Fiscal Fear Mongering in Quebec or Separatist Number’s Lunacy?

Independent Quebec’s greatest economist or numbers’ charlatan

Earlier this month Ed Devlin the head of Canadian portfolio management at Pacific Investment Management Company warned Quebec politicians to be careful in the upcoming elections. Devlin an expert in fixed income market and liability-driven investing wrote a research note¹ on Quebec’s debt dynamics and the possibility that talk of sovereignty had the potential to derail the province’s current virtuous debt dynamics as has been the case in parts of Europe in the last few years, most notably Italy.

The research note sparked indignation in French language media and in separatist circles. PQ economic critic Nicholas Marceau was ‘shocked’ by the scare tactics employed by Devlin and Martin Aussant head of the party Option National, an ex-economist himself, stated that the head of PIMCO Canada’s analysis wasn’t credible. Even the federalist Parti Liberal du Quebec felt the need to chip in, with finance Minister Raymond Bachand saying that Quebec and Italy were not comparable as they were not in the same ballpark.

It would seem that the lively reactions from the political sphere have proved Devlin right, Quebec politicians just don’t get it. The Liberals and the Option National seem to agree, Italy and Quebec cannot be compared. Martin Aussant actually went on record saying that Quebec was in the average of OECD debt to gross domestic product (GDP) percentages. The question now is whether Aussant wants to plead guilty to ignorance or deceit has he is wrong about Quebec’s relative average debt load.

If one were to take Quebec’s provincial ‘net debt’, which measures the provincial government’s debts minus the province’s assets, Aussant would be right, Quebec is just slightly below average in terms of debt to the size of the economy with a debt of 47% in 2010 versus 56% on average in the OECD. The conversation might have stopped there if Aussant had done his economic homework, but having been in politics for much too long it would seem that his professional due diligence might have slipped a little. Quebec’s net debt measure doesn’t use the same methodology as the OECD, one would have to add all provincially guaranteed debts to the equation to properly compare with the OECD’s numbers.

Thankfully the provincial Auditor General wrote a 2010 study attempting the exercise of comparison. He came up with another net debt number 53% of GDP. While this number is higher it remains squarely in the OECD average, this was surely the number that separatists like Aussant think about when talking debt dynamics. However it still isn’t the same number the OECD uses. The OECD calculates total debts not net debts. Using that number Quebec jumps straight to the top and comes in just shy of the podium in fifth place of most indebted jurisdictions in the OECD. Not really close to the average as certain like to claim.

But all this fails to take into account that separatist want to separate from Canada, hence the Canadian debt proportion that an independent Quebec would certainly have to assume. Adding today’s Quebec gross debt to its proportional share of the federal debt, an independent central Quebec government would have a whopping debt load of 135%. There you have it folks Quebec would take the bronze medal for national debts if independent, right behind gold winning dysfunctional Japan and bankrupt and bailed out Olympian Greece with silver.

Some might ask how is it that Quebec can be one of the most indebted jurisdictions in the world and not go bankrupt, while even the United States is quietly considering² State bankruptcy legislation for its lesser indebted local jurisdictions. The answer is hotly debated in Europe right now, and was correctly pointed out by Devlin in his research paper. Europe and even the US to a lesser extent are monetary unions without fiscal unions; they share currencies without sharing fiscal resources much to the contrary of the Canadian federation.

Through the equalization formula Quebec receives a fiscal top up (worth over 10% of its provincial budget), effectively buffering it against the reckoning of financial markets. While Europe dithers on the question of bailing out its member States, every year ‘have-not’ provinces get a mini bailout. Without assurances that this money stream is permanent international investors would drop Quebec debt securities so fast Spaniards would thank financial markets for having gone easy on them.

Another rationalization separatist economists like to use to explain why Quebec is much stronger than the rest of the worlds is that when looking at net debts Quebec’s finances are resilient. That could be true if there actually were assurances that those assets that can be sold off to pay debts were worth what Quebec’s balance sheet says they’re worth. Unfortunately, that never seems to be the case. Just before Iceland got into trouble and got bailed out by the IMF it had one of those on paper fortress like balance sheets. It actually had a much lower net debt ration than Quebec does today. Unfortunately when a country gets hit by a deep recession, increasingly likely nowadays, asset values tend to drop and net debt ratios tend to shoot up. Since the Caisse de Depot et Placement du Quebec (a huge chunk of Quebec’s assets) has already proved it’s capable of loosing 40 billion dollars in a single year, what assurances remain that those losses won’t repeat themselves. And If Quebec were to separate who exactly would like to swoop in and buy Quebec’s crown corporations? Greece has been selling its State owned enterprises for pennies on the dollar in its crisis, what assurances are there that Quebec’s assets will sell for much more? Using accounting valuation to describe the worth of a government’s assets is quite the precarious game and it takes a lot of optimism to believe those numbers as credible.

