David Yager – Yager Management Ltd.
Oilfield Service Management Consulting – Oil & Gas Writer – Energy Policy Analyst
July 12, 2017
“Albertans gave this government a strong mandate to act on its promises. That was to ask top-income earners to pay a little more for the betterment of all and to ask corporations who benefited the most during stronger economic times to contribute fairly to rebuilding our province”.
June 19, 2015, Globe and Mail. NDP Finance Minister Joe Ceci quoted after announcing a 20% increase in corporate taxes effective July 1, 2015 and a 50% increase in the provincial income taxes on the highest income earners effective October 1, 2015.
When Ceci uttered this pronouncement the new NDP government had only been office for six weeks. WTI averaged US$59.82 that month, 43% below the June 2014 average price. Nobody knew what to expect from the first NDP administration in Alberta’s history. So the reaction to the tax hikes was reserved. Nobody liked it but hopefully the oil price drop was only temporary. The oilpatch, particularly trade associations like CAPP, accepted there was a new sheriff in town named Rachel Notley and so the official approach was educational and consultative. Public criticism was muted; advice carefully worded. Surely the NDP would figure out what buttered Alberta’s economic bread. OPEC, with most members highly dependent on oil sales, would think this through and cut back production to increase prices. The 2009 oil price crash was temporary. This one would be the same.
What was unknown is how many more shoes would drop in the next two years that would make a bad situation worse. Looking back at Ceci’s remarks, Albertans and corporations should have taken them more literally. What Ceci said was, “…ask top-income earners to pay a little for the betterment of all…” All? What about those paying the higher taxes? And, “…ask corporations who benefited the most during stronger economic times to contribute fairly to rebuilding our province”. Rebuild what? What exactly was wrong with having Canada’s strongest provincial economy, the highest average wages and the lowest tax and unemployment rates? Most would love to have the alleged mess the NDP inherited back immediately, including US$59 WTI.
By November 2015 Alberta had introduced the Climate Leadership Plan which increased large emitter carbon taxes, introduced a general carbon tax and an oil sands carbon emissions cap, plus committed to reduce methane emissions by 45% by 2025. There was clearly some consultation because the senior executives of CNRL, Shell, Cenovus and Suncor appeared on TV with Notley as the policies were announced. But it was also clear with the Paris climate change conference looming, the existence of the plan was at least as important as the cost and long-term impact. There was no mention of these game-changing policies in the NDP’s election platform the previous spring.
The promised royalty review ended up being close to neutral after considerable industry lobbying. Ever deteriorating oil prices undoubtedly contributed to the government’s generosity.
By February 2016 things were much worse. WTI had fallen over 50% from the June 2015 level to under US$27 a barrel, only 25% of June 2014 levels. By the spring of 2017 Alberta-based companies had exported about $30 billion as Suncor, CNRL and Cenovus bought oil sands assets from Shell, Marathon, ConocoPhillips and Murphy. Statoil and Total had already pulled up stakes and Koch cancelled a major project. More Alberta jobs disappeared with every transaction as staffing levels were rationalized following the ownership change.
Provincial government spending continued to rise. Despite all the tax increases, low royalty levels and increased spending have ensured $10 billion deficits are Alberta’s second “new normal” besides low oil prices. Alberta’s credit rating has been downgraded multiple times with the latest report, from Dominion Bond Rating Service on July 7, indicating it is likely to happen again because the province “…is continuing to erode its low debt advantage through sustained deficit spending”. Each time Alberta’s credit quality goes down interest rates on the rising debt go up. Moreover, DBRS said the province “has yet to provide a credible plan to restore balance”.
DBRS figures the real deficit for last year was $12.8 billion, not $10.8 billion, and will be $13.6 billion in the current fiscal year, not the publicly forecast of $10.3 billion. No plan exists for balanced budgets until 2024 which is so far away it is just a number. The Fraser Institute calculated in May that by the time the next election rolls around in the 2019/2020 fiscal year interest payments will have doubled from last year to $515 per year per breathing Albertan, more if DBRS is correct and recent NDP deficit estimates are optimistic. That’s $2,045 for a family of four. Just a few years ago interest on public debt in the province the NDP is “rebuilding” was zero.
In May rating agency Standard & Poor’s figured the total debt could reach $94 billion by 2020, the year the NDP figures WTI will average US$68 a barrel. That would be an improvement but we’re US$23 a barrel short right now.
The reason all the foregoing matters is Edmonton’s flexibility on tax relief is non-existent without major spending cuts, something the NDP declares would damage Alberta’s fragile economic recovery.
With all the policy changes in place, the lights apparently came on in Edmonton last September when the government approached CAPP for input and suggestions regarding Alberta’s competitiveness relative to other jurisdictions. A long list of improvements was presented by CAPP in November. On July 5, the association publicly released a major policy paper explaining how the industry and province must work together to ensure Alberta’s oil and gas industry remains internationally competitive.
CAPP opened with, “The provincial government and the energy industry could create more than 24,000 jobs for Albertans and grow the province’s economy by nearly $5 billion over the next three years by working together to enhance the competitiveness of Canada’s leading trade sector….Industry continues to face mounting costs and barriers to growth due to changes in provincial and federal government policies and regulations such as methane emissions, carbon pricing, municipal and corporate tax increases, wetland policy, well liability and closure, and caribou management, among others. In addition, low commodity prices, rapidly changing market dynamics, and new policy directions in the United States have led to negative impacts on oil and gas investment and competitiveness in Canada”.
