Pedro van Meurs; You're Fired!

Request from comments:

"Take a look at Pedro van Meurs column in today's Edmonton Journal. The good doctor has now decided to break from the government and the Panel and go solo with a justification for the bitumen tax. He has essentially showed his hand-- he wants to shut down virtually every new oil sand project in Alberta through is bitumen tax. I assume you will do a post critiquing the good doctor's bitumem tax."

OK, will do. Hell I'd sooner SLEEP, but Stelmach is talking tomorrow and want to get this published in advance. Consider this a "published draft"; I may clean it up a bit and make points more clear in the future.

First, let's get in the mood. Trump in the boardroom. Pedro pleading his case. Donald throws up his hands and says "Pedro, you're fired!" Let's hope Ed has seen the show, LOL.

I'm glad that van Meurs did this piece, as it allows me to understand how he thinks. I had to read it a couple of times, and dissect it piece by piece to really take it all in. The amazing thing is that in reflecting upon each individual concept it is clear he is simply wrong about pretty much everything.

As the reader notes above, he takes swings at everyone. Mostly the premier and Alberta Energy, but also even the panel for daring to disagree with him. Talk about an ego.

Here is Pedro's gig. He is a consultant, paid to give his opinion and then go to his tax-free home. As a consultant who is not a resident of Alberta, he has no business entering into the political discourse of Alberta.

However, I think because he's a consultant he does have "business reasons" to write the article he did. If his recommendations get trashed, the next jurisdiction that investigates hiring him to "get the best possible deal" will think that if he screwed up his Alberta work, he might screw up their work too. This is a pure CYA operation to attempt to keep his business reputation from being tarnished.

This is Pedro pleading for his life in the boardroom of Alberta, and the world. Let's hear him out; and when the pleading gets too shrill, desperate and illogical call him out with a "Pedro, you're fired!"

All right, here we go:

Under the existing royalty regime, Albertans can wait more than 20 years before they see a dime of revenue from their non-renewable resources. Worse, the current system provides no incentive for orderly, sustainable development and bringing projects in on budget

Pedro van Meurs, Edmonton Journal

Published: 3:06 am

The royalty review panel proposes to create an oilsands severance tax, or simply a "bitumen tax." This tax, based on my testimony to the panel, is an important and integral part of the panel's recommendations.

Having lived and worked in Alberta for 16 years and having managed a small oil company here, I care deeply about the future of the province.

I assume this is his consultancy, as opposed to an exploration and production company? I'd love to know what Pedro's E and P business experience is. From my reading of his resume he was a federal civil servant who then got into the royalty bandito consultancy business.

He then left Alberta for a tax free, non "fair share" world of the Bahamas. From where he proceeds to tell Alberta how to melt down it's economy in the name of "fairness".

I'm pretty sure that Pedro does not own a house in Alberta that will be devalued should his vision come to pass. Yeah, you can tell how much Pedro cares about Alberta merely through his choice of jurisdiction he must pay tax to.

I believe it is important for the Stelmach government to create a new vision for oilsands development based on new policies.

I also await Pedro's vision for conventional development too. I really would like to see his justifications for the panel's position. Hopefully it is forthcoming.

This new vision is not shared by the oilsands division of the provincial department of energy.

So you are parachuted in to set them right? The professionals who run the provinical department of energy don't know what they are doing, that is directly what he is saying. Not a good way to treat your customers, Pedro.

What is the bitumen tax?

The bitumen tax will be paid by all oilsands producers based on the value of the bitumen at the time of production. The base royalties and net-profit share are deductible for bitumen tax purposes. Therefore, companies which already pay a significant net-profit-sharing royalty will pay less bitumen tax.

The panel proposes that the bitumen tax rate would start at one per cent when the West Texas Intermediate price of oil is $ 40 Cdn per barrel. The rate rises by 0.1 per cent for every dollar increase in the oil price.

With today's oil price at $86 per barrel, the bitumen tax rate would be 5.6 per cent. The maximum rate of nine per cent would be reached when oil hits $120 per barrel. Note that the tax rate is based on West Texas Intermediate and the bitumen tax itself is based on the bitumen values.