Another favourite retort against Devlin’s research note is that Quebec doesn’t have the fiscal evasion problems that Italy and its ilk have. While this is true, Quebec has a much lower proportion of taxable wealthy citizens than Italy does. Given wealthy anglos historical propensity to leave in times of separatist pressures, the issue in Quebec shouldn’t be whether we have a tax evasion issue come separation but rather will Quebec have a wealth migration issue if that time comes. All in all separatists may continue to find tricky accounting techniques to rationalize separation economically, but at the end of the day numbers and facts can only lie so much. The separatist project remains far from credible economically.

If separatist political parties want to head out the door of Confederation giving up equalization payments and accepting a whopping debt bill on the way out of the restaurant maybe a little more fear mongering is in order. Let’s hope that cooler heads prevail in this election campaign and that market rattling talk of separation can go back to were it’s been hiding for the past two decades: the dust bin.

CNOOC’s Nexen Bid Doesn’t Pass the ‘Net Benefit’ Smell Test

China National Offshore Oil Company bid 15.1 Billion dollars last week for Canada’s eight largest oil producer Nexen. The friendly bid offers a 60% premium on Nexen’s pre-offer stock price and was further sweetened with assurances of a new head office for the Chinese company’s North and Central American divisions in Toronto as well as an eventual listing of the company on the Toronto Stock Exchange.

Much of the talk surrounding the deal has had to do with the possibility that the deal may be blocked under the Canada Investment Act, which states that all foreign investment over 300 million must pass a ‘net benefit’ test before being approved. Such discretionary government powers have only been used twice to block deals in the past. MacDonal Dettwiler and Associates, a Canadian satellite-imaging firm, was the first firm to be saved from takeover based on national security concerns. BHP Billiton’s hostile takeover bid for Potash Corp of Saskatchewan was blocked by what can only be described as economic nationalism.

After an initial outcry from both Potash Corp’s management and the public in Saskatchewan BHP sweetened it’s then 39 Billion dollar offer by promising to continue any pre-existing community investments and reneging any potential tax breaks it would be eligible for following the takeover. That wasn’t enough to convince the political establishment in Regina.  For some reason the public outcry against the CNOOC bid is much more tame this time around.

Maybe the facts that Nexen is only the eight largest Canadian oil producer and that half its producing assets are foreign makes the pill easier to swallow for corporate nationalists. Also, assurances of heightened employment levels thanks to the new head office might endear CNOOC to Canada’s corporate and political elite. This time however Canadian corporate cheerleaders may actually have something tangible to worry about.

BHP Billiton is a commercially focused enterprise bent on squeezing out profit from all its assets. With BHP already building the world’s largest potash mine in Saskatchewan, any corporate or engineering synergies the company could have squeezed out of the takeover would simply have led to more labour productivity gains in the short run and more corporate profits to tax in the long run. The profit motive and BHP’s long track record in commercial ventures assured Canada both the those benefits. CNOOC’s bid for Nexen insures neither.

CNOOC has no efficiencies or productivity gains to offer, as it has never operated a steam assisted gravity drainage mine in the oil sands before. As a matter of fact we have no assurances that the company is a commercially minded institution as the Chinese have a longer track record of promoting its political interests than its commercial interests. A small example for the record is China’s financing of a new National Stadium in Costa Rica for no other reason but to make buddy buddy with the political class there. No one in Canada really understands what motivates the Politburo in Beijing, and since CNOOC is controlled by that same Politburo, why should Canada trust such sensitive and strategic assets such as the oil sands to them? As another example of the shadiness of China’s intentions, it is reported by Canadian security services that there may be as many as a thousand Chinese corporate spies passing on industrial secrets from Canada to China. China’s aggressive self-centeredness doesn’t stop there.

China has long had a policy of trying to secure energy assets to help feed its industrial base back home. In almost every commodity market China is one of the largest players, ever attempting to ratchet up the best deal so that its manufacturing base can wipe out the international competition. As far as we are concerned China may yet be willing to operate natural resource companies at a loss in order to bump up its local industries profitability. This has long been the case of the Chinese steel sector operating at a loss to bolster Chinese manufacturing competitiveness.

With such a history and the potential for direct trade in oil between China and the oil sands should Enbridge’s Northern Gateway get approval, it isn’t far fetched to imagine Chinese energy traders attempting to manipulate prices so as to reduce profits from their Canadian divisions, thus contributing less taxes to Canada and more profits to China. While this scenario is speculative many industry insiders wouldn’t be surprised to hear it.

