FRED CURATOLO

The Great Royalty Debate

Think the royalty debate started with Stelmach? Think again. Albertans have been debating (and raising) royalty rates for nearly 80 years.

By David Finch

We do get our pound of flesh,” quipped Premier Ralph Klein about Alberta’s oil royalty rate in 2006. Of his government’s in-house royalty review he said, “I don’t know if it was completed or not, nor do I give a tinker’s damn whether it was completed or not. I’ve always been satisfied that our royalty regime is proper and right.”

That same year, former premier Peter Lougheed advised Albertans to “think like an owner.” Some 30 years earlier, Lougheed’s government had conducted its own review. “What is a fair return?” he’d asked. “This is a sale of a depleting resource that’s owned by the people. Once a barrel of oil goes down the pipeline it’s gone forever. It’s like a farmer selling off his topsoil.”

Ernest Manning was premier during the 1950s boom. “In our view, we were going to get the most for our money,” said Manning of his government’s royalty rate.

The two most recent royalty reviews, released in 2006 and 2007, provoked a great deal of rhetoric. Emotions ran high. Debate ensued. But a sense of perspective was missing from the discussion. The Alberta government has changed royalty rates many times over the last 77 years, ever since Alberta gained control of its natural resources in 1930.

Now, as oil companies cry foul over the latest proposed royalty increases, and their investors (as well as a certain segment of the public) accuse the government of greed, Klein’s words echo. How did royalties go from a public right to an unfair imposition on industry—a pound of flesh? 

A royalty is a fee that the owner of a natural resource charges for the right to develop the resource. Economists define a royalty as “economic rent,” but a royalty is not “rent” in the popular sense of the word—a fee for using an apartment, for example—because the petroleum is being consumed, used up. A royalty is not a tax. Taxes are levied to cover the cost of providing services like police and fire protection, education and health care. Royalties have nothing to do with costs and are levied simply as a right of ownership.

Further muddying public perception, mineral resources in the US—the origin of so much of the original corporate ownership in Alberta’s oilpatch—belong to individual landowners. In Alberta, mineral rights are not owned by individual residents but by the government on behalf of the residents.

Communal ownership in Canada dates to the 1870s. The federal government held resource rights before Alberta became a province. To entice settlers to the prairies, Ottawa paid for the railways and other infrastructure and recovered its costs by collecting lease payments on land, income from the sale of the mineral rights and royalties on natural gas (but not petroleum). 

In 1930, Alberta gained control over its natural resources. As a result, in a province of committed individualists, the largest source of government revenue comes from communally held oil and gas resources. Royalties and other natural resource revenues (land sales, leases, taxes and other fees) allow the Alberta government to avoid charging a sales tax and maintain low rates of personal and corporate tax.

Alberta’s natural resources are our birthright, our inheritance. The people of Alberta hand over our petroleum inheritance to oil companies to exploit its value, and the only direct benefit to the people is the royalty payment.

The United Farmers of Alberta levied Alberta’s first-ever royalty—5 per cent—in 1930. The Social Credit party replaced the UFA in 1935 and changed the royalty rate by order-in-council to 10 per cent on April 1, 1936. Just five years later, they revisited the rate again. In a 1941 editorial in the Daily Oil Bulletin, Carl Nickle chastised the government for its proposal to raise the rate to 12.5 per cent, even though landowners in the United States were charging the same rate and the Canadian Pacific Railway and the Calgary & Edmonton Corporation were charging 12.5 to 15 per cent royalties on the oil produced on their lands. “While it is reasonable that the province obtain a larger return from promotion,” Nickle wrote, “it is vital that the increase not be obtained in a manner that will tend to disrupt the confidence of a great mass of Canadians—including thousands of Albertans—in Alberta Oil as an investment. Disrupting confidence could very well ‘kill the goose that laid the golden egg,’ seriously curtail further development of Crown leases and gradually wipe out the return to the Crown from royalties and rentals… It’s up to the government to keep the goose laying.”

