Thursday, September 27, 2007

The Alberta Royalty Review Panel Report

Mr. Harry Chase,

I am a voter in your constituency and I am writing to you regarding the recent report from the Alberta Royalty Review Panel. I was surprised by the magnitude and character of the recommendations, given the factors that have contributed to the success of our economy and the lessons we have learned observing the impact of regime changes in other oil-rich centers. I believe that implementing the changes outlined in the report could have devastating consequences to the Alberta economy.

I was born and raised in Calgary, studied finance and economics at the University of Calgary and have pursued a career in oil and gas related finance in this city. This is a truly extraordinary place to live and I feel very fortunate to have had the opportunity to pursue my academic and professional ambitions while staying close to my family. I like living and working here and would like to see the province continue to prosper.

During my 30 years in this province and through my academic and professional endeavors, I have come to appreciate that one of the key reasons that the province has enjoyed such prosperity is the Alberta Advantage – specifically, being a business-friendly province committed to responsible regulation. Our low overall tax burden and business-friendly environment has encouraged investment to flow in to the province. This, combined with a period of unusually strong commodity prices, has resulted in an incredible amount of investment in the sector and a robust economy that has benefited ALL Albertans, not just those that work or invest in the oil sector. To say that Albertans are not getting their ‘fair share’ is, in my view, inaccurate and misinformed.

Looking to the report put forward by the Alberta Royalty Review Panel, there are some glaring shortfalls in the analysis that grossly misrepresent the impact that such changes would have on government revenue. The most significant of these shortfalls is the failure to recognize the impact of higher royalties on investment in the sector. One cannot look at this as an academic exercise; there are practical implications that need to be considered. The report offers an illustration of the expected provincial revenue under the existing regime and compares it with the expected provincial revenue under the new regime, giving no consideration to the impact that the new regime will have on investment and, therefore, oil and gas production.

The analysis is incomplete and blatantly misleading.

Raising royalty rates lowers returns for investors in oil and gas. If we change the fiscal regime in a direction that lowers the returns to investors, it can be expected that investment in the sector will decrease. This is a basic principle of finance. Alberta is not the only place to find oil and gas – investors can and will go elsewhere.

Investment is an important part of the equation because oil and gas is a capital intensive business that requires continued investment in order to sustain production. That is, without investment, production will decline. If production declines enough, provincial revenue from royalties will decline – even at a higher royalty rate. If production is 40% lower, it doesn’t matter if royalties are 20% higher, the overall pie is smaller. Albertans lose.

Extracting oil and gas from the Western Canadian Sedimentary Basin is already marginally economic in a global context because i) the cost to find oil and gas in Canada is among the highest in the world, ii) the cost to produce oil and gas is high relative to other regions, and iii) Canada has a high overall tax burden (low royalties help offset our overall high tax burden, 11th in the world, and many places with higher royalties have lower corporate taxes such that the aggregate burden is lower). However, we are still able to attract investment at this time because i) Canada is perceived as relatively stable from a political and economic standpoint (as such, investors are willing to accept lower rates of return), and ii) continued strength in commodity prices has created an environment that supports development of our resources. With respect to my first point, if we proceed to change the royalty regime, it will be the SECOND major signal in less than a year that this is NOT a stable investment environment. We are sending the signal that we are not open for business and the expected consequence will be reduced investment in the sector going forward. In terms of the role that commodity prices have played on investment interest in Canada, we need to remember that this is a cyclical business. Squeezing the economics will impact both the decision to invest here and the decision to stay here. If a new regime is implemented that leads to a higher ‘break-even’ commodity price environment, it is reasonable to expect that capital investment will not only stall, but will flow out of the sector. This is not good for Albertans.

We can observe by example the impact that regime changes have on investment behavior. Jurisdictions that have attempted to re-trade investors include Venezuela, Ecuador, Nigeria, Algeria and Russia, to name a few. The result has been an exodus of capital investment from these jurisdictions. Oilfield activity in these areas continues in large part because of strong commodity prices; however, it is at a slower pace and the negative impact on the oil and gas sectors and the economies in these regions when capital investment flees is clear. When capital investment declines, it means companies are spending less money oilfield activity. This means less work for oil and gas sector workers; in some cases, layoffs. In Alberta, it also means less money for many farmers, many of whom rely on supplementary income from leasing out their land to oil and gas companies. This trickles through the economy as these groups spend less on goods and services. Carpenters, framers, electricians, painters, waiters/waitresses, cooks, salespeople, realtors – people that live in your riding will be negatively impacted. As people leave the province for better opportunities, the need for teachers, doctors, nurses, and other public service providers will decrease. The changes proposed in the report will not benefit Albertans.

Beyond considering the economic consequences of the changes proposed in the report, I think we should also reflect on the way this would impact how the province is perceived externally. It was not too long ago that Albertans received prosperity cheques from the provincial government. Besides being a colossal waste of money from an administrative point of view and poorly implemented, the rebate cheque program was a clear message from the province that it had more money than it knew how to effectively allocate. How does it look to turn around now and say we need a bigger cut? Alberta’s reputation as a credible business center is on the line.

I sincerely hope the Alberta government will thoughtfully consider the consequences of any changes to the royalty regime. I believe the changes outlined in the report will have devastating consequences for the Alberta economy. This affects the people living in your riding and I urge you to fiercely defend our interests.

Sincerely,

Tori Fahey

1 Comments:

Blogger KELI said...

ENJOYED YOUR PERSPECTIVE ON THE ROYALTY QUESTION.
YA! YA! YA! - LIKE THAT GUY ON BOW CRESCENT AND MYSELF WOULD EVER SEE A CENT OF ANY INCREASE.
KNOWING HARRY FROM THE ATA, HE WILL PROBABLY RECOMMEND TO HIS MINORITY FRIENDS A MINUTE INCREASE SO AS NOT TO UPSET ANYONE UNTIL THE LIBS GAIN MORE SEATS.
GUESS WHO??
KENEKI (EDITED BY KELI)

October 19, 2007 at 6:24:00 PM MDT  

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