There also remains the issue of environmental record. Chinese companies aren’t especially well known for green track records. Canada’s environment is prized by its citizens, and it is doubtful that Canadians would really trust a government backed company from the worst polluting country in the world.

Whether it be for national security reasons, environmental concerns, Canada’s commercial and economic interests, it would seem that everything points towards the necessity of prohibiting foreign government backed companies from buying up our strategic national assets. Canada did a great disservice to itself when it refused BHP Billiton’s bid for Potash Corp. We let our petty corporate nationalism get in the way of a deal that would have attracted financial and human capital to our country. We smudged our image as a trading nation open for business. Today for the sake of protecting that image we have spoiled, we are readying ourselves to accept a bid that is short on benefits and long on potential risks.

Canada already looks like the scared kid unwilling to dip more than a toe in the swimming pool of big business, and we may look it more so after blocking CNOOC. If the reasons for such a use of the ‘net benefits’ test are properly articulated and China is called out for its only half hearted adoption of capitalism, everyone outside of Beijing will understand and accept such a decision.

US still Wealthier than Canada

The commentary and Op-Ed spheres are a flutter with talk of Canada having finally surpassed Americans in wealth. The assertion stems from a report by the Toronto based Environics Institute. In its report Environics highlights the average net worth of Canadians and Americans and how Canadians have surpassed Americans in that respect since 2006. The report was than picked up by a plethora of commentators ranging from Jonathan Kay at the National Post and Stephen March at Bloomberg all jumping on the bandwagon calling Canada’s socialism lite version a success relative to America’s capitalism.

 It is being said from all quarters that the Canadian economic tortoise has passed the American economic hare.

While it is heartening to see that Canadians are wealthier than Americans by this measure, the unbridled optimism of the Left needs little reality check. First the numbers they use need some context. The traditional measure of wealth, especially for Keynesians, has always been consumption, or consumption power. By this measure Americans remain much wealthier than Canadians. The Environics report itself states that disposable income (after tax pay) remains much higher in the US than in Canada by a staggering 67%.

Now many would argue, and rightfully so, that after tax income is a poor number for comparison as Canadians live in a country where they receive much more government provided services, not counted in the disposable income number. Turning to the Purchasing Power Parity adjusted GDP per capita number, we get a clearer idea of how many goods and services, public and private, that both countries’ citizens get to enjoy. In Canada that number is of 38,988.94 US dollars as of 2010 by the World Bank’s count. The equivalent number in the US is of 47,198.50 for the same year. That means that counting all goods and services consumed by citizens and adjusted for monetary discrepancies, Americans remain a full 21% richer than we are.

So why does the net wealth number paint a different story than the consumption numbers? The reasons are many but important. The first reason is that the US is in the bottom of a business cycle. After a good few years of growth the American economy is adjusting and correcting a few accumulated imbalances in its economy. Canada on the flip side is not. While we did suffer a mild recession, by no means can it be said that Canada is at the bottom of the business cycle.

While GDP did contract and unemployment did rise in Canada, house prices haven’t contracted at a faster rate than inflation since 1990-1991. The pace at which Canadian housing has grown in the past decade or so, would seem to indicate the Canadian tortoise has grown some long legs and bunny ears. The point is comparing two nations relative wealths at different points in their cycles obscures the long term trends in relative wealth. When Canada’s debt bubble rears its head and interest rates creep up do not expect housing prices to continue in their current upward trajectory. With a correction already in the bank expect American house prices to do some serious catch up (albeit probably slowly at first). With Housing values being literally the only variable where Canadians win in this equation, odds are the current crown on our heads is sure to be a temporary footnote in economic history.

While the likelihood of Americans reclaiming their North American wealth crown within the near future seems all to real, this should not distract us from looking to the future with confidence. Some of the long-term trends that have been developing for years now point to the real chance that Canada may yet come on top one day.

The Oil Sands will provide abundant resource to Canada for the next couple of generations, so the possibility of investing those gains efficiently and fiscally responsibly might yet lead to sustainable wealth which we’ll then be able to boast about.

British-Columbians Without Leadership on Northern Gateway

There used to be an unwritten golden rule for Provinces in Canadian politics; if you are going to do some beggar thy neighbour monetary demanding or demonizing make sure it’s against the feds. Provinces typically demand funds from flush federal government coffers, or when they need a scapegoat for this or that local problem they can always trash the federal government for their ills. They usually abide by a set of rules of solidarity to put pressure on Canadian federal governments. With Stephen Harper immovably tightening the federal purse’s strings, it would seem that hard-pressed Premiers need new scapegoats for populist speeches and monetary extortions.

