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Albertans missing out on the benefit of soaring oil prices

Posted by mhudema on June 19, 2008

Royalty cap ensures firms aren’t paying top dollar for this natural resource

Diana Gibson and David Thompson
Thursday, June 19, 2008

Oil prices didn’t always used to make headlines, but they have now quadrupled in the last four years and doubled since just last summer.

In fact, prices have been increasing so fast that it’s hard to find decent graphs showing oil prices over the long term.

Oh, there are many price graphs. But most are terribly out of date. Many were produced prior to March, when oil cruised past the $100/barrel “psychological barrier.”

Remember that barrier?

No doubt oil prices will fluctuate in the future. They will go down. And then up, and much higher than they are today. Growing demand and a limited global supply will see to that. It’s not a question of if, but when.

What will happen with Alberta’s royalties when oil is much more expensive?

Well, it appears that the government’s new royalty framework, published last October and not yet in effect, is already well out of date.

When it adopted the new framework, the government said it was “fundamental and necessary change to current royalty structures. It creates a system that is more sensitive to market value … .”

What does “sensitive to market value” mean? It means royalty rates rise when oil prices rise.

However, the current cap maxes out royalty rates when prices reached $30 per barrel, and last October oil was hovering around $80 to $90 per barrel.

As the government’s own royalty review panel said, the $30 cap is “so low that royalty rates are no longer sensitive to market conditions. They do not rise or fall with price changes because prices are consistently above the caps.”

The government’s new framework will raise the rate cap to $120 per barrel in order to “ensure” royalties were sensitive to price. The document repeats the price sensitivity mantra no less than 12 times in 19 pages.

Of course, oil is now $130 per barrel. Or maybe near $140. Depends on the day. Anyway, we’re already above the cap, and thus the new rate would be completely insensitive to new higher price.

Note the “would be.” The greater irony is that the new cap doesn’t take effect until January of next year. Right now the cap is still only $30 per barrel.

And for natural gas, the same problem will likely emerge.

Gas has soared by 50 per cent in the last five months to $11.60/GJ. The new $16.59/GJ rate cap may well be of date before it kicks in.

Economist Pedro van Meurs, who has regularly worked with the energy industry and government, told the Calgary Herald this spring: “They are not capturing the proper economic rent … You leave a bundle (of money) on the table. It is just unbelievable.”

That money doesn’t stay on the table for very long; it seems energy multinationals break earnings records every year now. And the majority of company revenues in the Canadian energy extraction sector are controlled outside of Canada.

It seems the government has realized that the $120 new royalty rate cap may not be such a good idea.

In late April, when oil was approaching the $120 cap, Energy Minister Mel Knight was facing heat from MLAs on both sides of the legislature.

He said: “If oil is above $120 a barrel and stays above $120 a barrel for an extended period of time, then the province may have to take action to ensure that Albertans continue to receive their optimum value.”

So what to do — raise the cap to a higher price? Well, if a cap is a bad idea at $120, will it be a good idea at $150? How about when oil passes $180? Or $200, as many economists now predict?

Short answer: no. A royalty rate cap is a bad idea, at any price. Period.

Let’s get back to basics. The people of Alberta own the resource, and we should be getting top dollar when we sell it. Not a “fair share,” not a “balanced” deal, but top dollar. That’s how owners think.

And if we can sell at a higher rate when the price goes up, then we should do so. Can you imagine any corporation consistently selling at less than full price? If it did, the shareholders would fire the directors, and rightly so.

The provincial government owes it to the people of Alberta to sell our natural capital at the best rate it can.

The government needs to maximize royalties, so we can have savings for the future, when our energy resources dwindle. The first step is getting rid of the royalty rate cap.

David Thompson is an independent public policy consultant.

Diana Gibson is Research Director of the Parkland Institute, a policy think-tank based in the University of Alberta

The Parkland Institute is a charitable, non-partisan research network which is part of the Faculty of Arts at the University of Alberta

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