The Alberta government posted a $6.4-billion deficit in fiscal 2015-16, and is predicting a final deficit of almost $11 billion this fiscal year. This in a province that had no debt in early 2015 and, while Alberta still has one of the strongest balance sheets in the country, the numbers illustrate the ongoing problem of the province’s heavy reliance on the crack cocaine of the fiscal world: resources revenue.

Resources made up 30% of the province’s total revenue as recently as 2011-12 and averaged 26% over the past 35 years. In real terms, resources revenue plummeted by $6.5 billion last year and made up just 5.7% of total revenue. Reliance on dropping resources income is no way to run a budget.

But how to get off the roller-coaster? Diversify the economy if possible, but there’s no denying the power exerted by the province’s natural endowment. Alberta has tried a rainy-day contingency fund, but that is a talisman subject to political expediency. The $3.6 billion in the fund in March is expected to be drained this year as the NDP government continues to spend.

Tim Pickering, founder and president of Calgary’s Auspice Capital Advisors Ltd., points to Mexico’s government. He says Alberta should follow its lead and develop a long-term hedging strategy for the province’s oil and gas assets. “The fact that our government doesn’t take a hard look at how to hedge our production or, in the case of royalties, how to mitigate that downside risk is absolute ignorance,” Pickering says. “[The hedging problem] is entirely solvable and it’s not overly complex, but no government has had the courage to do it.”

Mexico has been spending about US$1 billion a year over the past decade on its hedging program, making US$5 billion from its hedge book in 2008 and US$6.4 billion last year. The years in between saw no payouts; but, over the past decade, the program has spent about US$10 billion in put premiums and received a payout of $15 billion. That’s a great result. But, as Pickering says, a hedge program is not about making money; it’s about evening out cash flows and protecting the province against downside risks. “In each of those years, [Mexico] knew that a minimum floor price was established on a significant component of the country’s resources revenue.” A similar program would allow Alberta to plan and fund its expenses with greater certainty from year to year.

Alberta has considered a hedge program many times, but avoided it, preferring to go with the contingency fund. But the reasons are best described as political, not financial. No politician wants to be seen sending big cheques to financiers when oil prices are high. To combat this negative perception, Pickering recommends a “mechanistic” approach to hedging. Mexico’s program starts several months prior to the hedge period. And ,like insurance on your house, it might look like a waste of money – until you need it. Which, in Alberta’s case, is every time the price of crude oil plummets.

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