WASHINGTON—The premier of Alberta, Canada, made another visit to Washington D.C. last week, pleading again for U.S. approval of the Keystone XL oil pipeline, which would carry Alberta’s heavy crude to refineries on the Texas coast.
Without expanded access to markets in the United States and beyond, Premier Alison Redford said, her province’s oil sands crude is selling for discounted prices—and that is creating big problems for Alberta’s budget, which relies heavily on oil royalties.
“It has really had an impact on our revenues, you know—we’ve expected that probably this year alone because of that differential that we are seeing about a $6 billion drop in revenues,” Redford said at the Brookings Institution on Tuesday.
It is a bit of a novelty for Washington to host the leader of a petro state controlling one of the richest oil reserves in the world, come to plead poverty as part of her sales pitch.
But in Canada, it was a familiar refrain—and one that many who study the province’s management of its natural resources dispute.
The province’s budget problems are not due to any discount in the price of bitumen or other fuels from the tar sands, they say, but to the way Alberta has subsidized the oil industry by charging next to nothing in royalties for the oil.
Designed to stimulate production, the subsidy has served that purpose well. Production has grown to 1.8 million barrels a day, and the industry forecasts it will double or triple in the next few decades.
But the production boom is outstripping pipeline capacity, and prices have not been as high as the government expected. So Alberta’s royalty income is falling short, leaving one of the richest regions on the continent facing a $2 billion budget deficit.
The problem has been likened to a spiraling addiction to a cheap and plentiful drug—but the addict, in this case, is the dealer.
“Alberta has a substance-abuse problem,” said an analysis published in March by the School of Public Policy at the University of Calgary, which called on the province to wean itself from oil revenues. “The substance is fossil fuels, and the province has become hooked.”
A vicious circle of subsidy and overproduction is behind much of the pressure to build ever more pipelines to reach new markets—including the intense demand to win U.S. permission for the Keystone XL.
Although the world’s many royalty systems can’t be compared directly—there are too many variables in the type of oil, the methods of drilling and mining, the tax systems and so on—Alberta’s royalties are among the lowest charged for access to any of the world’s major oil reserves.
Depending on world oil prices, they range from 1 percent to 9 percent during early phases of production. Even after companies have recouped all their capital and operating costs, royalties are still just 25 percent if oil prices are relatively low. At the highest possible level, which has never been reached, Alberta’s take would be roughly half of what Norway gathers from its oil production.
Even the United States, where subsidies of fossil fuel production are often criticized, is not as generous as Alberta has been.
Alberta expects to eventually see a huge payoff from its oil sands expansion.
One study predicts that if oil prices rise, tar sands production continues to increase, and producers recover all their initial investments, Alberta will collect $1.2 trillion in cumulative royalties by 2045.
Redford says world demand will provide an ever growing market for Alberta’s oil, and that if Keystone isn’t built, Canada will build other pipelines to the Atlantic, the Pacific, or even to the Arctic to ship out its crude.
But her critics in Canada say the province is moving in the wrong direction, and that the royalty regime is largely to blame..
“On every metric, whether fiscal or environmental, there is too much investment going into the tar sands,” said David Campanella of Calgary’s Parkland Institute, a public policy think tank. “The province would be much better off slowing down tar sands development and raising royalties.”
Royalty System Benefits Industry More Than Public
Parkland reported last year that the royalty regime “ensures the vast majority of wealth goes to the private oil companies rather than the public.”
Economists say that ideally when the public owns a resource, as Alberta controls its fossil fuels, private companies that exploit the reserves should be allowed a reasonable return on investment and a margin to cover exploration and other risks. In classical theory, the public should collect the lion’s share of the revenues.
But in Alberta, the opposite has been the case. Producers are charged exceptionally little for the reserves until all their costs have been recouped. Even after projects are completely in the black, only modest royalties are paid to the government.
In 2010, the province collected just $4 billion, even though the value of tar sands output was more than $36 billion—about the size of the province’s annual budget. Since 1986, “roughly 6 percent of the total value extracted from the tar sands has gone to the public through royalties and land sales,” the Parkland report said.
In another report, describing the history of the province’s royalties, Alberta Energy said rates put in place in 1997 “reduced the share of oil sands revenues flowing to the government in the form of royalties.”
The formula was revised a bit in 2009, but the changes haven’t yet made much of a difference. That year, the government’s share reached a new low point.
Here is how the formulas work:
Before the moment technically known as “payout,” when producers have captured all their sunk costs, rates vary on a sliding scale, from one percent of revenues when oil prices are above $55 a barrel up to 9 percent when prices reach $120 a barrel. After payout, the rate starts at 25 percent of net revenues and reaches 40 percent when the price of oil is $120 per barrel. (Recent prices have been roughly $100 per barrel.)
Even though it has long argued for higher royalties, the Parkland Institute also has recommended that Alberta get more of its revenue from other sources, such as income taxes.
“Even if the government raised royalty rates tomorrow, the problem of fiscal instability and long-term unsustainability would remain,” Parkland said in a February report on Alberta’s fiscal woes.
Keystone Alone Wouldn’t Solve Alberta’s Problems
Canadian economists and political scientists say Alberta’s current fiscal fix is due largely to flaws in the royalty system, not to any discount in the price of tar sands crude due to lack of pipeline capacity. As long as royalties remain low, the pipeline is less important to Alberta as a way of lifting prices, they say, than as a way of lifting production volumes.
They point out that bitumen always trades at some discount because it is an inferior fuel, that its price fluctuations are not unusual, and that the industry has been raking up profits in good part because of the generous royalty breaks.
Peer-reviewed economic research by economist Andre Plourde shows that changes in the royalty arrangements over the years have left the government more vulnerable than the industry to revenue shortfalls during price declines.
“They should have set up a system that was better able to absorb shocks,” said Plourde, who has formally advised the government on royalties and is the leading independent expert on the matter.
“Fundamentally the government take is not much higher than it was” decades ago, he said.
The low royalty rates have caused a variety of other problems, Plourde added. At times, overbuilding by the industry has caused its own construction costs to soar. And when projects are repeatedly expanded, that puts off the day when top royalty rates come due.
According to the Canadian Energy Research Institute, it will be another decade before most of Alberta’s tar sands projects reach payout and trigger the higher royalty brackets.
Another economist who specializes in the royalty policy, Kenneth J. McKenzie of the University of Calgary, cautioned against exaggerating Alberta’s fiscal woes, which he said are a convenient excuse to bolster the province’s case for new pipelines.
“Alberta’s fiscal situation is certainly the envy of any state or province in the world,” McKenzie said. “It is by no means a fiscal train wreck. The bond markets love Alberta.”