van Meurs Latest Shot at Bitumen Tax

I'm posting this in its entirety as it hasn't been widely disseminated and may not be easily available in the future. Comments will be made in another post.


Why Alberta needs a new tax on bitumen

http://www.canada.com/edmontonjournal/news/ideas/story.html?id=97b2db80-3af8-40d9-a683-11e52fa28e6a

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

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

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.

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.

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.

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.

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.

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.

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.

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;

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

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

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

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

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.

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.

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?

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.

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

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.

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.

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.

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.

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

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.

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 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.

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.

The bitumen tax must be paid equally by all producers. Therefore, it maintains 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.

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.

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.

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

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.

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