What's behind Alberta's startling reversal of fortune? Hint: It's oil prices

This column is an opinion from Trevor Tombe, aprofessor of economics at the University of Calgary. For more information aboutCBC's Opinion section, please see theFAQ.

Alberta's latest budget update opened with what is surely one of the greatest understatements in provincial fiscal history:

"The Alberta government fiscal situation," it read, "has changed materially from the forecast presented in Budget 2021."

This "material change", however, was one of the most significant improvements in government finances that Alberta has ever seen in its 116 years.

The government now projects the deficit for 2021/22 to fall from $18.2 billion to $5.8 billion which, though still large, would be the smallest deficit since oil prices tanked in late 2014. For perspective, this $12.4 billion improvement is the equivalent of over $2,800 per Albertan. Adjusted for population and inflation, this is the largest year-over-year improvement in Alberta history. And as a share of GDP, it's the largest since 1987.

It's a startling reversal of fortune.

Uncertainty remains, of course. But even despite recent oil price declines which are down roughly 20 per cent this month due to concerns around the new COVID omicron variant the budget projections are reasonable. The government is projecting oil prices of $63.50 (WTI $US) by 2023/24, for example, which is not too far off what investors are banking on.

While this is all good news, these short-term gains may unfortunately paper over some significant risks and could distract from solving longer-term challenges. To understand that, we have to first appreciate what's driving the incredible improvements this year.

Why Alberta's deficit declined

The government has one theory: "The second quarter fiscal update is in, and the results are STRONG!" declared a video tweeted by Alberta's Premier Jason Kenney, which added that "Alberta's Recovery Plan is working."

But this is not quite right.

Alberta's improved fiscal situation has little to do with the government's recovery plan. Very little.

Instead, the deficit shrank because of unforeseen (though very much welcome) increases in energy prices along with other positive external developments.

This year, the government anticipates oil prices of $70.50 per barrel up significantly from Budget 2021's original $46 per barrel. That extra $24.50 per barrel adds up to a lot for a province that produces over 1.3 billion barrels in a year. Natural gas prices are also way up.

Combined, this translates into an extra $8 billion in natural resource revenues this year alone.

Other factors add to this windfall. Higher oil prices lead to higher corporate profits and employment income, for example, and therefore higher income tax revenues. Strong stock markets and boosted federal transfers also help. I illustrate all of the changes below.

It's clear that the improvements are beyond the Alberta government's control.

Regardless, it's welcome good news. And it doesn't stop there.

A balanced budget next year?

A little noticed but surprising aspect of the fiscal update is just how close a balanced budget may be.

Depending on how dangerous the omicron variant proves to be, it's possible the government may just may be able to balance the books by 2023, or possibly, next year. (Which is crazy but also, not crazy.)

What would that take? A roughly $5-7 per barrel increase in oil prices above what the government forecasts. That's it.

Each $1 increase above the 2023 projection of $63.50 translates into nearly $450 million in additional tax and resource revenues. So if oil prices come in at $69 per barrel near the high end of private forecasts, and therefore not crazy then the budget could conceivably balance that year. And if prices come in at $71 per barrel or more next year, then perhaps even sooner.

The next few months will be critical. But either way, we should not dwell too much on the short-term gains.

The fiscal update also sheds new light on two large longer-term challenges that require action today.

Alberta's challenges ahead

First, the economy.

The strength of the recent economic recovery is far beyond what many expected earlier in the pandemic thanks to rapidly available vaccines. But it appears increasingly likely that despite this, Alberta's economy may remain persistently below its previous trend.

Consider the government's projections for 2024.

By that year, they reasonably suspect, the province's economy may be seven per cent smaller than their pre-COVID forecast. That's a $32 billion gap. (And mostly due to roughly 200,000 fewer people living in Alberta by 2024 than previously expected but that's another story.)

This is not unique to Alberta. The Bank of Canada recently lowered its estimate of Canada's overall "potential output" growth, reflecting lower business investment. For Alberta, investment challenges are compounded by potentially large skills mismatches between those displaced from resource sector jobs and employers in other sectors.

Unemployment is now projected at 5.7 per cent by 2024 (high by Alberta standards, and higher than before the 2015 recession). Education and training will be key.

Second, our dependence on resource revenues remains high.

We currently need 26 cents of each dollar of total government revenue to come from natural resources in order to balance. By 2023, this eases somewhat to 20 per cent. Though an improvement, even this is higher than the 17 per cent required under the previous government's 2018 "Path to Balance."

This doesn't mean the previous government's plans would have worked out. COVID would have blown those plans, or any other, off the rails. But this provides an important perspective. It measures how much of our government's revenue is and will continue to be exposed to unnecessary risk, even after recovering from COVID.

Despite the rhetoric around diversification and prudent fiscal planning, Alberta remains firmly on the resource revenue roller-coaster (wheee!) with no clear plan (or even a sketch of one) to get off.

Concluding thoughts

The fiscal update (and this article) is a lot to digest. And however sensible or prudent a government's plans may be, COVID may throw plenty of curveballs ahead.

Following years of economic and fiscal challenges, though, it's worth celebrating good news when it arrives. But not at the cost of avoiding securing a stronger long-term fiscal future.

It's common for governments to claim credit for good news; just as it is for opposition parties to blame them for bad. But in this case, it's all about higher oil prices. And what the roller-coaster giveth, it may taketh away.

Alberta can (and should) use this valuable breathing room to finally plan for a stable and sustainable fiscal future.

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