Higher oil prices may partly offset Alberta losses from fire

If you’re trying to figure out how Alberta’s already hurting budget is going to get battered by the Fort McMurray wildfires, don’t get too bogged down in the reports of massive losses in oil production shutdowns. You’re better off keeping an eye on the way the oil price responds to the drama playing out in the Alberta oil patch.

Certainly, the immediate impact of the wildfires has been staggering, even beyond the entire neighbourhoods of burned-down homes and the 90,000 human beings forced to flee for safety. The latest estimates are that the fires have shut in more than one million barrels a day of oil sands production, or about one-third of Alberta’s output.

But the impact of the disaster on the province’s finances, which were already headed for a $10-billion deficit in the current fiscal year, may prove much smaller than intuition might suggest.

In a preliminary analysis of the possible fiscal impacts of the disaster, National Bank of Canada economist Warren Lovely noted that despite the high estimates of the damage (which have been pegged at more than $5-billion), most of the costs won’t fall on the provincial government.

Since most of the damage was to fire-insured private structures, insurance companies will be on the hook for the bulk of those costs. The federal government’s disaster-assistance program could cover as much as 90 per cent of the costs of the evacuation, emergency supplies and shelter, restoring infrastructure, and compensating individuals and businesses for losses.

He also noted that between Alberta’s own disaster-assistance budget and the contingency cushion it built into its 2016-17 budget, the province has about $900-million in wiggle room to cover costs without blowing up its budget estimates.

The loss of a massive swath of oil production, on the other hand, does raise visions of a more severe hit to provincial coffers, which generally live and die on the royalties the government collects on oil revenues. But remember that roughly two-thirds of the province’s oil is still flowing each and every day – oil that is benefiting from rising prices.

At the current North American benchmark crude price of close to $46 (U.S.) a barrel, oil is about 20 per cent higher than the Alberta government’s forecast average for 2016 in its recent budget. While that doesn’t make up for a 33-per-cent decline in production, the fire-related production losses look certain to be relatively short-term.

Even if the wildfire-affected output is lost for a full month – which now looks to be on the pessimistic extreme, considering what we’re now hearing about the industry’s plans to quickly restart production – we’d only be talking about maybe 3 per cent of Alberta’s 2016 oil production lost to the fires. That would equate to roughly $30-million (Canadian) in lost royalty revenues for the provincial government – barely a rounding error in the province’s $41-billion budget.

And the reality may prove to be less than half that. Some operations have already resumed production, and others will be back within a week or two. Some may be able to make up for some of their lost output over the rest of the year. Some may take advantage of the fact that they are already shut down, and take care of some maintenance planned for later in the year that would have required shutdowns anyway.

The key to assessing the impact on Alberta’s finances, then, will be whether the oil market hangs onto and even builds on its latest price gains – which may, in some part, be related to Alberta’s lost production – after Alberta production returns to normal. That could be bigger news for Alberta’s finances than the wildfires will prove to be.

The government’s recent budget estimated that every $1 change in the benchmark price of oil affects its revenues by $130-million annually. If oil were to average, say, $45 (U.S.) a barrel this year rather than the budget’s forecast of $38 a barrel, that implies more than $900-million (Canadian) in added revenues above what the budget projected. Even a few-cents improvement in average oil prices for the year would quickly overwhelm the royalties lost to the wildfires.

There is, of course, the question of how much of Alberta’s broader economic activity – its gross domestic product – will be reduced by the widespread disruption caused by the wildfires in one of the province’s key economic regions, which will linger long after the flames are extinguished. That, too, has implications for the tax revenue that the provincial government can expect.

The lessons from another Alberta natural disaster – the floods of 2013 – may be informative here. An Alberta government analysis issued after the flooding estimated that during the main two-week crisis period, the floods caused about $500-million in lost economic activity. But that equated to a fairly inconsequential 0.2 per cent of the province’s annual GDP.

By the end of the year, Alberta’s real GDP had grown more than 5 per cent – well above what had been expected prior to the floods. Alberta’s 2014 budget noted that flood-related rebuilding played a big role in the year’s brisker-than-expected economic activity. Natural disasters of this scale, as dramatic as they may be, typically don’t pose a lasting impediment to GDP.

“At the end of the day, Alberta’s fiscal results will continue to hinge critically on the underlying commodity price backdrop,” Mr. Lovely said.