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Why a taxman losing money is a wake-up call

In the dog-eat-dog world of capitalism, losing money is considered the impecunious businessman's problem, often accompanied with Schadenfreude dished out by more fortunate moneymakers. But when the collective amounts being lost by the private sector are in the billions of dollars, the fiscal pain is everyone's issue, including the government.

Alberta's fiscal trouble, as highlighted today, is just the proverbial ground zero that will radiate across the land into other budgetary speeches to come.

The numbers are stinging: federal and provincial coffers will likely be short up to $11-billion this year due to the discounted pricing of oil and gas (see Figures 1a, 1b and 2).

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As discussed in last week's column, the root of the problem is that Canada's oil and gas industry is forfeiting an estimated $50-billion in upstream revenue this year. The mega loss is a direct result of selling hydrocarbon products to Americans at deeply discounted prices to world markets.

The provinces and the federal government are now acutely aware of the situation plaguing what has grown to become Canada's largest product-selling industry. For a sense of scale, the sale of upstream oil and gas commodities is now over 10 times larger than that of all agriculture and all forestry products in the land. As such, like big dominoes on a small table, one teetering chip in the western sedimentary basin is all it takes to impact fiscal matters up to a national scale.

Governments gather three streams of revenue from oil and gas companies: land sales, royalties and current taxes. The first two are pulled into provincial purses, while the last is the fed's primary collection mechanism. All cascade down from industry's top-line revenue.

Royalties dominate the provincial take. Canada's major hydrocarbon producers are Alberta, British Columbia, Saskatchewan and Newfoundland and Labrador. Because 75 per cent of all oil and gas production comes from Alberta, the biggest royalty deficit is being felt there. Newfoundland and Labrador is the only jurisdiction not suffering from price discounts and royalty shortfalls, because offshore oil from plays like Hibernia are not land-locked and hostage to a narrow market served by constrained pipelines.

As in any business, price discounts hammer cash flow and profitability. And it's on profitability that taxes are calculated, which is why current tax forfeitures in Figure 2 are multiples more than what will actually be realized by governments: $1.6-billion (estimated actual) versus $5.1-billion (assuming no forfeiture) in 2012; and an estimated $1.6-billion versus $5.3-billion in 2013. And it's from gathered taxes that federal equalization payments are calculated. Clearly, there will be less-than-expected to equalize.

Diminished cash flow at the producer level also cascades into the oilfield service industry and on downstream and peripheral businesses. Motel owners that host oil and gas workers pay taxes, too, as do rental car companies and equipment manufacturers. Exploration and development budgets are already being crimped in 2013, which means the peripheral tax take – otherwise known as the multiplier effect – from all sorts of businesses that serve the oil and gas activity will be falling short.

Similarly, land sales dry up when commodity prices are low and investment dollars are being tightly rationed. Case in point: just look at B.C. where $2.5-billion in natural gas land activity has evaporated to de minimis levels between the peak of 2008 and now. What company wants to buy more exploratory land when discounted natural gas is being exported to the U.S. for no financial return?

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Finally, Canadians view royalties as a provincial matter – in other words, largely Alberta's good fortune or misery, depending on circumstance. Yet this revenue stream is a wholly Canadian issue, because provincial accounting shows that all royalties are being spent on infrastructure and public services, effectively like stimulus money. Companies and employees on the receiving end are taxed, which is why Alberta has the highest "fiscal capacity" in the country. And that's why Alberta will be the largest contributor to the expected $16-billion in equalization payments the federal government expects to transfer to the six "less prosperous" provinces – P.E.I., Nova Scotia, New Brunswick, Quebec, Ontario and Manitoba – in 2013-14. Given the shortfalls in Alberta, the emphasis should clearly be on the word "expected."

Perversely, this is all good news. Massive price discounts on oil and natural gas are not just a regional nuisance, but also now a national concern. When everyone owns the problem there is much greater likelihood the predicament will be resolved sooner than later. When a businessman loses money it usually solicits a yawn, but when the taxman starts losing money, it's a wake-up call.

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About the Author

Peter Tertzakian is chief energy economist and managing director with Arc Financial Corp. in Calgary and provides analysis on technology and energy-related businesses to fund managers and portfolio companies. More


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