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Duel of the Saskatchewan Expatriates

Last week, I had the following letter in The Globe and Mail:

Oil sands royalties

The Canadian Association of Petroleum Producers’ most recent Statistical Handbook indicates that, in 2010, this industry sold $101-billion of oil and gas but paid only $12-billion in resource royalties.

Even Senator Pamela Wallin’s higher figure of $22-billion (Oil Sands’ Benefits – letter, May 12), which also includes general taxes applicable to all industries, amounts to only one-fifth of the resource value extracted by oil and gas companies.

Foreign investors eager to profit from this giveaway of public resources have been buying equity in Canada’s resource sector, which bids up the exchange rate to the detriment of manufacturing and other Canadian-based exporters.

Rather than attacking NDP Leader Tom Mulcair, Western premiers should raise resource royalties. In addition to collecting needed revenue, that would temper the inflow of foreign funds and help moderate the exchange rate to more competitive levels.

Erin Weir, economist, United Steelworkers

Today, Wallin and I kicked off The Bill Good Show’s second hour (audio here).

Enjoy and share:


Comment from Larry Kazdan
Time: May 23, 2012, 1:10 am

Letter in The Medicine Hat News:

Mulcair right to challenge
Tuesday, 22 May 2012

Finance Minister Jim Flaherty and the Western premiers dismiss the notion of “dutch disease” but the IRPP study which diagnoses Canada’s manufacturing woes concludes that we do indeed suffer from it, and that policy responses are required.

One of the suggested solutions is for government to offset a rising Canadian dollar by investing windfall resource profits in foreign assets. But in Canada, these super profits are largely captured by private companies who benefit from low resource royalties, low corporate taxes and lax environmental regulations.

Thomas Mulcair is right to challenge the unbridled development and export of unprocessed bitumen when the main beneficiary is not the Canadian public, but Big Oil.

Larry Kazdan

Comment from Francis Fuller
Time: May 23, 2012, 8:00 am

I agree with the Dutch Disease thesis but Larry’s letter prompted the following thought.

If the energy sector enjoys windfall profits and the majority of that sector is foreign owned then we should see the repatriation of those profits. In other words, the currency flows into Canada associated with energy sales should be balanced by outflows as the foreign owners send profits home. There should therefore be minimal impact on the CDN dollar.

I can think of two possible explanations.
1) The tar sands industry does not generate a great deal of profit. Alberta’s is not cresting a rising tide of oil revenues but rather has benefited from attracting foreign investment and this FDI has propelled both the AB economy and the CDN dollar.
2) The CDN $ is seen as a commodity currency and therefore viewed as “safe” in a world in which central banks are printing and debasing the value of fiat currency. This view of Canada as a safe harbour has attracted portfolio investment. Since Canadian equities have trended down the only other destination for such foreign money would appear to be real estate and this would explain why CDN housing is being priced out of the reach of the average CDN.

If 2) is correct then we run the risk of this foreign money departing once the CDN dollar is no longer viewed as a safe haven. The sudden departure of these funds would be extremely negative for the CDN housing market. Seeking to retain these funds in Canada may be the reason Carney wants to raise rates even though such an increase would have negative impact on already stretched Canadian families. We have a government acting to benefit foreign investors rather than its own citizens.

Comment from Ken Howe
Time: May 23, 2012, 8:46 am

It’s always sad to hear these kinds of debates, where both “sides” get to throw out their assertions and listeners are expected to work out the truth somehow. Perhaps an uninformed listener would notice that Pamela Wallin’s talk was full of wild generalizations and nasty remarks while Erin Weir seemed more interested in studies and facts. Perhaps.