Note that the prices are not indexed to inflation, as I understand it. This will result in rather massive tax creep over time.

The bitumen tax would bring in an additional $600 million from oilsands production (if oil prices average $70 Cdn per barrel) in 2008, increasing to $1.2 billion by 2016. Every year thereafter, Alberta will automatically collect higher bitumen tax revenues as prices and production go up.

Therefore, adopting the bitumen tax means securing the future for Alberta for generations to come.

"as prices and production go up?" All "automatically"? Pedro, prices do not always go up. You are selling a dream. They go down to; and when the go down bitumen tax revenues will also go down. It just isn't as "automatic" as you claim. In addition, under the scheme presented to Albertans there simply won't be production going up "automatically". Companies have to make huge capital investments for that to happen. Companies will probably NOT make those huge capital investments under your scheme. You allude to that yourself later in your article.

OTTAWA NOT AFFECTED

Another point is that the bitumen tax is not deductible for federal corporate income tax purposes. This is an advantage, because this means that the federal government is not impacted by changes in the rate. This makes it easier for Alberta to set its own fiscal policies.

POSSIBLY an advantage for the provincial government. I figure the feds will be looking for their "fair share" soon enough, no matter what we call it. Certainly NOT an advantage to producers of a low margin resource, especially not being deductible for tax purposes. This will get exasperated over time due to the price points not being indexed, and which are probably set too high to begin with?

The industry is bitterly opposed to the bitumen tax. This is understandable. The oilsands industry does not want to assume a higher share of the cost overrun risks and does not want to pay a higher share to government.

POLICY #1: PROMOTE 100 YEARS OF SUSTAINABLE OILSANDS DEVELOPMENT

Alberta has more than 140 billion barrels of recoverable oilsands. Alberta needs a policy of sustainable oilsands development aimed at maximizing the value of this resource and minimizing negative environmental and economic impacts.

Sustainable development is a misnomer for a finite, depleting resource. Pedro is being dishonest while pretending his vision is sustainable and other visions are not.

The uncontrolled boom in oilsands development has damaged the non-oil sectors of Alberta's economy. It has also caused significant losses in future oilsands revenues through excessive cost increases.

Agreed, and in addition it has caused even more significant losses to all oil, gas, and bitumen producers. Believe me, I am fair pissed how much capital costs and to a lesser extent operating costs have run up of late.

If costs go up, the profit share goes down. For every dollar of cost overrun during construction, Alberta loses 40 to 50 cents in royalty and tax revenues.

Overrun? This supposes that the costs are indeed overrun, and which are not simply higher due to inflation and budgeted for.

Alberta has already lost and will continue to lose billions of dollars in future net-profit-sharing revenues as a result of rampant local cost inflation. These losses are in addition to the $2 billion per year shortfall the panel said occurs because royalties have not kept pace with changes in the resource base and world energy markets.

Changes in conventional resource base in Alberta have been that poorer resources are being chased over time. This is because the better resources have already been developed.

Developing progressively poorer resources means that higher capital and operating costs are experienced per unit of production. This should result in conventional government percentage of gross revenues going DOWN with time, because the operator's percentage of profit margins are also going DOWN with time.

This is fundamental, basic economics.

Not actively progressively reducing royalty rates as the resource base matures will result in decreased activity. Decreased activity will result in royalty owner cash flow going down over time.

As per changes in world energy markets, I assume he means that if Venezuala, Russia, Ecuador, Libya, et al make their fiscal regimes more onerous, we should copy them. These nations economies and approaches to economic development are hardly models of success which should be emulated. For misunderstanding basic economics, if I was Donald Trump, at this time I'd say "Pedro, you're fired!

However, the losses will not stop there.

The Canadian Association of Petroleum Producers says projects to be constructed in the future may be as much as 25 per cent more expensive than the most expensive projects I assumed in my economic analysis.

It is easy to do a reality check on this. If construction on the projects mentioned by CAPP would begin in 2008, the first payments of the net-profit share would not be received until 2030 as a result of these excessive costs, at average price forecasts.

- Do not provide any significant revenues to Alberta for the next 20 years;

First of all, some basic research into the capital costs being experienced is easy to conduct via public sources. In addition, the panel was clearly told that capital costs were rising dramatically. Pedro gets fired for not doing basic background work.