 This new reality was on full display this week as British-Columbia’s Liberal Premier Christy Clark put down her conditions for the approval of Enbridge’s Northern Gateway oil pipeline joining Bruderheim, Alt and Kitimat in BC. Clark put down five conditions for her approval of the project the most important of which were world-class environmental emergency response plans, for Enbridge to go beyond the minimum legal requirements with respect to First Nations relations and for BC to get its ‘fair share’ of tax revenue from the oil to flow through Northern Gateway.

 The Premier from Alberta Alison Redford responded to Christy Clark today by saying that BC won’t get a looney’s worth of tax money it is not already entitled to from the pipeline. Stating that resource management is the purview of individual Provinces exclusively, Ms. Redford objected to Ms. Clark’s policy of nitpicking projects and subjecting them to targeted political scrutiny.

 Ms. Clark’s approach to Northern Gateway however deserves much more scrutiny than Alberta’s Premier has so far leveled against it. Let us start by examining BC’s request for world-class environmental disaster response plans. That such regulation wasn’t already the norm in BC should be news to British-Columbians. Since environmental regulation is as much a provincial responsibility as a federal one, why is BC home of Canada’s most ardent environmentalists not already the most protected and best regulated in the world? Does this mean that other energy projects aren’t going to be subject to such environmental scrutiny? Why single out Enbridge when it comes to protecting Canada’s Pacific coast?

 Moving on to the provincial Liberals’ demand that Enbridge go above and beyond legal requirements in dealing with First Nations. Enbridge states that it already has 60% of concerned Native bands signed on to Northern Gateway. If so many First Nation’s have already of their own volition accepted Enbridge’s proposals one might assume that the company has already gone beyond legal requires in enrolling Native support. Why go into the media playing the ‘white man guilt’ card against Enbridge? This looks like an almost Orwellian display of government interference in private affairs. Governments should not ever, be in the business of telling private citizens or corporations how they should think and behave. Ms Clark shames the name of her party with such private affairs meddling.

 That Ms Clark should go after private enterprises in trying to boost her pre-electoral profile seems to fit with the times but for her to go after another Province for revenue is a relatively new development in Canadian political history. Ms Clark has asked for a ‘fair share’ of tax revenue from Alberta.

 A report by Calgary firm Wright Mansell estimated that BC would only be getting a paltry 6.7 billion dollars worth of tax revenue from the pipeline over 30 years from a total pie of 80 billion. Ms Clark pointed out that BC would be shouldering 100% of the maritime environmental risks and over 50% of the land based risk. With such false assertion the BC Premier is effectively spitting in Albertans and Canadians faces. The environmental risks don’t start at Bruderheim, they start near Athabasca Lake where the extraction occurs and where Alberta will cover 100% of the risk. Let’s face it, the oil sands represent the largest oil related environmental risk worth monitoring, Northern Gateway is a sideshow. The oil must flow through pipelines all the way down to Bruderheim first where again Alberta is responsible for all leak risks. In any case the monetary responsibility of cleanup falls squarely on Enbridge so what kind of risk is the Province assuming exactly? With proper regulation, which BC is entitled to implement, risks can be minimized if not eradicated so why demonize Alberta?

 Ms Clark further added injury to insult when she said, “This project is good for Canada. It’s great for Alberta and at the moment it’s not very good for British Columbia”. It would seem that 60% of concerned First Nations disagree. Such blatant ‘not in my backyard’ styled blackmail is unbecoming of a Canadian Premier. What would Canada look like today if it weren’t for generations of Ontarian and now Albertan uncompromising funding of equalization? Such inter-provincial self-centeredness hasn’t been seen since the Lower Churchill Falls deal where Quebec unceremoniously screwed over Newfoundlanders.

 If political leadership is bringing out the best out of one’s constituents, BC’s Liberals have succeeded in wrestling the crown of leadership deficiency from Quebec. It was bad enough when Obama blocked Keystone XL for electoral purposes to the detriment of America’s economy and North American relations, that such demagoguery and populism should have crossed the 49^th parallel is a new low in the history Canadian Confederation.

(First published on The Prince Arthur Herald website)

***Apologies to all readers, this post has somewhat strayed from the more economic level headed commenting this blog was started for. None the less this was worth posting enjoy.

Let Sleeping Corpse Lie: Dawn of the Eurozone

Europe has long been a place of economic stagnation. Asides from the odd place or two such as Ireland or the Baltic States, Europe has generally seen its citizens’ standard of living stagnate over the years. Europeans are used to seeing inflation slowly eat away at their purchasing power, asset price inflation eat away at housing affordability and taxes reducing their disposable income. But when you are some of the richest people in the world as measured by per capita GDP stagnation isn’t the worst thing that can happen to you. What is about to happen to Europeans however is less tenable. What is about to happen to Europeans is a repeat of the Japanese experience with their ‘Lost Decades’, but in a World with heightened international competition and rapidly increasing productivity of developing nations this version of the Lost Decades syndrome will seem much more punishing.