Comment from Piccolo Economista
Time: May 23, 2012, 9:15 pm

Looking at Expenditures and Revenues for 2010:

Alberta Net Expenditures = $37Bn
Royalties = $3.5Bn (net of “incentives”)

Oil Sands Net Expenditures = $34.2Bn
Oil Sands Royalties = $3.7Bn

Value of Producers’ Sales (Oil Sands) = $36.7Bn

If these numbers are valid, does it not indicate a profit of $2.5Bn?
(I’m sure something is missing in this crude calculation)
The other thing I wonder is how these production contracts are settled at the export level. Is it in CDN$ or US$ or…? Would that also have an effect–or lack thereof–on the Exchange Rate, especially if they settle in foreign currency?

Comment from Purple Library Guy
Time: May 24, 2012, 12:30 am

Mr. Fuller, oil is sold in American dollars. Maybe the profit never gets turned into $ Cdn before it goes elsewhere?

Comment from Francis Fuller
Time: May 24, 2012, 7:51 am

Mr Purple:
Oil is priced in US dollars but the actual transaction may take place in what ever currency the parties to the transaction determine to be most beneficial.

US owned firms operating in Canada are still be required to fulfill Canadian reporting requirements. Regardless of the currency in which the transaction is settled the CDN $ equivalent would need to be reported to the Canadian government.

Comment from Francis Fuller
Time: May 24, 2012, 9:22 am

Mr Piccolo
Your data clearly reflects the 1% Alberta royalty:
Value of producers sales $36.7 Bn x 1% = royalties of $3.7 Bn

Your numbers help construct an indication of the possible profit per bbl produced:

Estimated 2010 production: 1.5 million bbls per day
Estimated annual production: 547.5 million bbls per day (1.5 x 365)

Profit of 2.5 billion / 547.5 million bbls = estimated profit of $4.57 per bbl

An alternate calculation:
During 2010 the US avg domestic price per bbl was $71.21 (approx WTI price)
The avg tar sands discount to WTI = $6
The estimated selling price per bbl = $65.21

Value of producer’s sales (tar sands) = $36.7 Bn
$36.7 / $65.21 = 562.8 calculated bbls sold per yr
$2.5 Bn profit per yr / 562.8 = $4.44 calculated profit per bbl

Note that if the CDN $ is at a premium to the US $ then this reduces tar sands profitability. The bitumen is sold in USD prices but most costs are priced in CDN $ and there is an Fx exposure which reduces the dollar value received by the producer.

I think it would be very valuable to build a model of tar sands revenue and expenses. I suspect such a model would provide a better picture of how much money is involved and who benefits from the tar sands. My hunch is that it would show:

1) That tar sands extraction is marginally profitable. If AB were to charge the same 25% rate it applies to conventional production the tar sands would no longer be profitable.

2) AB benefits by attracting foreign capital inflows. Figures I have found indicate AB had wage inflation of around 6% in 2011 and a CPI inflation rate of 2%. So the inhabitants of AB are becoming increasingly wealthy (incomes outpacing inflation). This population is Harper’s base and I suspect he will do whatever it takes to keep them happy.

3) 2 above does not take account of the economic losses occurring in ON, and QC. It would be useful to model this as it would likely confirm the economic imbalance resulting from Harper’s policies. The proposed changes to UI will have little to no effect on AB and SK but will reduce transfers to disadvantaged provinces. This is a double whammy: first, Harper promotes policies that have a negative impact on provinces other than AB and then Harper seeks to reduce the transfers that his own policies make necessary.

Comment from Piccolo Economista
Time: May 24, 2012, 2:12 pm

Actually, if the Royalty #s are correct, they are ~10%, not 1%… but that’s a side issue (and then there are the in-situ royalties, to which I am not sure how to factor in those #s).
And yes, the Asphalt Pits are marginally profitable. Keith Schaefer (an oil market analyst) has written about that subject constantly, which only leads to other questions such as “why are we putting so much emphasis into something that has marginal benefit?” (positive-economic/negative-environmental externalities precluded)

