Download Alberta budget missed a golden opportunity
EDMONTON, AB, Apr 3, 2015/ Troy Media/ – Premier Jim Prentice missed an important opportunity with this year’s budget to open a new chapter in Alberta’s economic future: if only he had been as bold as Peter Lougheed had been.
It was in the 1970s that Lougheed introduced an oil and gas royalty regime that collected an average of 27 per cent from oil and gas revenues. In 1977, in fact, royalty collections reached 37.7 per cent of the value of oil and gas production.
It’s been downhill ever since. The nadir for oil and gas royalties was 2012, when a mere 9.1 per cent was collected.
Jim Prentice should have included a change to royalty regime
The decline in royalty payments to Albertans since the peak reached in 1977-1979 is due in part to the updated oil sands royalty regime introduced by former Premier Ralph Klein in 1997. This generous royalty regime requires oil sands producers to pay a base production royalty of only 1 per cent of oil and gas production revenues while granting a capital cost allowance, or write off, of close to 100 per cent on new oil sands capital investment.
This substantial change in royalty policy was predicated on a belief that royalty charges were just another onerous tax, an unwarranted burden on productive industry.
If, like Ralph Klein, you believe this argument, you’ll be inclined to reduce royalties to encourage business growth; and – like income tax – base their calculation on net earnings.
On the other hand, if, like former premier Peter Lougheed, you believe resource royalties a return on equity for the province’s oil and gas assets, you’ll be more inclined to share the gross revenues to maximize the province’s equity return as his government did.
What’s the business logic of treating oil and gas royalties like a return on equity?
Simple. Alberta’s royalty is a reasonable return on assets and the revenue it generates allows the province to invest upfront in infrastructure, like roads, environmental and educational facilities and a host of others supporting services that directly support oil sands development.
In fact. the lack of this investment is probably the single most consistent problem facing oil sands operators.
One unintended consequence of Klein’s royalty regime was that it created a free-for-all on oil sands project costs.
The devastating result of this poorly constructed policy was a 300 per cent inflation rate on oil sands operating and capital costs between 1997 and 2012 (or 11.2 per cent per annum increase).
Fly in workers from Newfoundland, put them up on full expenses in camps – no problem – it all comes directly out of the pockets of Albertans.
The bad news is this unnecessary inflation not only ramped up costs on oil sands developments, it also super-heated labour markets across Alberta, placing an additional cost burden on all other businesses.
Had Prentice shown Lougheed’s political courage for the 2015 budget, he would have negotiated a new royalty agreement with industry beforehand to increase the royalty capture rate to 25 per cent.
Under a 25 per cent capture rate, Albertans would have been able to expect oil and gas royalties to reach $11.3 billion in 2015 (based on an average oil price of US$50/bbl), instead of only $5.6 billion based on the current capture rate of 10 per cent. When oil prices recover to US$75 per barrel in 2016, as some forecast, Alberta would then be collecting roughly $17 billion in royalty revenues.
Now just imagine this revenue picture lasting for another 200 years, which is the estimated time remaining for Alberta’s oil sands resources.
Jim Prentice’s budget lacked vision
Instead of ruing the day of another energy bust and a $7 billion projected fiscal shortfall, Albertans would be envisioning a future where Alberta’s natural capital advantage in oil is generating a healthy return on investment that could grow the Heritage Fund into a $100 billion asset by 2030.
The evidence suggests that Alberta does not have a spending problem, but a misplaced notion that our royalties are just another oppressive tax on business.
More than ever, Alberta needs a vision for a new economy based on optimizing the equity returns on Alberta’s non-renewable resource assets.
Mark Anielski is an economist and co-founder of the Genuine Wealth Institute, an economic think-tank whose mission is to provide practical ideas, analytics and solutions for businesses, communities, and nations in building the new economy of well-being.
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