s is in good shape: its future budgets will likely lead to a substantial improvement in the Province’s net debt-to-NGDP ratio over a relatively short timeframe; a positive development that should definitively catch the attention of bond investors.
