Wilf Gobert on the Royalty Review

Written by Wilfred A. Gobert - National Post

Thursday, 11 October 2007

Dear Ed Stelmach

I am writing to ask you this: Have you read your province's economic history?

Your provincial government has unleashed a public relations nightmare that could precipitate an economic policy shift that would, in turn, destabilize or crush the Alberta economy.

The Alberta Royalty Review Panel has attempted to stake out higher moral ground against the petroleum industry in its recent report to the government. The report is titled Our Fair Share. It asserts that because petroleum resources belong to Albertans, the royalty and tax system must justify every dollar that does not go to the owners. I beg to differ.

Alberta has a history of restructuring royalties and taxes based on lengthy strategy documents that purport to advocate on behalf of the citizenry. They've had devastating consequences for Alberta's economy. This panel's recommendations would have a similar impact. Given the diversified impact of petroleum investment across the country, all Canadians should be worried.

The fundamental error of the Review Panel's report arises from the manner in which it focusses on the proportion of revenue that goes to the province, and that which goes to the petroleum producers. Royalties are a revenue tax. Income taxes are levied net of costs. Comparing royalties in Alberta to income taxes in other countries, which the Panel did, represents a logical error. (Moreover, omitting comparisons with British Columbia and Saskatchewan was downright fraudulent.)

Imagine a scenario whereby governments proposed to restructure personal and corporate income taxes so that they were fixed at a percentage of one's gross income -- with no deductions of any kind. And the tax rate wouldn't change if your expenses go up. This structure is clearly preposterous. Yet the Panel believes the establishment of such a system for the petroleum industry to be Alberta's right.

Look back at Alberta's experiences with royalty changes. In 1974, with world oil and natural gas prices spiraling upward after the 1973 Arab oil embargo, Alberta increased royalty rates on crude oil and natural gas. The federal government, offended at these revenue taxes, declared royalties to be non-deductible in calculating income taxes. The economies of the western provinces were devastated. The index of energy stock prices fell by 60%. After cooler heads prevailed, misguided price controls on crude oil and natural gas kept the lid on royalties through the 1970s.

In October, 1980, the federal government introduced the National Energy Program (NEP).

Faced with another explosion in world oil prices, Ottawa introduced its own Petroleum and Gas Revenue Tax and a host of other equally insidious fiscal measures. Alberta was incensed and temporarily reduced oil production. Investment activity was crushed and the market for energy shares collapsed.

Equally devastating was when Alberta agreed in September, 1981, to changes to the NEP, allowing Ottawa to impose its revenue tax. Alberta believed that ever-rising oil prices would create a win-win situation. Western provinces suffered a staggering impact on their economies, and, again, billions in stock market value was lost in the aftermath. By April, 1982, the Alberta government was forced to introduce royalty reductions and other incentives in order to stop the bloodbath within its economy.

Yet public opinion in Alberta is wildly in favour of the government hitting the petroleum industry hard. More government revenues means more government spending on the things we care about: schools, hospitals and infrastructure. But explain to the rest of Canada, the G7 and the International Monetary Fund why the province needs to raise corporate taxation when the province is debt free.

Finally, is this even about "Big Oil"? The Canadian Association of Petroleum Producers has 150 producer members, representing 95% of Alberta production and 92% of investment. The Small Explorers Association has 470 member companies. The Canadian drillers association has 186 members. The petroleum services association has 270 members. These associations represent thousands of citizens in every area of the province.

The Panel's conclusions, and thus public opinion, are based on a report containing fundamental logic flaws, poor data and the assumption that the province's petroleum industry can be run like a state utility.

We all lived through the NEP. Premier Stelmach, tell me that you have read Alberta's history with royalty and revenue taxes, and that you don't want the consequences repeated.

-Wilfred A. Gobert has been an oil industry analyst since 1974, and is independently employed since 2006.