The Alberta Alliance (remember them?) has a response to the recent report calling for an increase of the Alberta royalty system for oil and gas. Unlike the whining of Brian Mason and his commie ilk, this analysis actually is based on, you know, what oil companies actually do. (Also keep an eye for a couple of observations that Alberta isn't Saudi Arabia or even Norway vis a vis climate and geography concerns...do you think Plawiuk would have thought of any of these?)
Alberta Alliance Response to the Report of the Royalty Review Panel.
Summary
Keeping in line with Chairman Hunter's warning that the report must be accepted in full or not at all, the Alliance Party rejects the Report of the Panel.
The Alliance Party has the following comments regarding the Report.
1. The panel did not follow the first term of reference given to them from the Finance Minister which was, "How Alberta's royalty system compares to other oil and gas producing jurisdictions, taking into account investment economics, and industry returns and risks in Alberta." The panel answers this question by talking about Alberta's royalties without mentioning what kind of return investors receive in Alberta. From our review, we cannot see where any effort was made to measure the rate of return of Alberta's oil and gas producers and explorers. To the contrary, the panel in its own words states that "Costs are not an argument for or against a particular finding of a fair royalty level" (Page 37). Costs in Canada are very relevant as our oilfield workers and tradesmen and women are well paid compared to many jurisdictions mentioned in the report. In some of the countries used to compare the government rate of take, rig workers earn less than a thousand dollars per month. Our environmental regulations are more stringent than most countries in the world (as they should be) and this costs money also. To suggest that costs can be controlled by good management in a booming economy is an absolute lack of understanding of the current state of the oil and gas industry.
2. The Report seems to discount in a rather flippant way, and fails to differentiate between, the effect of capital dollars invested versus the overall economy of Alberta and Canada. The main health of the Alberta economy comes from new capital and not just reinvestment of cash flow from Canadian oil and gas companies. Do we think that 140 billion dollars of investment in the oil sands are going to come from the cash flow of companies? Failure to demonstrate good rates of return will lead to the inability of companies to raise additional capital for reinvestment. The report does not mention the downturn of that capital investment, already being experienced today in Alberta. In conventional oil and gas, this has resulted in an estimated 10,000 people being laid off in the service industry. To scare away additional capital could result in layoffs tenfold higher than currently being experienced. We have seen that movie in the past and we do not want to see it again. We must retain a favorable investment climate for our future well being.
3. We have heard plenty of rhetoric from the Liberals, NDP and the left wing MLAs of the PC Party about the average royalty rate dropping to 19%. However, nobody in government seems to take the time to explain to Albertans that our revenue from the oil and gas royalties and leases has gone from $6.5 billion in the fiscal year 01-02 to $12.5 billion in 06-07. The report also does not consider other revenue streams that have resulted from the oil and gas industry under the current royalty structure. Corporate and personal tax incomes have also both increased since 2001. In the last fiscal year, the personal tax revenue jumped from $4.6 billion to $7.5 billion, for example. When estimates say that oil and gas drive 35% to 50% of this province's economy, these tax revenues should have been considered by the panel. Albertans have been served well by the current structure of the conventional oil and gas industry.
4. The panel has recommended an increase of 56% for conventional oil royalties and an additional 16% for natural gas royalties. The Panel does its best to sell this increase with a break to low producing wells but fails to recognize a basic fundamental of how the conventional oil and gas industry works. The good wells drilled pay for the poor wells drilled. Raising royalty rates to 50% maximum on good wells will cause companies to change their risk profiles and drill fewer wells. When wells are drilled that will never pay for themselves due to low productivity, it does not matter what royalty rates are, the well is an economic failure. The low royalty rates are in place just to keep the good wells producing and contributing to the overall economy of Alberta. The good wells pay for the poor wells.
5. The Alliance Party understands that oil sands, being a relatively new industry that is just being proved economically viable, will always require some adjustment up or down. We believe that industry understands this also. The key is to not kill the goose that is laying the golden eggs for Albertans. We saw what happened in 1982 with the National Energy Program and thinking the industry could withstand large tax increases. Albertans were subject to severe economic hardships that took years to recover from. We cannot go there again.
6. It should be noted that in the fall of 2006 a total of $700 million was clawed back from the industry by the removal of the Alberta Royalty Tax Credit (ARTC) and Low Producer and Well Reactivation programs.
7. We were also disappointed that the report did not take the initiative to compare oil sands mining with other low margin mining projects in the world. It should be noted that in Alberta, like oil sands, coal mined for electricity generation is also a low-margin product mined in pit operations. Coal royalties give a rather paltry 11 million dollars per year to the Government of Alberta. The most probable reason for this number being so low is the political liability that would come with increasing Alberta's take of coal royalties due to a resultant increase in electricity costs for consumers.