Alberta oilmen went on strike and refused to pay the higher rates. Because they had signed their leases with the federal government, they considered Alberta’s order-in-council increase “questionable” or even “illegal.” In July 1941, they submitted cheques to the Alberta government on the basis of the old rates. 

The legislature debated the royalty issue as a committee of the whole in early 1942 and passed legislation confirming existing rates but promising a review every decade. Independent Calgary MLA J.C. Mahaffy objected to the changes on behalf of the oilmen in his riding who had federal leases, but Alberta Minister of Lands & Mines Nathan Tanner insisted such leases would be subject to regulations in force from time to time.

Though oilmen and politicians argued royalties throughout the 1940s and 1950s, the Social Credit government was in the driver’s seat. In 1979, then-retired premier Ernest Manning recalled, “It was always our conviction that we should have adequate flexibility in the terms of the leases under which the development took place to control the resources in the interests of Alberta and Canada, without any question.”

The Second World War caused Alberta oil production to rise from just over 1 million barrels of oil per year in the 1930s to a high of 10.1 million barrels in 1942; it dropped to 6.8 million barrels by 1946. But the discovery of oil at Leduc in February 1947 irrevocably changed Alberta history. Notably, oil and gas revenue to the government went from less than $1-million in 1945 to almost $42-million in 1950, from less than 2 per cent of the annual budget total to almost a third.

In 1951, royalties came up for review on the decadal schedule established in 1941. Again industry lobbied against any change to the royalty rate. “The oil industry has presented strong (and sound) arguments against any material boost in Alberta Crown royalty during the period of urgent need for growth of reserves, rising costs and taxes,” wrote Nickle. “Arguments just as strong (though far less sound) have been presented by some Albertans in favor of boosting royalties to the full limit permitted under existing leases.”

This cry fell on deaf ears, and Manning’s government increased the maximum royalty rate to 15 per cent. The average was 12.5 per cent. “[This] deal is probably as tough as could be imposed on the oil industry, and still leave incentive for exploration and development,” wrote Nickle. “The policy has been progressively made tougher, within the framework of the government’s moral and legal commitments to the riskers of capital, as discoveries in Alberta made the province increasingly attractive to the oil seekers.”

The Manning government went on a spending spree in the 1950s, priming the province for its decadal boom and bust rollercoaster. Alberta left its “have-not” status behind for good; in 1955, the province collected $225 per citizen in income from all sources, compared to the national average of $125. 

Manning was unapologetic to the end of his days for his government’s tax-and-spend policies. He paid off the provincial and municipal debts left over from the 1930s, and spent the annual surpluses on numerous programs.

A 1956 poll showed that Albertans desired more spending on social programs and infrastructure. Education was listed as “important” to 73 per cent, medical services to 54 per cent and aid to municipalities to 45 per cent, while only 13 per cent wanted a citizens’ dividend. In spite of the poll, the Manning government passed the Oil & Gas Royalties Dividend Act in 1957, setting aside one-third of all energy royalties to be paid to Alberta residents in the form of $20 dividends in 1957 and 1958—the equivalent of about $151 today.

The government discontinued the oil dividend in 1959. Manning, explaining how the poll influenced his government: “Interestingly enough, the majority said ‘No.’ They would prefer the money to be spent on capital expenditures. So that was the time in Alberta when we launched a program of building homes for senior citizens. In one year, we built 50 senior citizens’ homes all over Alberta.”

The boom of the 1950s stalled in the early 1960s when oil markets became glutted. Ottawa asked Alberta to lower its royalty rate. Manning believed this was to make Alberta’s expensive oil competitive with cheaper oil east of the Ottawa River valley, an area served with oil from the Middle East and Venezuela.

He refused. “We said ‘No way,’” he recalled. “We’re not getting an unfair portion for our people in our royalties, and we’re certainly not going to subsidize the price of oil just to extend our market.’” Manning did, however, conduct an extensive review of government oil and gas regulations, including the royalty rate.

