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Danny Williams and Oil Royalties

In April 2006, Newfoundland Premier Danny Williams walked away from proposed Hebron development because the multinational oil companies were not offering sufficient benefits for his province. The national media and federal government heaped scorn on this decision.

A couple of days ago, Williams secured a new deal that gives the province a 4.9% equity stake in Hebron, a 6.5% “super royalty” if oil prices stay above $50 per barrel, and a commitment to construct a gravity-based structure using local suppliers. In today’s National Post, Andrew Coyne mocks Williams by pointing out that the province is paying slightly more for the equity stake than initially proposed and receiving a slightly smaller “super royalty” than initially requested. Coyne also correctly notes that there may be a tradeoff between building a gravity-based structure and the project’s profitability, in which the government now has a direct interest.

As in almost any bargaining process, neither side received everything it initially asked for. Nevertheless, by driving a hard bargain and being willing to delay development, Williams clearly secured a better deal for his province than was initially on offer.

Williams’ victory contradicts the view that oil is a “globally competitive” business in which governments need to give away substantial resource rents to get investment. In fact, Canadian governments have a very strong bargaining position because our country hosts more than half of global reserves open to private investment. Even the Premier of a small, poor province successfully stood up to the multinational oil companies. This outcome begs the broader question of why larger, richer provinces collect such unimpressive royalties on the depletion of their finite oil and gas reserves.

The following table uses the most recent available Statistics Canada data to show oil and gas royalties as proportions of the value of marketable production of conventional oil and gas. In other words, it excludes Alberta’s oil sands and their ultra-low royalties. The “Canada” column includes all provinces and territories, but the four provinces shown collectively account for some 97% of the country’s conventional oil and gas output. I suspect that the figures for Newfoundland are so low because its offshore development was in its early, less profitable stages and perhaps also because of low-royalty regimes put in place before Williams became Premier in late 2003.

Royalties as Shares of Conventional Oil and Gas Output

 

Canada

NL

SK

AB

BC

2000

19.8%

2.0%

18.2%

21.7%

20.0%

2001

21.5%

1.5%

18.8%

23.6%

21.6%

2002

16.4%

1.6%

15.2%

18.7%

20.3%

2003

16.1%

2.3%

17.3%

17.2%

21.7%

2004

16.8%

3.7%

16.8%

18.2%

22.2%

2005

17.4%

5.8%

16.7%

18.7%

21.5%

My own analysis, and other studies, suggested that provincial royalties were quite low in relation to resource rent during the 1990s. As world oil prices tripled since then, provincial royalties fell somewhat in relation to ouput.

Since the exchange rate appreciated significantly during these years, the price of oil in Canadian dollars rose by a smaller magnitude. Also, the volume of conventional oil and gas extraction declined slightly from 2000 to 2005. As a result, the Canadian-dollar value of this output increased by 62%.  Conventional royalty payments grew by 42% during this period.

Since rising oil and gas prices increased rent in relation to output, provincial governments had ample room to increase royalty revenues faster than output. However, no government made an effort to capture the rent created by higher prices. On the contrary, some reduced their royalty rates during these years in order to accelerate development. One hopes that Williams’ example might help foster a more sensible approach.

Turning briefly to the oil sands, where the volume of unconventional output has increased dramatically, today’s Financial Post reports that a shortage of pipeline capacity has raised the spectre of pipeline rationing and large volumes of crude being stranded in northern Alberta. Typically, free-market economists would advocate the price mechanism instead of rationing. Will they call for royalties high enough to bring the volume of output into line with available pipeline capacity?

Stay tunned for a future post on Danny Williams and public ownership.

Comments

Comment from Gary Marshall
Time: September 15, 2008, 9:45 pm

Hello Erin,

The big problem with your analysis is that it looks only at the direct government revenue or royalities from oil and gas revenue.

Albertans and Alberta have benefited from enormous amounts of investment and demand for labour. Albertans have the highest wage rates in the country and unmatched prosperity. Homeowners and landowners have seen huge increases in the value of their properties.

You unfortunately neglect these facts in your analysis, concentrating instead upon what a bunch of squandering politicians and bureaucracies might have reaped.

Danny Williams, by delaying all that development for a direct reward to his expending power, has only limited Newfoundlanders in participating in that prized prosperity.

Look at the big picture and not at what some small minded politicians and government ministries might have collected at the expense of the provincial economy and the citizens’ financial well being.

Regards,
Gary Marshall

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