On May 5, the NDP won a majority in Alberta by toppling the long-reigning Progressive Conservatives, who had dominated the province for over four decades. So, it’s a shift in politics for the energy-rich province.
Stock markets were rattled by fears the NDP victory in Alberta would result in job losses and corporations moving out of the province, as the newly elected government would have to pay for its social spending ambitions by increasing taxes. Despite the premier’s promise to create jobs, the business community in Alberta remains on edge. Further, the premier has already increased taxes on corporations and the wealthy, while spending more on health and education. The new government has also pledged to raise the levy on industry carbon emissions and phase out coal-fired power plants over time.
A promise of a royalty review
Alberta has long relied on both economic activity and direct revenue from royalties and land sales to underpin government budgets. The government has not had particularly auspicious timing when it comes to reviewing royalties levied against a business that lives and dies by commodity prices, which are, by and large, out of Canadians’ hands.
In 2007, the Alberta government decided to tinker with royalties and in 2008, in the midst of its review, Canadian AECO natural gas prices nearly hit $12/GJ before falling to less than $2/GJ by 2009. This time, the government is targeting the business at a time when commodity prices have had a significant collapse, and capital spending for the sector in Canada is expected to fall almost 40% in 2015.
Markets hate uncertainty: a history lesson
On September 18, 2007, the Alberta Royalty Review Panel released its report on the royalty regime for conventional and unconventional oil and gas development in the province. The conclusion was similar to the view of the NDP today: Albertans were not receiving their fair share of energy development revenues. The result was sweeping recommendations that would negatively affect returns for producers. At the time, the panel had suggested increasing royalty payments to the government by 20%, based on prevailing commodity prices.
By year-end of 2007, the Canadian energy sector had significantly underperformed its peers in the U.S., and lagged behind increases in the price of crude (see Figure 1, below). Markets hate uncertainty, and the ensuing months of tinkering with the royalty structure cast a gloomy pall over the sector until the government settled on a final framework. It was a tough pill for the Alberta energy sector, which was already grappling with precipitous declines in commodity prices as the speculative commodity bubble of 2008 unwound, and the credit crisis gained momentum. Figure 2, below, shows the dramatic underperformance of Canadian equities in the months following the announcement of the review.
Capital is mobile
The problem is that western Canada has one of the highest cost structures globally, and negative changes have the potential to make Alberta a less-attractive investment opportunity.
Governments must realize that investment capital is mobile, particularly in the oil and gas business. The industry extracts a product that is a commodity, and a barrel extracted halfway around the world is effectively the same as a barrel extracted in Alberta.
Looking back at Premier Stelmach’s royalty review of 2007, it’s clear from Figure 3, below, that the impact on capital allocation in western Canada was profound. Both land sale bonuses to the provincial governments, and the average price paid per acre, rose in Saskatchewan and B.C.
Raising government revenues on the back of the resources sector is a tricky game to play, because it has the potential to drive dollars out of the province.
4%
An ETF tracking the S&P Global Clean Energy index is down over the last 12 months.
Industry voices to be heard
The new government seems committed to consulting industry leaders. The review is coming at a time when the province’s most important sector is grappling with the downturn, and as jobs losses in Alberta are forecast to continue through year-end. Alberta Energy Minister Marg McCuaig-Boyd has announced that David Mowat, president and CEO of ATB Financial (owned by the Alberta government), will lead the royalty review panel. We view this as a positive step because of ATB Financial’s key role in financing the energy sector in Alberta, particularly junior oil & gas. The process is set to conclude by the end of 2015.
Until then, in this climate of uncertainty in Alberta, lawmakers shouldn’t kill the proverbial goose that has contributed so much to the fortunes of the province over the decades.
by D. Mason Granger, P.Eng., MBA, CFA, is a portfolio manager in Toronto.