Pedro tries to have it both ways. On one hand, he professes ignorance to the capital cost increases, and seems to be accusing CAPP of making up numbers. On the other hand, he goes on at length about the negative impacts of capital costs increasing on royalty take, so it would appear that he does accept the reality of cost increases. So, what is it? He uses either argument at his convenience, which is hardly honest or logical.

Pedro are you saying that 20 year payouts are what industry is seeing? I'm not disputing the number; I've been a bit bug-eyed about some numbers I've been seeing and scratching my head about how the heck they'll make money. Please, make these economic runs public. I'd be quite interested to see them. No baiting here; truly would like to see what current deterministic economics for oilsands look like.

- Would create even greater local cost inflation, resulting in further billion-dollar revenue losses from existing oilsands plants;

By "local cost inflation" I assume he is referring to operating cost increases more than capital cost increases. I doubt operating cost increases would result in thne scenario he paints. The fixed operating portion that'd be subject to local inflation won't be that big; albeit it still will have some presence. Capital is the big item.

- Would cause further disruption of the local non-oil economy;

Is Pedro talking about Fort McMurray? What local non-oil economy would there be in Fort McMurray be, LOL? For not understanding the Alberta economy, Donald says..... "Pedro, you're fired!"

- And cause significant environmental problems in terms of water use and CO2 emissions.

Pedro oversteps his mandate here. Environmental issues and policy should be dealt with separately from royalty issues, bringing them up only muddies the water. Yeah, that was an intended pun.

Further, it exasperates his general argument. For example, maybe projects should recycle all water, and capture all CO2. Those costs should be project costs that further delays payout, and reduces overall project royalty take. Is Pedro and the Panel willing to accept that? Seems that it'd be fair to me as the developer would also see delays in payout and return on investment.

It seems that CAPP failed to determine whether Albertans are interested in such a mindless pursuit of unhappiness.

It also seems that CAPP failed to determine whether or not a fair and balanced Royalty Review Panel was constituted. Huge mistake. Industry is way pissed at them over that.

Unhappiness? Is Pedro unaware of the last big nuclear strike on industry, the NEP, resulted in a rather large level of unhappiness for Albertans and Canadians as a whole, too. Remember that Pedro had his association with the NEP to. If not a direct role, the NEP was a tune that by his old band. Yeah, Pedro was a big cheese for the feds in the 1970's on petroleum fiscal systems.

Memories of the NEP unhappiness is why industry, the people who can assess its impact, is so vehemently and universally opposed to it. The same will hold for Albertans as a whole once they realize what this report's implications are. I just hope they don't find out through the report being implemented and melting the economy down. This is one "I told you so" I really don't want to be able to say in the future.

Alberta oilsands developments need to be put on a more sustainable growth path. This can be done by slowing the approval of oilsands projects. And it can be done even more effectively using market forces, by introducing the bitumen tax, because this prevents excessively costly projects from being started.

Big disagreement here. BIG. No, the pace would be slowed far more effectively via the regulatory route. It is far easier and more practical to implement. Man hours in; project development out. Very little volatility. I don't care what the fiscal regime developed is; it will subject developers to massive swings in profitability depending on commodity prices. Using the fiscal regime to regulate project development is like driving a car from the back seat with a broom stick. Very sloppy thinking. Donald says; "Pedro, you're fired!"

The provincial energy department says its policy is not to play a role in managing the rate of oilsands development through bitumen taxes or otherwise.

This policy must change.

Agreed. I've been advocating some form of regulated pace of development via project approvals since the early days of the oilsands "boom".

Alberta Energy's stated objective is to maximize government revenues from petroleum developments. A hands-off policy with respect to the rate of oilsands development means that every time the oil prices increase, even more costly projects will be launched, causing higher local cost increases and reducing further the revenues from net-profit shares from existing projects. In other words, a hands-off policy actually minimizes the revenues from oilsands developments.