8. Finally, it is disturbing that the report did not seem to seriously consider the possible repercussions of raising royalty rates. The panel despite making firm predictions in other areas, refuses to take a position on how investors will react to royalty hikes. It also takes a dismissive tone when mentioning those who did predict consequences for Alberta if rates go up. In order to judge the panel's findings and the government's response to them, the people of Alberta deserve more balanced information.
Alliance Recommendations
1. Before it even considers royalty changes, the government needs to get its current royalty house in order. One of the findings of the panel often ignored in the media was that the government's understanding and maintenance of the current royalty system is incomplete and flawed. Evan Chrapko, one of panel members has been quoted as saying about the current royalty accounting structure, "we have record-keeping that works for Third World countries in the 1960s." This need to be rectified before we can move forward.
2. Leave the conventional oil and gas royalty system as is. We are in a basin that consistently yields smaller and smaller pool discoveries. The cost per barrel of finding these pools is increasing. We must accept that Alberta is at a disadvantage regarding potential discoveries in conventional oil and gas and work to remain competitive in attracting capital.
3. We should not break deals currently in place without consultation with the industry. The report suggests that it is common place for governments to change deals with companies around the world. The Alliance Party suggests that we should be what Albertans want us to be and that is deal-keepers. We can make changes only through consultation with those who are investing and Albertans themselves. Albertans want Alberta to be known as trustworthy. This is not just a moral obligation but a practical financial one. International investors will certainly think twice about putting money into this province if they know their deals with the government aren't worth the paper they are printed on.
4. After consultation and with contribution from industry, increase oil sands royalties on the front end by 1% in a progressive four year phase-in. When fully phased in, this would result in an increase of $292 million per year by 2010 and $438 million per year by 2016 when bitumen production will have risen to three million barrels per day (based on $40 per barrel bitumen.) The phase in period will give industry proper time to adjust for the increased burden. The 1% would continue after projects payout as well, in essence be a Gross Overriding Royalty.
The Alliance Party is convinced that if the report in its current form is implemented that it will result in catastrophic consequences for all Albertans through our collective connection to the oil and gas industry.
Other Alliance Points of Contention with the Report
- The panel had no mandate to suggest what should be done with the additional two billion dollars it suggests the government should grab. It is the underlying belief of the Alliance Party that money in the hands of business and people is far better spent than in the hands of government. The PC government over the past several years has demonstrated that clearly. Most industry profits are reinvested in more drilling or paid out to shareholders. It is well understood that primary dollars such as oil and gas industry profits will have a five to seven times multiplier in growing the economy of Alberta. Why not turn the two billion into 14 billion rather than allow the government to waste money on projects that will only increase costs to taxpayers?
- We feel that the Alberta Department of Energy has performed in line with the expectations given to them by the Government of Alberta. Any changes should be in who the government is and not by adding more departments and ministries as suggested by the panel.
- In comparing Alberta with some of the states in America, little recognition is given to distance from markets and the harsh climate we must build and design for, in Alberta.
- The report regrettably does not acknowledge the fact that the Alberta oil sands are unique in this world and should be treated so, rather than being compared to some heavy oil projects in the world.
- The report makes a large number of comparisons to countries where dictatorships and communism are the rule. Alberta is a free market society and should not be compared to any state-owned companies or industries.
- Regrettably the report does not compare the Marginal Effective Tax Rate (METR) in percent to the mining business, which is what the oil sands are.
- The report intentionally leaves out municipal taxes as stated on Page 32. The terms of reference specifically instruct the panel to include taxes in the review.
- The report talks about the importance of stability but then suggests a radical change to the royalty system. Industry has said they can accept some small changes. Why create an atmosphere of instability?
- Presentations to the panel suggested satisfaction with conventional oil and gas royalties yet the panel suggests a 16% increase in gas royalties and a 56% increase in oil royalties. Why?
- Alberta's average size of gas pool discoveries is 1.7 BCF since 1994, while the global average is 490 BCF. This in itself should explain why we have to have more competitive royalty rates to attract investment.
- Alberta's average size oil pool discovery since 1994 is 0.3 million barrels, while the world average is just over 100 million barrels. Once again, why do we compare our royalty rates with these giants?
- The report recommends an increase of 50% of the Freehold Mineral Tax from an average payable currently of 4% to 6%. This is a tax on 50,000 mineral Freeholders in the province. This is a tax, off the top, on people and companies who own the oil and gas below the ground. Should this be taxed at all?
- The report claims that oil sands costs are largely a management issue. This shows a total lack of understanding of how business works during a commodity boom economy. Plenty of socialists think this can be controlled but then Albertans will miss out on the upside of the commodity cycle.
