…. Or Why Canadian Upstream Oil and Gas Is
More Attractive to Investors Than Its American Counterpart
A recent 450-page study shows why it makes economic sense for investors to choose Canadian upstream oil and gas. As Petroleum Economist recently reported, “Canada has
systematically and significantly improved the attractiveness of its upstream terms compared with the US over the last 15 years,…”.
The study, World Rating of Oil and Gas Terms: Volume 1- Rating of North American Oil and Gas Wells, is a joint undertaking by Van Meurs Corporation, PFC Energy, and Rodgers Oil and Gas Consulting. Barrows Company and Ernst & Young provided technical assistance.
This particular volume provides data, analyses and insights, i.e., “detailed investor-favourability ratings of 188 fiscal systems for oil and gas wells in 10 Canadian provinces
and 25 US states.”
The authors’ conclusion: Canadian fiscal systems as applied to upstream oil and gas are way more attractive to investors than those in the United States.
A paired analysis of fiscal regimes of the two countries’ prime producing jurisdictions, namely the province of Alberta (Canada) vis-à-vis the state of Texas (US), is
particularly revealing. To quote the report – “The gulf in difference between the two countries’ regimes is truly remarkable considering Canada is the exporter and the US the importer – with a desire to wean itself of expensive imports.”
Sliding-scale Royalties vs. Flat-scale Royalties
The province of Alberta has adopted a royalty system that enables a producer to pay lower royalties when the price of the commodity is low and/or when production from the well is correspondingly low. This sliding-scale royalty system has proved very attractive to investors who are able to avail themselves of downward adjustment mechanisms. Thus the applicable royalty payments range from a low of 0% and a high of 40% for oil; and a minimum of 5% to a maximum of 36% for gas.
The state of Texas, on the other hand, has opted for a flat scale for royalties, typically 25%, regardless of commodity price and/or well production fluctuation.
Severance or Production Taxation
Alberta has earned very high investor favourability ratings in terms of severance or production taxes: the province does not – repeat– does not have a severance tax; same is true for all other Canadian jurisdictions. Contrast this to the state of Texas which charges a 4.6% severance (or production) tax rate.
The other significant point of differentiation is property taxation where Alberta and the rest of Canadian jurisdictions only charge minimal property taxes; compare — the state of Texas levies a 2.5% property tax “ ..based on the net present value of the well, which fluctuates with oil and gas prices.”
Corporate Income Taxation
A more telling disparity is in terms of corporate income-tax rates: Canada has significantly made corporate taxes more palatable to investors such that from a typical 45% federal-provincial tax rate (1997) it is expected that by next year (2012) the federal-provincial tax rate will plummet to 25.5%.
How about the US? Well, they are maintaining the average combined federal-state income tax rates at 38.5% — a difference of 13.0 percentile points. Proportionately (and roughly), this translates to doing business in Canadian upstream oil and gas cheaper by 34% compared to the US!
Overall “Government-Take” Burden
The bottom line is that when combined altogether – royalties plus severance or production taxes plus property taxes plus income taxes plus the minutiae of all other payments to different levels of government concerned – the configuration of comparative fiscal regimes leads investors to a widely disparate set of Canadian vs. US total-government-take-burdens.
The study shows that even in terms of a simple arithmetic average the
divergence in total government-take-burdens is highly noticeable: 42% for oil
in Canada, vs. 65% in the US; 61% for natural gas in Canada; 79% in the US.
In an earlier blog I echoed Ezra Levant’s main points in making a case for Canadian oil (and gas) being the ethical choice.(See his book for a very comprehensive but engagingly readable discussion on the subject).
Also, I had previously noted in two other posts (PLENTY OF OIL: 1.4 TRILLION BARRELS, AND COUNTING, and Why Policy is Important to Global Energy
Supply Stability) that in many instances the “ situation-above-ground” (namely,”…peace-and-order situation, socio-political climate, and of course the obtaining policy and regulatory framework..”, etc.) could turn out to be the decisive factor to bringing petroleum reserves to actual production.
Now we know a very important element of that policy and regulatory framework is the obtaining fiscal regime.
And truth to tell, I believe ordinary investors would be strongly influenced by the fiscal system leading them to choose to operate in a business environment that offers a lower total-government-take-burden; the lower the burden, the higher the rate of return.
I daresay, subject to being proven wrong, that between ethics and economics the ordinary investor is likely to choose the latter — if they cannot have both at the same time. My own wish, however, as seems to be the clamor of the nascent “Occupy Wall Street” popular movement (and its variants) is for investors (particularly rich investors)to be more ethics-minded.
Notwithstanding, the study shows that because the total government-take-burden is lower in Canada the attractiveness of its upstream oil and gas investment opportunities is significantly greater than in the US.
So here in Canada, arguably, investors have the best of both worlds: its
upstream oil and gas is definitely the ethical and economic choice, hands-down!
Is there a downside to this attractive fiscal regime, especially from the perspective of ordinary Canadians – not necessarily oil-and-gas investing Canadians? I bet there is. Let me hear from you even as I prepare a follow-up post on the subject.