Norway's petroleum fund was created by a profit-based hydrocarbon tax, for the benefit of all 4.6 million Norwegians. It has now reached $317 billion. Norwegians understood that the first priority of a profit-based tax system is to protect the profits from being eroded by rampant local cost inflation. Therefore, Norway has controlled the rate of oil and gas development.

Norway's Petroleum Directorate states: "Our vision is a sustainable petroleum industry for the next hundred years based on a co-operative approach to knowledge and technology." Why not adopt such a vision for Alberta?

Hundred year plan, eh?

October 10th 2007; Norway's production is plummeting.

http://www.iht.com/articles/ap/2007/10/10/business/EU-ECO-Norway-Economy.php

Excerpt: "Developments in the petroleum industry have been quite disappointing," Bank of Norway Governor Svein Gjedrum said at a briefing for the international news media. "In the past few years, we have seen quite a decline in oil production." Norway's average daily oil production has declined to about 2.1 million barrels per day as of September, about 35 percent under peak levels of over 3.2 million
barrels in late 2000 and early 2001.

Pedro, that is success? Next hundred years? Remember my points about too high of fiscal regime results in decreased recoveries of hydrocarbons? Time to roll out Donald again; "Pedro you're fired!"

POLICY #2: PREDICTABLE AND CERTAIN REVENUES FROM OILSANDS

Over the next decade, the share of revenues from oilsands is estimated to double from 25 per cent to 50 per cent. In 20 years, the vast majority of petroleum revenues in Alberta will most likely be derived from oilsands.

Under the current oilsands royalty system, most of the revenues come from the 25-per-cent net-profit share. It should be emphasized that the so-called net-profit share is not a share of accounting profits -- it is far less. The share only applies after companies have completely recovered all their capital and operating costs, as well as a minimum rate of return equal to the long term bond rate on all costs (called "payout"). This means that payments to the province begin many years after the company starts to produce bitumen.

You know, the capital allowance never sat well with me. Any oilsands development I did had a quick payout so didn't make so much difference. But the mines and thermal projects with long payout........ yeah that could be something that'd be fair to ditch.

Government revenues from this net-profit share are unpredictable. They depend on volatile bitumen prices and unforeseeable cost developments.

Agreed. Make a note of it. I don't disagree with everything the gentleman says. Only the nonsense. Decent, well thought out concepts I can agree with.

Even after payout, companies can reduce the net-profit share to zero by expanding their projects and starting the cycles of cost recovery and rate of return allowance over again.

Ring fencing of projects would be relatively easy to implement. Clarity could be added, and a far tighter process put into place. Pretty easy and simple with the added bonus of not demolishing the provincial economy in implementation.

As oilsands revenues become more predominant, it will be impossible to manage Alberta's finances properly in such an environment of unpredictability. Therefore, Alberta should not only receive a higher share of the oilsands wealth, but also a more predictable and certain share. The bitumen tax achieves this objective.

Commodity prices will swing like wild as they always have done. No fiscal regime can isolate government income from this. There are some other approaches, such as hedging, forward sales, etc. Using those mechanisms would be much more efficient and would yield more smooth revenue streams than tinkering with the fiscal regime. Alternatively, if the jurisdiction has a capital cushion like Alberta does, the
jurisdiction could take the volatility risk and receive more sales revenue. Alberta did this first by paying off its debt. It could do other things too; like cut personal taxes to its citizens. Donald fires Pedro yet again.

As explained above, the base royalties and net-profit share are deductible for bitumen tax purposes. If the net-profit-sharing revenues are low, the bitumen tax will automatically rise. The bitumen tax therefore helps stabilize Alberta's oilsands revenues.

I must confess to not understanding WTF he is saying.

I'm trying to think of what he is saying in realistic terms.

In the real world, it sounds like this: If "net-profit-sharing revenues" are low, I assume this is more likely due to commodity prices being low. Bitumen tax will automatically fall. The bitumen tax therefore helps to destabilize Alberta's oilsands revenues.

Pedro gets fired again, I think my real world statement makes sense while his does not. He may indeed be correct but if I can't understand WTF he's saying I bet literally no one else in the world does either.

Alberta Energy says it is not its policy to increase the certainty of oilsands revenues and promote revenue stabilization. It argues that unpredictable revenues from oilsands can be managed through a stabilization fund.