On the face of it bank bailouts may seem like the appropriate thing to do when your banking system looks like a rocking Humpty Dumpty on the wall. The Japanese experience should have served as a warning to other governments against the dangers of bailing out banks. When Japan’s property and equity bubble burst at the end of the 90’s the government hit the bailout peddle full steam in an effort to avoid bank runs. The result, was the creation of Zombie banks. Bank’s in Japan had the real value of their assets crippled, forcing Japan’s central bank to come in and pump massive amounts of liquidity into the banking system to keep banks liquide. As banks used the extra liquidity to pay down their overstretched balance sheets’ liabilities, instead of lending them out into the real economy, growth stagnated for years. Japanese banks became simultaneously liquide and insolvent.

The usual process of bankruptcy is to have a judge look over the balance sheet of a corporation and determine how much of the liability side needs to be reduced to create a solvent and sustainably profitable firm. Equity investors are typically wiped out and debt investors get a ‘hair cut’ on their bonds, or see their bonds converted into equity (shares). The process reduces the debt of a bankrupt company to a level that can be covered sustainably. The alternative to this form of bankruptcy is a winding down of the business. If a company is recognized to have a permanently crippled business model and is expected to sustainably loose money, it becomes preferable to liquidate all assets and try and pay back as many debts as possible. In the US these two forms of bankruptcy are called chapters 11 and 7 respectively.

Following a chapter 11 bankruptcy two things may occur that will send a company back into bankruptcy or forced to liquidate. Either business conditions deteriorate and the company’s revenues no longer suffice to pay its interest costs, or the debt reduction is not steep enough from the get-go and the corporation’s normal revenues never really cover the newly diminished interest expense.

The emergence of Zombie banks would occur when both the above mentioned difficulties arise. Bailouts, taking the usual form of a capital injection (the government buying lots of newly issued shares, to the detriment of previous share owners) has the partial effect of of wiping out equity investors but saves debt investors. Without hair cuts to bonds a banks interest expense remains high hence crippling the banks ability to inject loans to underpin the real economy. This problem is further compounded by a lack of chapter 7 style bankruptcies.

Banks’ profit margins tend to be extremely narrow in the best of times; According to the Bank of International Settlements Spanish banks’ current profit margin as a percentage of assets is a measly 0.61% at present, while Germany’s big banks barely squeak out a 0.20% profit margin in 2011. Hundreds of variables will explain why European banks profit margins are razor sharp but Anglo-Saxon banks in Canada and Australia rise above the 1% mark, most economist and financial analyst would chalk up a big part of this discrepancy to the competitive nature of banking in different countries. Canada and Australia are countries were industry concentration is high whereas in the US and Europe the banking industry is atomized and fiercely competitive.

When chapter 7 style bankruptcies are effectively ruled out by bailouts, banking industries are prohibited from consolidating to a more natural level of concentration. Profitability is kept artificially low by excessive competition to issue loans and attract savings. The effect of too much competition in an environment where bank profitability is hampered by both excess industry atomization and crippled balance sheets is obviously the creation of Zombie banks. What European authorities are doing with bailouts is stopping progress in its tracks. While bank bankruptcies might raise long term interest rates in the sector, it would mostly lead to consolidation and concentration which would embolden banks to lend to the real economy. This is how over the counter European bailouts are killing growth.

There is however bailouts of the under the counter sorts. The ECB has done what the Bank of Japan has tried before it, albeit in its own way. The ECB’s LTRO (Long Term Refinancing Operations) have been used to increase the liquidity of banks in Europe. Instead of its normal refinancing operation, lending to banks for less than 6 months with adequate collateral posted, the ECB has accepted lower quality collateral (despite what it may say) and refinanced at maturities up to 3 years at favorable rates. The idea was to buttress banks’ balance sheets to avoid a dry up in lending. The effect however was to lend cheaply to banks in PIIGS countries (but also elsewhere) who then plowed the money back into high yielding Spanish, Italian governments bonds and the like. So we are in a funny situation, bank profits in Europe are dismal (Italy’s banking sector is yielding -1.22% profits over assets) but their net interest margins are creeping up, all while real business is starved for credit.

Astute observers will have seen this all before, in Japan. Most will be distressed at the pueril actions of leading bureaucrat financiers and economists. Many now regret the resignations of Jurgen Stark and Axel Weber, some of the last monetary hawks who warned against the current ECB roster of economists frivolous policies. Time alone will tell how foolish or not the current fiscal and monetary policies of the Eurozone are. Let’s all hope that a repeat of Japanese banking woes don’t make a repeat appearance and finally slay what was one of the noblest experiments of our times.

