After premier Ed Stelmach’s
decisive election victory in early March, we will soon find out whether last fall’s fiscal onslaught was mostly political posing or whether Stelmach truly seethes with resentment toward Big Oil.

The fantasy that energy companies maintain virtually inexhaustible troves of loot is virtually ubiquitous. But it would be a bit strange if it is shared by the premier of a province that has risen to prosperity through the productivity of that industry.

The quick succession of last fall’s promise to increase royalties and the election may have served an important purpose. The royalty battle may have contributed to Stelmach’s election victory. Stelmach demonstrated to suspicious voters that the Progressive Conservative party isn’t merely the political wing of EnCana Corp. The oil industry had a chance to prove that hundreds of thousands of jobs and Alberta’s economy hinge on a fiscal regime that promotes rather than punishes investment and growth. Both sides called each other’s bluff; both realized what’s at stake and both blinked — at least, with one eye.

One of my colleagues, who is representative of the broad middle class in today’s Alberta, personifies the political situation. Like 53% of those who cast votes, he went for Stelmach. “After companies slashed capital budgets and some started laying off workers, I got spooked,” he explains. “It was clear the industry could only take so much. Yet the Liberals and New Democrats were promising even higher royalties.” Had Stelmach done nothing, my colleague would have voted for another party.

So much for the political angle. The proposed royalty regime is a technical and economic fiasco. With oil at US$110 per barrel, the oilsands megacorporations can pay more. But the new structure for conventional oil and natural gas is absurd, as if drawn up by one of those schoolteachers who thinks nobody should ever be allowed to lose — or win — decisively. On the one hand, it coddles low-rate, unproductive wells. There’s an argument to be made for that, if we’re to wring every last drop out of our aging reservoirs.

But to cover the reduced take, the new royalties are steeply graduated according to a well’s productivity. This creates a huge disincentive for highly productive wells. The royalties effectively punish exploration geologists for being good at their jobs, and will virtually wipe out deep natural-gas drilling — along with the specialized companies that have built their businesses around that.

Many smaller companies are already being frozen out by investors (some have even been taken over at fire-sale prices); medium-sized firms are diverting money to British Columbia and Saskatchewan; and large companies are shifting abroad.

Despite focus on the word “royalties,” Alberta’s system often derives half its revenue from competitive mineral rights tendering. These “land sales” are an indirect but effective proxy for collecting economic rents during high commodity prices. The system encourages investment, drilling and production.

But the new system attempts to collect rents directly — and has virtually annihilated land sales, along with possibly $3 billion in government revenue.

Stelmach has thereby wrought the worst combination of outcomes: collapsing mineral rights revenue, lower capital investment and abandoned drilling plans. He has unwittingly substantiated the Laffer Curve — the economic hypothesis that holds that higher marginal tax rates result in lower tax revenue. The concept is simple: a 100% tax on anything results in zero revenue. In the case of oil and natural gas, excessive royalties equal new wells not drilled. To learn this economic equation, Stelmach used 3.5 million people and a $220 billion economy as the props.

Although it’s already been a pricey lesson, there’s still an out. The royalty proposals don’t take effect until next year. Stelmach and his energy minister, Mel Knight, have promised they’d review the plan to ensure there aren’t any “unintended consequences.”

I’d say these were “easily foreseeable,” but the delay may yet save the day. IE

More of George Koch’s writing may be found at www.drjandmrk.com.