I disagree. Stabilization funds have been tried by many governments over the years. Except for Norway, I do not know of a jurisdiction where such a fund has worked satisfactorily.

This touches on my point above. Pedro states there is a bad history of stabilization funds, and then throws out the concept. By this logic, I can state that there is a bad history of petroleum developments in jurisdictions where the government take is too high.

Recovery is seldom optimized, for example. Lower recovery equals less royalties paid.

Fewer exploration wells are drilled. Fewer exploration wells drilled leads to a smaller resource base that is developed, which in turn results in less royalties paid.

Pedro is fired with a vengence for being myopic to the overall industry as opposed to being a fiscal regime specialist.

Alberta's fiscal system should be designed to make the management of the provincial economy easier, not more difficult.

The fiscal system being proposed will make the management of the provincial economy much, much, much, smaller. If that is easier, then I guess Pedro might be correct. All facetiousness aside, Pedro is fired again for advocating the engineering of a massive recession in Alberta.

POLICY #3: PROMOTE EFFICIENT, LOW COST OILSANDS OPERATIONS

The current net-profit-share system encourages inefficient operations. Every time costs go up, companies pay less profit share and pay it later.

A bitumen tax would correct this problem because it is based on the gross bitumen value of the production, regardless of whether companies are inefficient or efficient. With a bitumen tax, the risk of cost overruns is borne by the investors. This is fair because ordinary Albertans are in no position to influence a project's costs.

Marginally correct, if fact so marginal it is essentially incorrect. Reductions in costs will improve producers bottom lines to some multiple that of royalty payments lost. Remember that generally oilsands projects are low margin ventures, so operators are fully incented to operate as efficiently as possible.

Alberta Energy's policy is to focus on economic rent collection from oilsands, based on sharing a percentage of this economic rent. This means promoting higher after-payout profit shares, rather than bitumen taxes.

This is because of the capital and risk profiles of oilsands projects, and is in my judgment and most other knowledgeable observers the correct approach. It is even emulated in the Royalty Review Panel's recommendations.

This policy also should be changed. Creating higher profit shares means higher subsidies to inefficient operators. It does not make sense to encourage the development of the most expensive and inefficient projects right now.

Taking away such a policy would likely result in NO projects being developed in the foreseeable future. Is that the van Meurs vision?

POLICY #4: CREATE A LEVEL PLAYING FIELD

A level playing field means that all investors are subject to exactly the same fiscal terms. This is fair to all companies and promotes transparency and competition.

Geology is not a level playing field. This cannot be over-stressed. Utilizing rate based royalties does have the effect of leveling the playing field to account for profitability of investments. Fixed royalty rates and severance taxes are the antithesis of a level playing field. This entire section is poorly thought out on this basis alone. Pedro gets fired because of it.

The bitumen tax must be paid equally by all producers. Therefore, it maintains a level playing field.

So a mine with a higher stripping ratio pays the same as a mine with a lower stripping ratio? How is that a level playing field?

By 2009, Alberta will, for the first time, reach a level playing field for all producers, because Suncor and Syncrude will join the generic system of 25 per cent net-profit share based on bitumen prices. It should be a very important policy objective of Alberta to maintain the level playing field from 2009 onwards.

Therefore, I do not agree with the panel's proposal to increase the net-profit-sharing rate to 33 per cent. This would destroy the level playing field again, because Suncor and Syncrude would continue to pay only 25 per cent as a result of their agreements with the Crown, which would be grandfathered.

Money quote - the panel wanted more royalties than even Pedro "absolute best deal" was after. Wow. What the hell is their game? More below:

I favour keeping the 25-per-cent net- profit share unchanged for everyone, and increasing the bitumen tax.

ALTERNATIVES TO THE BITUMEN TAX

A variety of alternatives to increase government revenues from oilsands are possible, but not recommended.

A base royalty starting at three per cent and increasing with oil prices has some of the same advantages as the bitumen tax. However, the bitumen tax is far superior because of its revenue stabilization features, its non-deductibility from federal taxes and its ability to promote sustainable growth and create a level playing field.