Another Spill Another Outrage

Oil spill on Red Deer River, Alta

Another spill another excuse for environmentalists to block the Keystone XL and Northern Gateways of this World. Alberta suffered its third significant oil spill of 2012 near Elk Point 200 km northeast of Edmonton, as Enbridge’s Athabasca pipeline spilled some 1450 barrels of oil onto farmland. This comes as environmental crews are still cleaning up two larger oil spills in Alberta near Red Deer in Alberta’s deep north.

One can now expect to see the Pembina Institute, Greenpeace et al. descending on Alberta with renewed fervour to oppose the Oil Sands development. Likewise, south of the border, environmental groups will use these spills as further proof that Keystone XL and other pipeline projects must be stopped. Industry insiders and astute observes might come to a different conclusion based on these spills.

It is well know in the industry that the leading cause of pipeline rupture is third party related. That is to say I pipeline is most likely to be ruptured when a construction crew doesn’t do its land surveying due diligence. In the rest of incidences, the leading cause for ruptures or spills are corrosion and excess pressure.

Now both these causes have their own causes and those are the ones environmentalists should be worrying about.

Corrosion occurs most often when the interior coating of a pipeline isn’t adequately maintained and is exposed for long periods of time to acidity. Heavy Crude oil can be highly viscous and must be diluted with various sorts of acids and chemicals to help ease the flow in a pipeline. Such additives may corrode a pipeline over time when coating isn’t sufficiently or regularly applied. In Germany for example most of the pipeline infrastructure dates from the post war recovery, and thanks to consistent coating, the industry there reports some of the lowest incident records.

Excess pressure is a problem due to mismatching of the pressure pumped through a pipeline and its design pressure capacity. With time the structural integrity of a pipeline tends to diminish somewhat, which means that pressure needs to be corrected downward as a pipeline ages. With the ramp up of production in the Bakken oil fields of North-Dakota and Oil Sands in Alberta’s Athabasca Region, expectation is that pipeline operators will be pushed to capacity, increasing pressure flow to its limits and playing catch up on pressure capacity assessment.

In both cases monitoring is key to safety. Nobody argues that industry norms need to be updated regularly if not imposed through regulation. What can be argued is that in both cases there is a common variable. Time. A Canadian study by the Energy Board of Canada said that non third party related spills were time dependent. On average the first spill in a pipeline system occurred after 28 years of operation. After adequate monitoring of pressure and coating adequacy quality control, the most important contributor to pipeline spill prevention is keeping pipeline systems young. In other transportation industries such as airlines, shipping and railroads the norm is to limit the age of fleets as well as do proper maintenance.

So what do Keystone XL and Northern Gateway have to do with all this. These pipelines would both do three things. One, they would reduce average pressure throughout the North American pipeline system by increasing flow capacity for a predetermined amount of oil and gas production. Secondly, modes of oil transportation with even worst safety records wouldn’t be used. Trains and trucks tend to derail or get into highway accidents, causing injuries or fatalities as well as spills that wouldn’t occur in pipelines; today without XL and Northern Gateway trucks and trains are increasingly being used to transport large amounts of oil. The third effect of building Keystone and Northern Gateway would be to decrease the average age of the pipeline system, as they’d be new.

All in all these pipeline mega projects would serve to increase the safety of the North American energy industry and reduce ecologically destructive oil and gas spills. Environmentalists should ask themselves whose side they’re on: the anti-oil lobby side, or the environment’s.

Also published in the Prince Arthur Herald here. 

Environment & Capitalism Marriage 1 – Government Dirigisme 0

An attendee at a cocktail party given by Export Development Canada during the International Economic Forum of the Americas remarked that inventors and entrepreneurs needed government R&D subsidies to help commercialize new processes. An entrepreneur in new Pipe Organ technology manufacturing, he insisted that his technological advances would never have been brought to market without bridge loans and taxe credits for R&D.

Today General Electric and Sargas of Norway have announced a breakthrough in carbon capture technologie. A new model of GE’s gas plants will be built with Sargas’s new process that would capture 90 per cent of their output of carbon dioxide, which can then be injected into oilfields to squeeze out more crude.

This could be doubly environmentally friendly as such a technology could potentially be used to reduce energy consumption in the energy extraction process to complement such technologies as Steam Assisted Gravitational Drainage which consumes much energy in the extraction of bitumen oil in Alberta or heavy crude in California.