However, my original concern is with the effects on the Exchange Rate (EXRATE).
I learned in “Money & Banking” that when FDI is a factor, this drives up the EXRATE (since the foreign currency needs to be transformed into CDN$ to acquire the assets). BUT at the output side, if the contracts are settled in foreign currency, this has no effect on the EXRATE. Ergo, the loonie is pushed up on the input side, and left dangling when the resources are sold.
That is a definitive component of “Dutch Disease”, no?
Granted, a large chunk of the payments–assuming foreign currency–need to be converted back into CDN$ to cover ongoing Variable Costs.
However, this would further drive the EXRATE up. One of the ways to balance this activity is for some other sector in the economy to import more (thereby selling CDN$ to acquire foreign assets). Of course, the BoC could engage in ForEx interventions to balance this offset–which may be happening as I write, based on the Foreign Reserves drain I see on the Ministry of Finance reports–but to what extent?
And at this point my tiny, undergrad mind turns to mush due to all the assumptions required, notwithstanding the errors/exclusions I am probably inserting into my hypothesis… Nevertheless, I find it hard to accept that focusing on Asphalt Juice as an “economic saviour” for Canada does not create disproportionate distortions in the rest of the economy.
Where’s James Moore? I need someone to call me “divisive” so I know I’m onto something…

Comment from Francis Fuller
Time: May 24, 2012, 7:42 pm

@ Piccolo
The published figure for the AB royalty on tar sands production is 1% with the intention to raise that to the conventional production royalty of 25% once the producer has earned back his capital investment. I did my sums incorrectly 🙁

I agree with you that FDI is a key reason for the overvaluation of the CDN $ on a PPP basis. The second reason is that because the CDN $ is seen as anchored in commodity prices it is viewed as a safe haven in a world of central bank money printing. Until recently Canada shared this “commodity haven” status with Australia but Australia has recently taken a hit due to worries over the status of thier key market China.

What I find interesting is that we are seeing policies resulting in increased well being in AB and SK with a combined population of 4,902,000 and with the same policies forcing a decline in well being in ON, QC, and the Atlantic with a pop of 23,912,000. This will make for an interesting dynamic in 2015.

I’ll call you “divisive” if that helps.

Comment from Piccolo Economista
Time: May 24, 2012, 9:36 pm


Ahhhh… that would explain the discrepancy, then. Some projects must have recaptured the capital investments and are now paying the higher royalties (hence the ~10% figure).
And you bring up a good point with the Aussie comparison. What happens to all of these “miracle jobs” during a commodities slump? What do we have to fall back on? The way things are going, EI will be a spurious “safety net”.
And the ramifications on the jobs created through externalities won’t be any better, especially if there is “forced” competition from those falling down from the commodity high.
I just get a terrible feeling when I consider the illogical rationale of whittling away diversity (thanks in part to FTAs) in the economy to focus on a few sectors, which are overly sensitive to exogenous demand (irrespective of the time-limited benefits). Especially when the margins are already tight to begin with.
The again, maybe my imagination is too pessimistic… and yes, I feel better now that you’ve called me “divisive”. Thank you 😉

Comment from Francis Fuller
Time: May 25, 2012, 5:25 am

@ Piccolo
You are welcome!

Re jobs during a commodities slump. My first career was in the oil industry. A fantastic, dynamic job in which I made a strong positive contribution and started a family.

Then came the global oil market crash of the late 1980s and my entire world collapsed. My employer closed but so did all other firms in the industry. Everyone was out of work, including all of my contacts. I could not understand what had just happened – one minute a bright, stable future, the next minute nothing.

Later, I learned that such a boom bust cycle is common in the oil industry and that the effects are made worse due to the capital structure of the industry.

I believe there is a present day risk of a similar bust and, due to the fact of the tar sands having the world’s highest marginal cost per bbl coupled with the fact of both low quality and high processing costs, that tar sands oil will be the oil to be squeezed out of global markets. Since Harper’s policies accept the destruction of industries and regions while priviledging his corporate base in the tar sands, the national outcome of such a bust would be extremely negative and long lasting. You cannot accept the slow destruction of a mfg sector and then expect to rebuild that sector from scratch in a matter of months.

So, I don’t think you are being pessimistic enough!!!

Still far too “divisive” though.


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