Tristone Capital has proposed a three-per-cent minimum base royalty, instead of the current one per cent. I agree that this is a fair minimum rate, but it should be a minimum two-per-cent bitumen tax rate in addition to the one-per-cent base royalty rate. The bitumen tax rate should be increased above prices of $50 Cdn per barrel.

Tristone's proposal would increase the base royalty only after payout is achieved. For the high-cost projects that CAPP predicts, this additional royalty would not be paid for 20 years. For existing projects, the scale starts at a price of $70 Cdn. This is so high that it does not provide a fair share to Albertans.

That darned "fair share" tune again. Of course the price should start at whatever the price of the day of the new policy. To backward-date the price is remarkably unfair to people who've made billions of dollars of capital investments. Pedro is fired again.

Changes to the net-profit-sharing system are also an option. However, such changes make the oilsands revenues even more unpredictable and provide even stronger support for inefficient companies.

This is a rather bizarre point. Generally in Canada and the Western World funds are raised on taxes that are based on net income. Corporate taxes and graduated individual income taxes being the prime examples.

Pedro is suggesting a philosophy that is more akin to a head tax than any modern progressive taxation method.

What Pedro is suggesting is that companies pay taxes whether they are profitable or not, and that there is no graduated level of payments based on profits.

Think of what he is saying in the broader sense. Let's assume an example from the auto industry. Imagine if the government received tax revenues from the auto companies based on the cars sold.

The following numbers are all illustrative only and may be very different in reality, this is being done to make a point. Say each car sold by GM was taxed $10,000. Each car sold by Ferrari is taxed $10,000 as well. GM cars have a gross revenue of $20,000, from which it mmakes a pre-tax net income of $11,000 per car, hence would have a net after tax income of $1000 per car. Ferrari cars have a gross revenue of $160,000, from which it makes a net income of $100,000 per car, hence would have an after tax income of $90,000 per car.

Is GM the inefficient company? Or is it the efficient company because it is able to sell a car for 1/8 the price of Ferrari and at 1/6 the cost?

Efficiency is a concept that must be first defined to which context it is being applied or it is meaningless. Fuel efficiency? Passenger safety efficiency? Durability defining efficiency? Maximization of labour inputs defining efficiency? Minimization of capital inputs defining efficiency? Efficiency in minimizing the 0 to 60 mph acceleration?

I personally think it is pretty damned efficient to take an unrecoverable resource, and through years of hard work, ingenious thoughts, and billions of dollars of capital figure out how to economically win that resource out of the ground.

It would take me a very long article to describe what efficeincy is in hydrocarbon development. There are dozens of parameters which must be considered, and optimized. The end result is seldom the what would be the most efficient as measured on any individual parameter.

I don't know Pedro defines efficiency, but am pretty sure you could write it on a postage stamp. I just don't think he has the business or development experience to "get it". He's got his head too far into the economic models.

A bitumen tax is essential for the future of Alberta for generations to come.

Easy to say when he is are going back to the Bahamas and leaving a potential mess behind; unless Ed can put up the courage to fire him.

The question is:

- Will Premier Ed Stelmach have the vision to create a sustainable future for Alberta oilsands and accept a substantive bitumen tax,

- Or will he cave in to the unjustified threats of the oil industry and accept a proposal similar to the one developed by the petroleum industry through Tristone Capital.

Meaning will Stemlach adopt "the Pedro van Meurs vision" of Alberta?

I hope to hell not.

Remember, Pedro isn't going to have to live with the mess he creates as he's in a tax-free sunspot.

If he implements it, Ed Stelmach would forever be known as the dude that did something really, really bad. I don't think "Steady Eddie" wants that legacy.

Ed has a third alternative; fire Pedro and the whole Royalty Review Panel and appoint some reasonable and thoughtful people to do far better than the proposals tabled by the panel.

Pedro Van Meurs is an international royalty expert who was hired by the Alberta government to advise the royalty review panel.

He recently worked with the Alaska government to increase its royalties

A big brue-yahh to that! Some day when I find some time I've got to do some digging on it but sounds like the Alaska experience has turned into a hell of a mess. Revenues are FAR SHORT of what was expected, apparently. Same result will occur if the panel report is implemented in Alberta, too.