The Economics of Deception

The following is a guest post by Robyn Allan, the former president of the Insurance Corporation of British Columbia who appeared with me on TVO’s panel about Dutch disease. It summarizes her recent paper: An Analysis of Canadian Oil Expansion Economics.

There is a chorus singing the praises of the oil industry and its vast economic benefits — from the boardroom of pipeline company Enbridge to the office of the Prime Minister. They advocate rapid expansion and export of crude oil resources as a panacea for our economic future. They cite big numbers from numerous studies.

The reports are used like quantitative billy clubs to beat back public inquiry and drive the discussion away from a thorough examination of macroeconomic implications. Instead, we have a forced narrative — industry financial gain must take precedence over environmental risk and First Nations’ rights. This is a false dichotomy.

The reports include Enbridge’s Application to the National Energy Board in support of Northern Gateway pipeline; Canadian Energy Research Institute’s (CERI) studies No. 122, 124, 125 and 128; the University of Calgary’s School of Public Policy paper, Catching the Brass Ring; and the Wood Mackenzie report prepared for the Government of Alberta.

The benefits range from hundreds of thousands of jobs and trillions of dollars in Gross Domestic Product (GDP) in CERI’s studies, $270 billion from Enbridge, $132 billion from the University of Calgary, and $72 billion from the government of Alberta.

These studies suffer from serious weaknesses which render the results not only unreliable, but unusable.

1. Input-Output Model: All the studies calculate a benefit without sensitivity analysis and develop a single long-term scenario. No board of directors would accept this approach when making an important investment decision, particularly when the rosy picture is forecast to continue for decades. All but Wood Mackenzie use this information as input into an Input Output (IO) model to further expand their case.

An IO model presents results as GDP, person years of employment, labour income and government revenues. Using these indicators of economic well-being gives the illusion that the model has measured macroeconomic impact, when the model has not — because it cannot.

IO models have severe limitations, over-estimate benefits and ignore economic costs. They do not perform a cost-benefit analysis. The underlying math constrains the models — they are static, linear, partial equilibrium representations of a sector of the economy at a point in time.

The models have no feedback mechanism so do not incorporate price, exchange rate, interest rate, or other input cost changes on the oil industry or the broader Canadian economy.

All the studies assume higher oil prices — rising to as much as $200 per barrel—but do not consider their impact on consumers as they cut back spending and saving, or businesses as they postpone investment, cut wages, and layoff employees.

IO models tell us the Vancouver Canuk riot was a wealth generating opportunity and — if jobs really matter — forget oil spill prevention and response. More person years of employment are created — per dollar — spilling oil than safely transporting it.

2. Exchange Rate: It is generally understood rising oil prices put upward pressure on the Canadian dollar. The studies ignore this. They assume a fixed and relatively low dollar over the long forecast period which inflates the benefit. Enbridge, Wood Mackenzie and the University of Calgary assume an 85 cent Canadian dollar. Their U.S. dollar revenues automatically receive an 18 per cent increase when translated to Canadian dollars.

An appreciating dollar hurts the Canadian economy. When the Canadian dollar goes up, the price of exports increase, foreign demand falls, and slower growth with job losses, follow. This phenomenon — when due to the expansion of the resource sector — is symptomatic of the Dutch disease. By holding the exchange rate fixed, the studies pretend a continued hollowing of our manufacturing sector does not occur.

Mention the Dutch disease and the oil industry and its proponents get defensive. However, even the oil sands are not immune to petro-fever. A rising dollar fundamentally affects profit performance of oil producers.

Crude oil sales are denominated in U.S. dollars while production costs are paid in Canadian. An increasing dollar squeezes profitability. For example, if the dollar is at par and oil sells for $100 U.S. per barrel, gross revenue is $100 Canadian. If the dollar rises to $1.05, that same barrel is worth $95.24 Canadian — a decline in gross revenue of 4.76 per cent.

Unless this relationship is included, estimates of financial returns, investment, and future supply, will be exaggerated. These unrealistic supply forecasts are then used to support the need for new pipelines to service the U.S. and China.

3. Oil Prices: Not only do the studies depend on rapidly rising oil prices, a number also require higher oil prices in Canada with new pipelines than without them. This perverse market outcome occurs because access to the higher priced markets in the U.S. Gulf Coast and Asia will allow producers to charge higher prices for the oil they sell in Canada.

Enbridge assumes the price lift with Northern Gateway is $2 – $3 U.S. per barrel, on every barrel — conventional to bitumen — every year for 30 years. The Brass Ring assumes $7.20 U.S. to $13.60 U.S. from 2016 – 2030 while the Wood Mackenzie Report assumes an $8 U.S. per barrel price increase on heavy oil sands production from 2017 – 2025. These price increases are on top of the studies’ anticipated doubling of oil prices over the next 30 years.

Refineries pass higher prices on and if they can’t, suffer reduced margins and may shut down. When refineries close, the price on petroleum products rises anyway because of lost production. Either way, Canadian consumers and businesses pay more because of new pipelines, and this needs to be incorporated into a macroeconomic discussion of their impact.

These deficiencies render the studies unusable. Their benefits should not be cited to expedite environmental review as they were in the Federal Budget 2012, demonize concerned citizens as Minister Joe Oliver has done on numerous occasions, or silence discussion of economic development challenges facing Canada as Alberta Premier Redford recently succeeded in doing in an open conversation with Ontario Premier McGuinty.

Economic growth in all parts of Canada is needed to ensure national progress. To realize this progress requires a courageous look at economic reality along with sound analysis — not a reliance on studies that enable the economics of deception.