Alberta continues to have a revenue problem

Mark Anielski April 2, 2015, Published on Troymedia.com April 3, 2015 as “Jim Prentice missed a golden opportunity with this year’s budget”

I had the pleasure of meeting the new Premier Jim Prentice at the November 2014 Premier’s dinner in Red Deer. As he spoke about his passion and vision for Alberta, I sensed that he may become the next Peter Lougheed of Alberta.

I was hoping that Prentice’s kitchen-table cabinet would have the vision of making the most of Alberta’s incredible natural assets. Alberta’s oilsands reserves of roughly 168 billion barrels are worth $8.2 trillion based on a conservative US$50 per barrel of oil. At current rates of production of 2.1 million barrels per day, Alberta’s oilsands will provide 215 years of production benefit.

This week’s budget was disappointing because Prentice missed an important opportunity to open a new chapter in Alberta’s economic future by being as bold as Peter Lougheed was in the 1970s when he brought in a oil and gas royalty regime that collected a fair share of industry revenues while at the same time saving 30% of more of those revenues in Alberta’s Heritage Savings Fund.While I do applaud Premier Prentice’s announcement that in future 25% of Alberta’s oil and gas royalties will be saved Alberta’s Heritage Fund, there is another key statistic that Albertans are ignorant about. That is the rate of return Albertans are receiving on every dollar of oil and gas extracted from our natural asset wealth.

Most oil-rich nations of the world collect a royalty tax on the percentage of the market value of oil and gas produced. I’ve run the numbers for Alberta using the Canadian Association of Petroleum Producer statistics for the ratio of oil and gas royalties (net of credits) collected by the Alberta Government to the total value of oil and gas producer sales between 1962 and 2014.

During the Socred era (1962-1971) Alberta collected an average of 17.8% of the value of oil and gas produced when oil prices averaged $3.15 per barrel. During Lougheed’s tenure (1971-1985) an average of 27.0% of the value of oil and gas was collected in royalties when oil averaged US$20.52 per barrel. The year 1977 was the peak in royalty collections reaching 37.7% of the value of oil and gas production at a time when oil was trading at US$14 per barrel. During Ralph Klein’s tenure (1992-2006) an average 15.2% of the value of production was collected in net royalties when oil prices averaged US$25.52 per barrel.

Under Premier Alison Redford the lowest royalty return on oil and gas produced in Alberta’s history was reached in 2012 with a mere 9.1% of the value of Alberta’s oil and gas sales collected. This was at a time when oil was trading at record highs of US$92 per barrel and the total value of oil and gas production was $83.6 billion. The numbers aren’t available yet for 2014 but they are likely to be at or below a 10% capture rate. Estimated net royalties collected by the Alberta Government for 2014 are forecast to be $9.6 billion collected with an estimated 2.6 million barrels per day (972.7 million barrels) of conventional and bitumen (oilsands) production.

By contrast Norway in 2012 collected US$68 billion in royalties and other taxes or 72.4% of the total of Norway’s oil and gas sales of US$94.2 billion. The majority of these revenues were in turn invested in Norway’s Government Pension Fund that in 2014 was estimated at US$857 billion). In contrast Alberta’s Heritage Fund, which was founded by Lougheed in the late 1970s, many years before Norway’s fund, was worth only $17.4 billion in 2014.

The historical evidence shows that despite enormous market growth, the percentage of total revenue getting kicked back to the Alberta Government has been decreasing since the peak in royalty collection in 1977-1979 under Peter Lougheed. This decline is in part owing to the updated oilsands royalty regime of 1997. This generous royalty regime requires oilsands producers to pay a base production royalty of only 1% of oil and gas production revenues while granting a capital cost allowance or write off of close to 100% of new oilsands capital investment, against total revenue. This generous oilsands royalty regime has actually resulted in a significant 300% inflation in operating and capital costs per barrel of oilsands production between 1997 and 2012 (or 11.2% per annum increase). What was originally rationalized by economists as necessary to stimulate capital investment in Alberta’s oilsands may have actually done Albertans a disservice resulting in real inflation throughout the economy.

Had Premier Prentice the political courage of Peter Lougheed, he might have negotiated a new royalty agreement with industry while oil prices are lower with a royalty capture rate of 25% charged to the petroleum industry on the total value of Alberta’s oil and gas production. This would still be a lower royalty capture than during Lougheed’s entire political tenure, when he average 27% returns during a time when oilsands was a far riskier and costly venture.

If Prentice would have made such a bold announcement, I’ve estimated that Alberta would expect oil and gas royalties of $11.3 billion in 2015 with oil prices averages US$50/bbl. This is based on an estimated value of oil and gas production of $56.5 billion. If oil prices recover to US$75 per barrel in 2016, as some forecast, Alberta would collect roughly $17 billion in royalty revenues in 2016.

Such a system would require a simple invoice issued to all Alberta oil and gas producers by the Alberta Government based on a quarterly accounting of the value of oil and gas industry revenues.

Now imagine this revenue picture lasting for another 200 years, the years remaining from Alberta’s oil sands resources, the second largest oil reserve on earth on an oilsands reserve estimated at over $8.2 trillion?

As an economic advisor to governments I would advice Prentice have the political courage to provide a full cost accounting of the return on investment from Alberta’s natural capital assets. This would present an honest picture that Alberta’s oil and gas industry enjoys one of the most generous royalty regimes in the world in a province that has the second largest reserve of oil in the world.

Instead of being filled with the anxiety about falling oil prices and a gloomy $7 billion projected fiscal shortfall, Albertans might be talking at the kitchen table about a future where Alberta’s natural capital advantage of oil is generating a healthy return on investment that could grow the Heritage Fund into a $100 billion asset by 2030.

I would encourage Premier Prentice and his colleagues along with all Albertans to open an honest and informed debate about the future economic well-being of our children and grand children with the same boldness and vision Peter Lougheed showed in the 1970s.

The evidence suggests that Alberta does not have an expenditure problem as much as a revenue collection problem. More than ever, Alberta needs a new vision for a new economy that is based on the new bottom line of well-being by ensuring the optimized the returns on Alberta’s natural capital advantages.