Sargas’ technology which promises to capture up to 99% of Carbon emission in certain instances will now be commercialized by Big Business as embodied by one of the worlds largest, most profitable conglomerates: GE

Since GE’s CEOs are typically anti-tax, anti-big government and republican, one might wonder if Obama and the Democrats of this World will be shaken in their belief of Government economic and social ‘dirigisme’ now that the company promises to do what billions of dollars of American taxpayer money subsidized R&D research could not?

The OECD Has it All Wrong About Canada

The OECD came out with its Economic Survey of Canada last week and like so many other institutions and commentators before it, has got it all wrong. The report lauded Canada for its fiscal performance but gave it a failing grade for productivity growth. The report, amongst other things, criticizes Canada for its declining multifactor productivity, a measure of output denominated by an assortment of production inputs. The report asserts that multi factor productivity (MFP) has been declining since 2002 and seriously lagging that of the United States. The report adds that Canada’s factors of production mix is skewed heavily towards engineering structures to the detriment of machinery and equipement.

While MFP has been dropping in Canada since 2002, many would argue that looking at labour productivity is more important. Productivity per hour worked in Canada has grown from $156 to $183 from 1997 to 2011 an increase of 17% over the period, far from the alarming trend the OECD reports. Noteworthy however is the slowing growth of productivity growth during this period from a high of 2.61% in 1999 to the present growth of 0.75% in 2011

The error of the OECD report however is one of not looking into the underlying trends and the break down of productivity change by industry. If one breaks down the numbers to find out which industries contributed to the change in the overall economy a few truths become apparent. The slowing growth is mostly attributable to one sector: mining and oil & gas extraction. This sector registered the steepest loss in productivity since 1997 contributing -8.17% to overall per worker productivity in Canada. Virtually all other sectors contributed positively to productivity growth (with the exception of the public sector and its tangents). And since mining and oil & gas extraction is the fastest growing sector in Canada the loss in productivity weights down heavily on the numbers reported by the OECD.

MFP is weighted down even more heavily by the this sector, as much of new fixed capital formation originates from Alberta’s energy industry. So why isn’t this trend worrying? the answer lies in the basics of economics. Productivity in tangible assets tends to lagg investment by tangible assets. Basic macroeconomic models tend to assume a lagg of one year between investment in fixed assets and new production from those assets. But the oil sands development in Alberta is bucking that trend as the magnitude of those  investments is larger than ever before, and the huge oil sands mines of the Athabasca region are unparalleled in history.

Most of the mines under construction take between 5 and 10 years to reach capacity and since the oil sands developments are still relatively new, few if any of the largest mines are near capacity. Production in the oil sands is estimated to double within the next decade while employment will drop as temporary construction jobs in the sector are slated to be replaced by fewer permanent operating jobs.

These trends will lead to a complete reversal of the national productivity contribution of the sector, from the most negative to what will be the most positive contribution. Canada’s over investment in Engineering structures isn’t a fluke accident on the part of Canadian businesses. It is rather a sign that business leaders in the nation understand where Canada’s growth will come from in the future.

What is strange is that these developments are widely known, as the Canadian Association of Petroleum Producers widely communicates them. That the OECD and the Bank of Canada before it, have not picked up on these trends is testament to the short term vision of macroeconomic study at some of the most important economic institutions. One hopes that policy makers don’t get wound up in the noise from these economist and continue to provide policy changes geared towards letting Canada shift economic activity to where the nation has a comparative advantage.

New Bridge Coming to

The most populous province of Canada Ontario does not share a land border with the United States. From the Angle Inglet flowing into the Lake of Woods all the way to the St-Lawrence River near Cornwall, Ontario is continually separated from the Northeast States by the water system of the Great Lakes. This border’s particularity is surely a vestige from the 1812 war pitting the British Colonies of which Ontario was part of, against the expanding American republic headed by James Madison. Since that time relations have warmed significantly to fraternal levels. Joint participation in two World Wars, the signing of the Auto Pact between  Prime Minister Lester B. Pearson and President Lyndon B. Johnson, the signing of NAFTA between Prime Minister Brian Mulroney and President Ronald Reagan served as a few, among many milestones, on the way to developing one of the most important bilateral trade relations the World has ever known.

Today, this commercial and economic partnership is anchored by a set of infrastructures reducing the historical and natural barriers separating the foes of old. Eight bridges, one tunnel and a plethora of train tracks and hydrodames help connect the millions of Canadians and Americans separated by the Great Lakes water system. This connection is particularly embodied by the Ambassador Bridge. That privately owned crossing is the route by which 25% of cross border trade volumes transits. Much of the automobiles assembled in Michigan source their parts from Ontario and vice-versa. This symbolic and economically vital route is now clogged, bogging down vital trade and hurting both jurisdictions were it hurts the most; their respective manufacturing industries.

