The C. D. Howe Institute is out this morning with a press release entitled, "Raising Oil and Gas Royalties Does Not Benefit Provincial Coffers." A complete analysis of the accompanying 30-page paper -- featuring many graphs, tables and regressions -- will take time. But here is my initial take.
The Institute correctly notes that provincial oil and gas revenues comprise both royalties paid on production and bids paid for the right to explore and produce. There is a trade-off because companies will bid more for resource rights in jurisdictions that offer lower royalties and hence higher potential profits.
The executive summary states, "We recommend that provinces reduce their reliance on royalties and increase their reliance on bonus bids in the conventional oil and gas industry."
However, the paper is extremely thin on proposals to improve the auction process to ensure that it generates more revenue. One suggestion is to "subsidize explorers to find new -- and publicly available -- geological information" (page 19).
The C. D. Howe Institute is advocating a faith-based approach. It wants governments to slash royalty rates, boost exploration subsidies, and hope that these giveaways prompt energy companies to bid more in provincial auctions.
These C. D. Howe Institute directors are involved in extracting Canadian oil and gas:
- Murray Edwards, Canadian Natural Resources
- Al Monaco, Enbridge
- Henry Sykes, MGM Energy Corp.
- Kent Jespersen, La Jolla Resources International (and more)
Others are from related industries such as mining, construction and real estate in Alberta and Saskatchewan.
Auctions are an important component of provincial resource revenue. However, there are often too few bidders to make them truly competitive. Start-up companies face liquidity constraints on how much they can bid before getting into production.
Furthermore, bids are severely discounted because the resource's value is unknown prior to exploration and development. Even given perfect information, private companies would apply a higher discount rate than governments to future income.
For these and other reasons, governments have enacted royalties rather than just relying on auctions. A possible improvement would be to have companies bid to pay higher royalty rates (beyond the statutory minimum) instead of up-front cash. However, the C. D. Howe Institute does not consider such reforms.
The C. D. Howe press release quotes one of the authors as saying, "A shift in emphasis toward auction revenues would have the added benefit of reducing government revenue volatility resulting from short-term energy price shocks."
Anyone who has looked at Alberta or Saskatchewan provincial budgets knows that auction revenue is far more volatile than royalty revenue. After all, bids reflect the incremental exploration and development in a given year while royalties reflect the ongoing flow of production from established wells.
The Institute's counterintuitive claim is entirely based on one province: "Although Alberta and Saskatchewan count auction results as revenues when the auctions close, British Columbia's bonus and lease auctions revenues are spread out equally over a nine-year time horizon" (page 22).
That is an argument for "modified accounting of resource revenues," but not for more reliance on auctions. Indeed, it would be equally possible and desirable to smooth out royalty revenues over a longer time horizon (e.g. through provincial savings funds).
Unfortunately, the C. D. Howe Institute's agenda appears to be slashing oil and gas royalties rather than collecting higher and more stable public revenues.
This article was first posted on The Progressive Economics Forum.
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