The Offshore Exploration Disincentive Program

This hastily designed—and expensive—provincial government program fails to deliver on its promises.

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The Offshore Exploration Initiative, announced last September in response to heavy industry lobbying, is a new subsidy program to encourage the drilling of offshore oil exploration wells. Fully funded by the provincial government, officials estimate it will cost more than $250 million over four years, though in principle it could be more than $600 million.

Should the public subsidize offshore drilling?

Probably not. 

Both the federal and provincial governments are aiming for carbon neutrality by 2050, which is 29 years from now. It usually takes more than 10 years from discovery until first oil, and a major find like Hibernia or Hebron would be in production for more than 20 years. 

Based on input from industry experts, the Provincial Economic Recovery Team (PERT) led by Moya Greene believes “the window for new oil and gas exploration and development has narrowed considerably. Projects that are not discovered in the next five years and sanctioned in the next 10 years may never be developed.”

PERT is just guessing; it is entirely possible that the exploration window has already closed. With even existing projects being deferred and potentially abandoned, is it a good idea to pour public money into the search for new oil?

For the sake of argument, let’s say it is. Even then, the Offshore Exploration Initiative is seriously flawed.

How the offshore exploration system works

Every year an auction is held for exploration rights on different parcels of the offshore. Oil companies put in their bids and whoever commits the most money wins the exclusive right to conduct exploratory drilling on that parcel for a period of time—usually six years. 

Suppose that Company Exx wins the auction for a parcel with a bid of $400 million. They must deposit a quarter of that amount—that’s $100 million—with the CNLOPB, the agency that regulates the offshore. As Company Exx spends money hunting for oil, their deposit gets returned to them until they have spent the full $400 million they committed to invest. If they do not spend the full amount by the time their license expires, they lose whatever is left of their $100 million deposit.

Until last September, those lost deposits would go to the provincial government’s general treasury, where the money could be used to pay down public debt or fund social programs. But under the new Offshore Exploration Initiative, those lost deposits will now subsidize more drilling by oil companies, with the government paying up to $50 million toward the cost of a single well.

As of January 15, 2021, there was $682 million remaining in deposits. Based on past experience, officials estimate that more than $250 million of that money will end up being forfeited and used to fund the subsidy.

Is this program really funded with public money?

The Furey Government claims that the program isn’t publicly funded because it is paid for with deposits made by industry. At the press conference announcing the initiative Premier Furey said: “It’s a creative way to unlock value […] with no risk to Newfoundland taxpayers,” while Industry Minister Andrew Parsons assured reporters, “this is not funded by taxpayers, this is money actually invested by industry.”

These claims do not stand up to scrutiny. Oil companies made these deposits knowing full well that if they broke their commitments, their deposits would go to the government treasury. The Furey Government has now decided that instead of healthcare, education, or debt repayment, the money will instead subsidize drilling by private oil companies. This makes it, effectively, a government-funded program.

How does this program discourage exploration?

The most obvious problem with the program is how it is funded. The value of the subsidy grows when companies fail to fulfil their exploration commitments.

It is true that a forfeited deposit doesn’t go directly back to the company that forfeits it, but could be used to subsidize a competitor. If there were hundreds of companies operating offshore, there wouldn’t be much of a problem. 

But offshore exploration is dominated by a handful of big players. More than 80 percent of current deposits were made by just five companies: ExxonMobil, BHP Billiton, Equinor, Husky, and CNOOC. With so little competition, each of them can expect to get a significant portion of any forfeited deposits back as incentives, even in the absence of collusion (implicit or explicit) between companies.

To make matters worse, most of the parcels are jointly owned. For example in 2015, Equinor, ExxonMobil, and CNOOC together committed more than $450 million on parcels that they share. Since together they own half of all offshore spending commitments, if they forfeit deposits on some of their co-owned parcels, they should expect to get half of their money back via the incentive fund. This is a serious deterrent to exploration and is the exact opposite of what the program is trying to achieve.

How did they get it so wrong?

The Offshore Exploration Initiative is a clear example of politics driving policy. The oil industry was pressuring the government for a bailout, but giving heaps of money to private companies while simultaneously making enormous cuts to public services was sure to be unpopular. So they concocted this scheme to pretend they were not spending public money. Political problem solved.

At the press conference when the program was announced, it was clear that none of the details had been worked out. All they knew was that the subsidy would be funded by forfeited deposits. Minister Parsons admitted: “Obviously there are concerns here […] when you have a policy like this you need to ensure that you don’t have a gaming of the system that can happen, so there are still details to work out here.”

When the details were published months later, these incentive problems were not solved. Industry can and will “game the system” at public expense.

How could civil servants have failed to see this problem? Part of the answer can be found in the PERT report:

Government no longer has adequate analytical and policy capacity. PERT has been told that this capacity was greatly impacted by previous cuts to core government. The lack of both evaluation and analytical capacity is a serious shortcoming in many government departments.

Premier’s Economic Recovery Team Report, pg. 65

Fundamentally though, the problem is with politicians trying to fool us into believing that public spending isn’t public spending. If the Liberal Government believes that subsidizing exploration drilling is a good investment, they should fund it as a line item in the budget. But if they can’t defend it honestly in the face of austerity, then the program should simply be cancelled. 

With editing by Sharon Bala.

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