Many in Alberta’s oil and natural gas sector have looked to the Royalty Review Panel with trepidation. That fear might be misplaced if the panel recommends that the province have a best-in-class resource tax. With a cash-flow tax, the province can raise more revenue without discouraging new investment.
By Benjamin Dachis and Robin Boadway
The new Alberta government’s promise to launch a Royalty Review Panel has threatened to make a bad year for Alberta’s oil and natural gas companies look worse. But instead of adding to the nightmare caused by declining prices, the review could lead to a better tax design that could raise more revenue without discouraging investment.
Alberta collected $46-billion in non-renewable resource revenues between fiscal years 2009-2010 to 2013-2014. That represented more than 20 per cent of total government revenues over that time. Until the mid-2000s, the province relied mostly on revenue from natural gas. Now, most non-renewable resource revenues come from oil sands bitumen and conventional oil.
Alberta collects non-renewable resource revenues in two main ways. First, the province auctions the right to explore and develop oil and natural gas deposits. Second, once companies start producing, they pay the province a share of the value of production. That’s the royalty rate.
Alberta’s royalty system differs by the type of resource. Natural gas and conventional oil producers pay what is called a gross-revenue royalty. That gross-revenue royalty rate applies to the value of production well-by-well. The rate varies from zero to 40 per cent depending on the price of the product and the productivity and age of the well.
Gross-revenue royalties are simple to administer. But they have a downside. Gross-revenue royalties discourage companies from taking on some investments. Why? Companies that face taxes on their dwindling production might choose to shut down production early. Companies also might not pursue investments that would be profitable but for the royalties they would owe.
The Royalty Review Panel would be ill-advised to propose raising gross-revenue royalties. When Alberta last hiked tax rates on the gross-revenue royalties that companies pay to produce conventional oil and natural gas, the evidence shows that companies moved elsewhere.
Alberta’s oil sands tax is different. It is a cash-flow tax. The tax doesn’t apply to the gross value of a company’s production. Instead, the oil sands cash-flow tax applies to the cash flows of oil sands companies. Cash flows are a company’s revenues less its costs. Cash-flow taxes are better than gross-revenue royalties in reflecting cumulative costs resource companies face.
So how does Alberta’s resource tax system stack up? The oil sands cash-flow tax is close to this ideal. But the province could still improve the tax. The current oil sands tax puts limits on when companies can deduct expenses. Those limits discourage firms from looking for new, but risky, deposits.
The current royalties for conventional oil and natural gas, however, fall far short of the ideal tax. The Royalty Review Panel should look at how to make all resource taxes in Alberta cash-flow taxes. That is how the panel can help Alberta companies keep up with their global competitors. Australia levies a cash-flow tax on all its oil and natural gas companies. Norway does too. And Alberta can look across the Rockies for tax design tips: British Columbia’s mining tax has this setup too.
Extending the cash-flow tax beyond the oil sands would complement other changes coming to the province. Looming emissions policies may increase the costs of production. A cash-flow tax would lessen the cost of compliance to companies without affecting incentives to cut emissions.
If the province had a cash-flow tax for all resources, it would have no incentive to raise or change the tax rate in the future. The province would automatically share both the gains and the losses from oil price changes.
Many in Alberta’s oil and natural gas sector have looked to the Royalty Review Panel with trepidation. That fear might be misplaced if the panel recommends that the province have a best-in-class resource tax. With a cash-flow tax, the province can raise more revenue without discouraging new investment.
Robin Boadway and Benjamin Dachis are the authors of the C.D. Howe Institute study Drilling Down on Royalties: How Canadian Provinces Can Improve Non-Renewable Resource Taxes
Published in the Globe and Mail on September 25, 2015
