Alberta Distortions

I am big on big investment spending.  I’ve argued for years that weak business investment undermines our job creation, our productivity, our incomes, and our competitiveness.  I’ve proposed lots of policy measures to stimulate more investment spending: public as well as private.

But what’s happening in northern Alberta is enough to nauseate even a Soviet-esque advocate of mass capital accumulation like myself.

Just last week alone, 3 companies announced $38 billion in new capital spending in the oil sands, stretching out for a decade or so.

$38 billion in one week.

In the auto industry, we sweat bullets for years trying to nail down investment in an auto assembly plant that might cost $1 billion.

38 times that much is committed for northern Alberta in one week.

I know what the macro consequences of $38 billion in one week will be:

  • higher dollar
  • higher wages for the fraction of one percentage point of the national workforce employed in the northern Alberta construction industry
  • higher inflation emanating from Alberta
  • higher interest rates from the Bank of Canada (and a still higher dollar)
  • higher greenhouse gas emissions

Alberta is already the largest CO2 emitting province in Canada — more than Ontario, with 3 times the population.  This will grow dramatically with all these plants.

The unbelievable scale of the Alberta investment boom reflects some unique features of oil sands:

  • their immense size and geographical disperson, allowing this incredible piling in of simultaneous megaprojects
  • the unbelievable profitability of digging this stuff out of the ground, paying a 1% royalty, and selling it for three times as much as it cost to produce
  • the insatiable hunger for the resource from America, whose strategic planners quite explicitly view the resource as “theirs” (thanks to NAFTA)

The only risk these companies face with these massive investments is how far over budget their construction costs will run.  But with returns on equity for oil sands producers averaging about 50 percent (that’s 50 percent), there’s an awful lot of room for overrun but still turn a huge profit.

What’s happening in Alberta is an utter distorion of economic rationality that, if it were being perpetrated by any government, would be denounced violently as unsustainable and corrupt.  But since it’s private business creating this distortion, it must be fine.

Unlike financial bubbles, which you will know pop sooner rather than later (with predictable effects), I am not sure what will bring this hyperexpansion to an end.  Regional labour shortages are pinching, but they can always find more workers somewhere (imported from China soon).  There’s no financial capital constraint: even with the current credit squeeze, the banking system will eagerly conjure up new spending power to finance projects this lucrative.  There’s no resource constraint (the oil sands won’t encounter that for decades).  There’s no meaningful limit on the environmental destruction these things are allowed to wreak (on top of the CO2 emissions, there’s massive deforestation involved in the strip mines — which adds to climate change from another direction by reducing natural carbon absorption).  There’s no limit to the market for the product (it’s called America).  And even if oil prices collapsed to half their current levels (something no oil analyst predicts), oil sands plants would still be a license to print money for the Encanas of the world.

In short, the only thing that can stop this unbelievably destructive shift –  one that is remaking our federation, our currency, our industrial structure, and our environment — is deliberate regulatory efforts to reign in oil sands development.  Lots of Albertans are opening up to this conclusion.  In the rest of Canada we should be pushing much harder, because we pay the costs without so many of the benefits.

I think this is a structural issue that will leave its mark on our country for the next 50 years.

5 comments

  • Nice post, Jim. And nice to have you back in Canada and on the blog.

    Instead of grappling with the Alberta issue, our premiers are having silly distractions, like the non-issue of “trade barriers” (alleged “distortions”) and the “solution” of TILMA, placed on their agendas (TILMA would actually diminish the capacity for regulation by provincial governments). And the feds are nowhere on this either, even as the Bank has raised rates on the basis of inflation in Alberta.

  • Nice post. I generally agree, but do wonder if an expansion of this magnitude is physically possible given the constraints on water supply and energy inputs now that natural gas supplies are running down.

  • Raising the royalties on oil-sands extraction would not only help slow development to a more appropriate pace, but would also yield huge provincial revenues.

    A regulatory strategy to slow development might pit Alberta’s interests against the rest of Canada. A high-royalty strategy would pit the people of Alberta against the oil companies, while still providing the benefits of slower development to the rest of Canada.

  • If you’re in the business of making oil and cars, and if the price of oil relative to cars quadruples, then the optimal response is to shift productive resources from cars to oil.

  • Theres a line up of foriegn oil companies just waiting to get in on the action. look at the big picture there are three trillion barrels of oil recoverable by todays technology we know where it is, how to get it, and howmuch it’s worth, compared to conventional oil where they drill ten dry holes for every producing well.
    conventional oil is on it’s way out, the oilsands are the future – 88 dollars a barrel is nothing compared to what you will see in 5 years – 1.50 a litre will seem like the good old days

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