One can only imagine the panic in the NDP backrooms as oil prices crumpled while the Alberta Royalty Review panel ground its way through the issues: “Guys, times are tough, is this really the hill we want to die on?”
Clearly the answer is no; the Review panel released its finding and – no surprise – the status quo wins again. Despite having campaigned on the principle that Alberta’s had one of the most unfair (and lowest) royalty regimes in the world, the Notley government conceded that – after all – Albertans are getting their fair share of value from the oil and gas development.
There is no doubt that economic uncertainty created by extraordinary volatility in oil pricing was compounded by the Spring election of the left-leaning NDP, with its stated ambitions of raising royalty rates.
Given the perilous state of the industry today, no one expected the government to make significant changes to the amounts collected. But it was reasonable to expect the NDP government to re-examine and re-set some of the basic principles of royalties so that when, not if, oil prices reverse course Albertans are not left standing on the curb as they have been in the past.
So, let’s examine a few key principles.
It would have been nice if the Alberta government had stood up to the principle of royalties being paid on ‘net profits’. This idea sounds reasonable at first glance; after all, industry takes the exploration and financial risk. And in order to attract the capital needed, the industry needs to recoup those costs.
But it’s not only industry that has associated costs to resource development. The government also has costs; it needs to invest upfront in building roads and other physical infrastructure, funding colleges and universities to train the industry’s workforce, providing legal and administrative foundations and a host other support services.
It’s clear – given the rapid capital cost inflation during the last boom and state of Alberta infrastructure – that the present royalty regime starves the government of the resources it needs to provide these services. And the industry suffers as a result.
Royalties are – by definition – payable on gross earnings to compensate the asset owner for monopoly access to a valuable resource. Dividends are different; they are calculated on net profits, but generally go to shareholders who are already earning an equity return on their share prices from higher corporate earnings.
Regardless of the actual royalty rates payable, a gross royalty increases transparency, reduces the opportunity (and temptation) for industry to fiddle the books and puts the onus to manage costs squarely on the business managers – where it belongs.
Regrettably, an opportunity was lost to set this principle in place.
But that’s not the only principle that needs review. There is the presumption that the government alone is responsible for creating a positive climate to attract the investment needed to build the future.
If we examine resource development from an asset perspective, it becomes a little clearer who should be responsible for what.
The people of Alberta (through their government) bring the resource asset to the table, providing monopoly access to a publically-owned resource to a privately-owned company. The company then provides other kinds of assets, particularly the organizational competencies and financial capital to see the project through.
Many in the industry suggest that ‘without their expertise, there would be no oil business in Alberta’. True, but the same could be said for the resource itself and it is doubly true for the financial capital needed to make it all work.
Each of these assets is vital to building and sustaining a successful oil and gas industry. As a result, when former Premier Peter Lougheed was in power in the ‘70s Alberta earned a royalty that averaged about 30 percent. The industry, of course, earned 70 percent of gross revenues for bringing their human and financial capital to the table.
Regrettably, like the ‘net profit’ principle, the ‘investment climate’ principle also misplaces responsibility. It is the oil industry’s role and responsibility to provide a reasonable return for their investors; after all, it committed to that role and has the lion’s share of the gross revenues to work with.
Dave Mowat, chair of the royalty review panel summed up the deliberations this way: “Success doesn’t exist when one really wins and one really loses.” Regrettably, in Alberta, success is the industry winning and the people of Alberta losing, again.
Robert McGarvey is an economic historian and former managing director of Merlin Consulting, a London, U.K.-based consulting firm. Robert’s most recent book is Futuromics: A Guide to Thriving in Capitalism’s Third Wave.