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Potash Royalties: Lessons from Def Leppard

Advocates of low potash royalties have floated some pretty bizarre arguments. Last week, the Saskatchewan Party put out a news release emphasizing that local farmers use some 0.6% of provincial potash output, as though this tiny sliver of domestic consumption somehow complicates the province’s interest in maximizing revenue as a potash producer.

Equally strange are claims that Alberta’s oil and gas industry was damaged by the 2009 implementation of modestly higher royalty rates only above high price thresholds, rather than by the collapse of global oil and gas prices far below those thresholds. There is never an explanation of why continued low royalties in Saskatchewan failed to prevent mass layoffs at potash mines during the same year.

Defenders of the status quo have made one decent argument: that the government must honour its commitments to remain credible with investors. An important response, developed by my friend Greg Fingas in Thursday’s Regina Leader-Post, is that dramatically higher potash prices warrant a review of existing royalties.

However, commodity prices are often volatile. Resource companies may be less likely to invest in Saskatchewan if they expect to bear the losses when prices fall, but to have the government take away the gains when prices rise.

What the province needs is a royalty formula that automatically and sharply increases rates as prices and/or profits rise (and the reverse when they fall). That way, companies know the rules before they invest and the province collects most of the economic rent without having to repeatedly change the rules.

Unfortunately, the Saskatchewan government instituted a ridiculous royalty regime in 2003 and 2005. Although the immediate 120% deduction of investments is very costly, it will eventually run out after the investments are finished. The base-payment holiday on mine expansions is moot at today’s potash prices, since Crown royalties and the Saskatchewan Resource Credit now exceed the maximum base payment anyway.

As I point out in today’s Saskatoon StarPhoenix, the problem that will not go away is the profit-tax holiday on sales in excess of the average sold in 2001 and 2002. This giveaway is not tied to any particular investment and is not subject to any time limit. Sooner or later, the Saskatchewan government will have to renege on its absurd commitment.

In his speech rejecting BHP’s hostile takeover bid for PotashCorp, Premier Brad Wall discussed having difficulty following the plot of Inception. Perhaps he should instead have listened to Def Leppard’s Promises.

Regarding the profit-tax holiday and other royalty concessions, PotashCorp asked Wall to promise, “That everything is true.” He eagerly did so. But he should have responded, “I won’t make promises that I can’t keep; I won’t make promises that I don’t mean.”

It is problematic for the provincial government to break its commitment to investors. However, there is not much choice when the commitment is untenable.

Royalty structure hurting Saskatchewan

By Erin Weir, The StarPhoenix, March 21, 2011

Following is the viewpoint of Weir, a former Saskatchewan resident who is the senior economist for the International Trade Union Confederation.

In the article, “PotashCorp royalties, taxes understated: exec.” (SP, March 11), PotashCorp chief financial officer Wayne Brownlee argues that investment in mine expansions will soon provide a bonanza of revenue for Saskatchewan, at the world’s highest potash royalty rates.

In fact, Saskatchewan’s current royalty regime will unduly limit future revenue. International competition should not dissuade the province from collecting more.

The most important component of Saskatchewan’s royalty regime is a potash production tax based on mine profits. PotashCorp did not pay this tax in 2010 because it received investment writeoffs that exceeded the second-highest profits in the company’s history.

PotashCorp and Agrium expect to complete their capital investments by 2015. However, Mosaic has announced investments through 2020.

Since the allowable deduction is 120 per cent of the amount invested, companies may have deductions left to carry forward after their investments are finished. This “onetime incentive” will continue reducing provincial potash royalties for a decade.

Thereafter, sales above the average sold in 2001 and 2002 will still enjoy a never-ending holiday from the potash production tax. In other words, companies will go back to paying this tax only on the tonnage they produced a decade ago.

Revenues could be higher if this tonnage is sold at higher prices. If anything, increased production actually tends to put downward pressure on prices. Certainly, it will not add to potash production tax revenue.

Additional tonnage will only be subject to the resource surcharge, set at three per cent of sales, and Crown royalties. PotashCorp initially reported paying $77 million of surcharge, and recently disclosed paying $70 million of Crown royalties, on Saskatchewan potash sales of $2.8 billion in 2010.

Taken together, the resource surcharge and Crown royalties amount to five per cent of sales. For every additional dollar of potash extracted, Saskatchewan people will receive a nickel of additional resource royalties.

Brownlee presents corporate income taxes as a substitute for royalties. However, he reveals that PotashCorp’s 2010 corporate tax payment to Saskatchewan was just $82 million, less than it paid to Trinidad, and only one-quarter of its total Canadian corporate tax bill.

Most tax revenue flows to Ottawa and other jurisdictions where PotashCorp operates. Mosaic, an American company, also pays U.S. corporate tax on profits repatriated from Canada.

Corporate taxes do not effectively compensate Saskatchewan for the depletion of provincial resources. Indeed, all industries are subject to corporate tax whether or not they extract resources.

Finally, Brownlee contends that Saskatchewan should not raise royalties because it already has “the highest potash royalty rates in the world.”

The only evidence ever cited to support this claim is the Potash Cost Report from CRU Group, a private consultancy. Since CRU charges 15,000 British pounds ($24,000) for this data, it is not realistically accessible to anyone but corporations and the government.

The U.S. Geological Survey’s publicly available report indicates that Canada has 46 per cent of global potash reserves. A further 43 per cent is controlled by oligarchs in Russia and Belarus.

The only other countries with more than two per cent of global reserves are Brazil and China. Both restrict foreign ownership of potash, and have state-controlled enterprises in the industry. Even if they have lower royalties, multinational potash companies cannot necessarily shift investment to these countries.

Furthermore, Saskatchewan has the world’s richest reserves closest to the world’s largest potash consumer: the American corn belt. These natural advantages should allow Saskatchewan to collect the world’s highest potash royalties.

To do so, the province needs a comprehensive public review of royalties rather than relying on the dribs and drabs of information that PotashCorp chooses to disclose.

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Comment from Michael Smart
Time: March 21, 2011, 8:25 pm

So I guess the current royalty regime was set at a time when Saskatchewan was receiving payments under a federal Equalization formula that reduced the federal transfer by 70 cents for each dollar of royalties charged to potash producers. In that environment, keeping royalties low in the hopes of getting more investment was a very low-cost development strategy.

It looks very different now, since SK is out of Equalization, and the formula has changed in any event.

Comment from Erin Weir
Time: March 22, 2011, 6:33 am

I distinctly remember a couple of Saskatchewan cabinet ministers citing Equalization as a rationale for low oil royalties. As I pointed out in this paper, that argument was wrong because Alberta dominated the national average tax rates for oil. Cutting Saskatchewan’s oil royalties had little effect on the province’s Equalization entitlement.

However, you are quite correct that Saskatchewan dominated the national average tax rate for potash. The province could increase its Equalization entitlement by cutting potash royalties. If that was the plan, it was horribly timed. Saskatchewan was a “have” province by the time these potash-royalty concessions kicked in.

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