To anyone who works in the financial side of the industry or interacts with investors, that certainly sums it up. Finally, CAPP has put in writing what many in oil and gas and capital markets have been saying for the past two years.
The report is full of data. CAPEX globally is expected to only rise slightly in 2017 compared to 2016 but in the U.S. the Oil & Gas Journal is forecasting a 38% increase this year. Meanwhile, CAPP figures Alberta’s spending recovery will be only half of that or 19%. Why?
CAPP figures the collection of new levies and restrictions will cost between $450 million and $750 million per year in the near term and will be a permanent reduction in free cash for reinvestment forever. This is based upon a 12 to 21 per cent increase in the estimated annual base policy and regulatory compliance costs of $3.6 billion. These expenses will rise further after 2023 when carbon taxes reach higher levels. CAPP charts the cost of the new onslaught of regulations and levies in terms of a producing Montney well. The total impact equates to $0.15/Mcfe (natural gas, thousand cubic feet equivalent) today rising to as much as $0.44/Mcfe in the high carbon tax environment proposed by Edmonton and Ottawa.
To put this into perspective, at some points last year this would have been about 40% of the spot price of natural gas or 16% of the average AECO spot price for the first five months of 2017. This is above royalties and operating costs. This could take between $1.1 billion and $2.1 billion out of industry cash flow in five years. The high case is some 5% of total industry CAPEX for 2017. At US$100 a barrel this is expensive but survivable. At US$44 a barrel it’s a huge amount of money and big drag on profitability and investment.
CAPP lists the extra costs by program. In Alberta it includes the Aboriginal Consultation Office and its impact on the regulatory system; Climate Leadership Plan; Caribou Recovery Strategy; Alberta Wetland Policy; and Land Use Framework. Federally it is the new Canadian Environmental Assessment Agency and the National Energy Board reviews which are pitched by Ottawa as improvements to the existing NEB process which approves pipelines that never get built or are still facing strong opposition.
This deterioration in the profitability and predictability of Alberta’s petroleum industry has not gone unnoticed. CAPP cites the Fraser Institute’s 2016 Global Petroleum Survey in which it ranks the attractiveness of investing in 96 different oil producing jurisdictions around the world. Factors include fiscal terms, general taxation, environmental regulations, regulatory enforcement, cost of regulatory compliance, extent of protected areas (restricted access), trade barriers, labor regulation and employment agreements, infrastructure, geological database, labor skills and availability, disputed land claims, political stability, security, regulatory overlap and the legal system.
While Alberta scores high on data, skill, labor availability, geological databases, infrastructure and legal system, the Fraser study highlights how much ground the province has lost. While Alberta ranked 17 of 96 in 2014 it had to fallen to 43 in 2017. It now ranks behind every other Canadian province except Quebec, New Brunswick and Nova Scotia. The top 10 of 96 in descending order are Oklahoma, Texas, Kansas, Saskatchewan, Wyoming, North Dakota, Norway, Mississippi, Utah and Montana. The only one Alberta doesn’t compete with every day for capital is Norway.
CAPP also drew attention to the Donald Trump administration in Washington and the President’s determination to cut loose America’s energy industry by reducing costs, regulations and red tape. CAPP wrote, “While the U.S. is reducing the cost of environmental regulations and streamlining regulations, in some areas Canada is moving in new policy directions that have the potential to increase costs and reduce competitiveness. While we recognize the importance of developing our resources in a responsible manner to help achieve key regulatory, social and environmental outcomes, it is important to do so in a manner that does not unnecessarily adversely impact industry investment”.
Which has already happened. But if governments will accept CAPP’s case as real and agree to sit down and discuss competitiveness as a single issue unto itself – not the cumulative unintended consequence of a series of policies introduced by various government departments and agencies – CAPP figures 24,000 new full time equivalent jobs could be created (a 25% reduction in unemployment), $4.5 billion growth in incremental GDP, $207 million in additional income taxes and $79 million more in royalties. Given the current state of the economy one would hope this is compelling to Premier Notley and her colleagues.
Moving forward, CAPP proposes the creation of a “Sustainable Prosperity Steering Committee” which would oversee a consultative process by which “…the province (would) adopt a whole-of-government approach and mandate to strengthen investment attractiveness while achieving government policy objectives”.
It will be interesting to see how the NDP responds to these challenges two years after Ceci told the province higher corporate taxes on previous high profits were required to “contribute fairly to rebuilding our province”. Now apparently the government is inquiring what the cumulative impact of changing Alberta from what it was to what they think it needs to be has done to the petroleum industry.
While it is difficult to be optimistic the dialogue between CAPP and the government will change anything in the short to medium term, perhaps Notley and her team will realize Alberta cannot be competitive in the global oil industry through regulations, taxes and public debt alone.
About David Yager – Yager Management Ltd.
Based in Calgary, Alberta, David Yager is a former oilfield services executive and the principal of Yager Management Ltd. Yager Management provides management consultancy services to the oilfield services industry in a number of areas including M&A, Strategic Planning, Restructuring and Marketing. He has been writing about the upstream oil and gas industry and energy policy and issues since 1979.