It would seem that the relationship has outgrown the infrastructure underpinning it. There have been vocal campaigns (mostly from but not limited to the Canadian side) to build a second bridge. Previous efforts by the Republican Governor of Michigan and various levels of Canadian government have been stymied by  the owner of the Ambassador Bridge Manuel “Matty” Moroun’s lobbying efforts.

The Ambassador Bridge effectively holds a monopoly on commercial truck traffic. Efforts to stop the construction of a competing bridge is the definition of rent seeking behaviour and crony capitalism. Using his leverage and clout within the State Congress of Michigan to try and legislatively block such a construction, including through state constitutional amendments while rational, is the summum of selfish and amoral commercial behaviour.

An announcement by governments from both sides of the St-Mary’s River is expect Friday, where the Canadian government is thought to renew its pledge to pay for the American shares of construction costs. Let’s hope a new bridge is on its way as the beleaguered World economy can use every bit of trade increase in can get.

Krugman Baltic Bashing 2.0

It would seem that after a tweeter row with Estonian President, Krugman hasn’t had enough fun senselessly putting down Baltic States. In his new blog post, Krugman turns against Latvia in his anti-austerity tirades. While he initially criticized pro-austerity commentators for ‘lionizing’ Estonia as a standard bearer for successful austerity policies, he know seems to believe that Latvia was the lionized example for austerity. Leaving aside Krugman’s inability to decide which austerity policy orientated government is easiest to criticize let’s take a closer look at his accusations.

Krugman quotes Eurostat numbers for real GDP levels, showing that Latvia has had the deepest contraction of the Baltic States, Ireland and Iceland, also showing Latvia having the smallest recovery of pre-crisis level GDP. A few notes must be added to his demonstration. Firstly, both Ireland and Iceland received EU/IMF bailouts to stabilize GDP and also e currency’s value in Iceland’s case, none of the Baltic States received such external inflow of capital to buttress government spending.

Furthermore, both Latvia and Lithuania racked in relatively big budget deficits during the crisis in comparison to Estonia. Why attack the Baltics states least keen on austerity for their austerity policies, why stop talking about Estonia, the real standard bearer for fiscal hawkishness. Again leaving aside this Krugmanesque inconsistency let us look at Baltic States in Comparison to other Euro economies many of which signed on to the G20 pledge for stimulus spending during the crisis.

 Here, seasonably and daily adjusted quarterly per capita real GDP numbers from Eurostat (same source as P. Krugman) tell a different story. This chart shows that while the recession was deep in the Baltic States the recovery was strong, leading all Baltic Nations to have caught to their pre crisis levels (per capita of course) and to the EU as a whole. While Germany, arguably the strongest economy in Europe is above its pre crisis level, there should be no denying that the Ba;tic States chose to bite the bullet early but recover quickly. One wonders if so much can be said for the PIIGS. So without a European bailout Latvia and its Baltic colleagues don’t seem to be doing all that bad. As has been argued before Krugman fails to take into consideration decline population into his thinking when using national GDP numbers. A guess can also be ventured that depending on what time series he chooses to use (constant vs market prices) numbers may vary substantially when evaluating economic performance, no nuancing words from him on that subject.

In any case to better understand recovery dynamics between nations attention must be paid to the depth of contraction as well as the magnitude of recovery. The above chart shows the ratio of real per capita GDP recovery to real per capita GDP contraction. With an EU average a smudge over 1, one can see that the strength of the recovery has been stronger in the Baltic States than in most of Europe. Only the Norther nations of Germany, Austria, Finland, Luxembourg and a few others have been stronger.

So how to explain the difference between austerity in the south and in the Baltic region. The most obvious answer is that states that don’t rely heavily on Government spending during the good times stand to loose less from tight fiscal policy in the bad times. Ireland and Spain do of course buck that trend but the conjecture of their recessions were different in nature than in most of Europe. 

Again it must be repeated that much of the superficial weakness in the Baltic States must be attributed to Europe in general and the rest of the sluggish growth in the World. As export dependent nations they should not be expected to outgrow other regions when there is only week growth in consumption outside their borders. There is however much hope for the Baltic tigers future prospects. As export dependent nations who have refused to transition to internal consumption driven economies, they remain leveraged to an eventual uptick in World growth and are less dependent on foreign capital flows to pay for their growth.

Small open economies the World over should learn from the Baltic experiment that is unfolding and look forward to the next chapter that will surely put stubbornly uncompetitive economies to shame. Let’s hope Krugman can remember his own writings when that happens, so that the rest of us can enjoy his efforts at keeping a straight face when attempting to convince us he was right all along.