When the dramatic fall in crude oil prices started in late 2014, the Province of Alberta’s debt was a tiny $13B (3.4% of NGDP). With such as small burden, the NDP government has the luxury to let the debt level soar going forward. Clearly, the main message imbedded in this budget is that the NDP government does not want to go down the road of tax hikes and spending cuts in order to compensate for the massive oil-driven revenue shortfall (non-renewable resource revenue is budgeted at only $1.4B in FY 2016-17, a level not seen in over 40 years). In turn, the amount of debt the Province will carry will increase significantly in the next three years: from $31B in FY 2016-17 (9.6% of NGDP) to $58B in FY 2018-19 (15.5% of NGDP). High debt naturally means a larger debt issuance program: total borrowing requirements are projected at $14.1B in FY 2016-17, $19.9B in FY 2017-18 and $16.5B in FY 2019-20 (for a sum of $50.5B, slightly greater that the $47.8B amount the Province of Quebec intends to borrow during the same 3-year period).
In our view, if there is one province that can afford more debt and to borrow more heavily on financial markets, it’s Alberta. The debt-to-NGDP ratio is projected to rise to “only” 15.5% in FY 2018-19, an envious position for any finance minister (even if this 15.5% figure requires the NDP government to abandon the self-imposed cap of 15% on the debt-to-NGDP ratio set just five months ago). Also, one could argue that a 15.5% debt-to-NGDP figure does not pose an imminent threat to the Province of Alberta’s credit profile (S&P: AA+; Moody’s: AAA negative outlook; DBRS: AAA negative outlook) since the next door neighbour British Columbia has a triple-A rating with a 17% debt-to-NGDP ratio.
Another consequence of not introducing a sales tax (Albertans have historically been strongly opposed to such tax) and countercyclical spending reductions is the absence of a timetable showing a return to surpluses, something that may raise some eyebrows among bond investors. In fact, Finance Minister Joe Ceci has no intention of going back to a balanced budget before 2024. Since the Province has registered deficits since FY 2008-09 (with the notable exception of a $755M surplus in FY 2013-14), this means the Province could potentially be in for a 15-year era of fiscal shortfalls.
Oil Outlook
This being said, we advise investors not to make a big deal out of this situation as Alberta’s medium-term fiscal outlook is primarily contingent on future developments regarding the global oil market. If our above-consensus call on oil proves to be right, things will turn out for the better financially for Alberta. Yet, the oil outlook still remains very much uncertain. For instance, the global oil market could move closer to (or further) from balance, depending on whether participants at this weekend’s OPEC meeting in Doha agree or not to freeze their crude production going forward. In turn, the Alberta government appropriately used prudent assumptions in its budget: WTI crude oil prices are projected to increase moderately from US$42 per barrel in FY 2016-17, to US$54 in FY 2017-18 and US$64 in FY 2018-19.
The LBS Economic Research and Strategyteam projects that the new equilibrium price will be higher-than-budgeted by the Alberta Ministry of Finance (even if the Alberta oil assumptions are a little less conservative than the one used in the N&L 2016 budget released the same day). Beyond the imminent OPEC meeting outcome in Quatar, our rationale is based on the forthcoming reduction in non-OPEC output (especially U.S. oil shale production), stronger demand (especially during the U.S. summer driving season from April to September), and eventual production cuts by OPEC and Russia. In our view, the combined impact of these factors will clear excess global oil inventories 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.
Beside the price of oil, access to new markets remains a critical issue for both Alberta‘s and Canada’s future, a topic that made the headlines recently after Premier Rachel Notley pleaded for the additional approval of a new pipeline. Without surprise, the budget documents highlight the much-needed “support for the construction of high-capacity pipelines to ship the province’s landlocked crude”. Without positive developments on that front, the Province expects the WTI-WCS differential (the heavy oil benchmark WCS is the price that Alberta producers receive for much of their crude) to gradually increase from an average US$15 per barrel in FY 2016‐17 to US$18.50 by FY 2018-19 since oil sands production is expected to rise faster than available pipeline capacity. This maybe a conservative assumption, as partial transportation solutions may be found and crude production will probably increase only marginally over the next few years.
Conclusion
The Province of Alberta faces a challenging economic and fiscal situation. For instance, the $10.4B deficit penciled for FY 2016-17 is poised to be the largest relative to NGDP (3.3%) since the early 1990s. Since the Province is not least financially vulnerable among Canadian provinces, the government judges it can afford to let program spending rise at a modest pace and invest $35B over the next five years in various infrastructure projects. Also, the 2016 budget introduces $250M to support job creation, business investment as well as, ultimately and almost imperatively, economic diversification.
Finally, the NDP government decided to implement tax increases to pay for green infrastructures and energy efficiency projects. More precisely, the government expects to raise $9.6B over the next five years through carbon levies targeted at consumers and heavy emitters (the laudable objective is to implement an effective price on carbon in order to reduce GHG emissions, following similar actions taken by BC, Quebec and Ontario). Without financing these green initiatives through tax increases, the deficits and debt levels projected would have been higher.
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