In 1961, an Oil and Gas Law Revision Committee of nine men—five from government and four from industry—was given a year to make its recommendations. Hubert Somerville, a career civil servant who had risen to the rank of deputy minister of mines and minerals, chaired the committee. 

The final report sided with industry. “So that the high level of confidence that industry has enjoyed in the Government may continue, your Committee suggests that the royalties for the next 10-year period should follow as closely as possible the rates prevailing during the past 10-year period.”

Manning raised the royalty rates anyway. Nickle noted the new rates were “higher than industry wanted, but lower on oil than first proposed by the Government. Thus, frank discussion between representatives of government and industry has in this case brought a degree of compromise.” The new royalty rate was complicated—they always are—but the net effect was a maximum 16.66 per cent royalty, up from 15 in 1951. The length of new leases was set at 10 years—reduced from 21 years—and the government made other changes in order to encourage exploration and development.

Why did Alberta take an additional $12-million, including lease fees and other oil income, when the industry was hurting? Oilweek magazine noted that the government’s rising costs and a decline in revenue were responsible.

In 1965, Alberta built a new railway to the Peace River area to accommodate settlement. Serendipitously, the oil industry discovered a new oilfield at Rainbow Lake in 1966, triggering more exploration and development in northern Alberta and the Northwest Territories. Over the next decade, production nearly doubled, access to markets improved and the price of oil increased modestly.

In 1971, Alberta’s young, urban premier Peter Lougheed and his newly elected Progressive Conservative party decided to raise the take from the oil industry. By a lot. Though income from petroleum royalties was still growing, income from land sales and rentals was falling off as oil companies cut back on exploration and development in the face of an international oil glut. Overall, government revenue from the petroleum industry was in decline.

When the Canadian Petroleum Association (CPA) heard that the new government was proposing a Natural Resources Revenue Plan to collect $50-million to $90-million more from industry, it hired consultant George Dunlap to review the situation. “The question will be how much should the petroleum industry be required to contribute,” Dunlap wrote. “The CPA brief should recognize the industry’s obligation, it should be factual and realistic (don’t cry wolf).”

Instead, the CPA’s submission emphasized the need to keep the Alberta oil patch competitive, that the resource was a declining asset, that costs were on the rise and that new reserves were becoming increasingly scarce. It concluded “that an increase in the royalty rate on production of oil and gas in Alberta is not in the best public interest or in the interest of the Government of Alberta.”

Given that the maximum royalty rate had been set by contract by the Social Credit government, Lougheed did not increase it. Instead, he proposed a new “reserve tax”—a tax on petroleum in the ground (or “unproduced” petroleum) that allowed the government to increase total government share beyond 16.66 per cent.

The CPA asked for a meeting with the premier on the subject of natural resource revenue. “We appear to be at a turning point in the history of the oil and gas industry in this province,” wrote Dunlap. “It is respectfully submitted that the Government should not come to a final decision on this most important matter without having further discussions with representatives of the industry.”

The premier agreed to meet with the CPA executive to discuss the reserve tax, as well as incentives industry wanted which would have reduced the provincial share. But Lougheed was unambiguous about his bottom line. “We would… like to make it abundantly clear that we are committed to the parameters of obtaining, by way of fair return to the province, an equivalent royalty of between 19 and 23 per cent before any offsetting exploratory drilling incentive system.”

An Oilweek editorial by G. Barry Kay asked: “Can Alberta really be serious?” Of the new tax he said, “…there can be little doubt that it would sound the death knell of Alberta’s goose with the golden egg.” He predicted it would create uncertainty and impose on the industry, and cringed at the idea that “the industry will have to at least face the possibility of annual hikes, especially as taxable reserves decline.”

And so the Lougheed government revisited the 1942 royalty review system. The legislature sat as a committee of the whole and called for oil companies and industry associations to send witnesses to testify, under oath, in front of the Legislative Assembly. The final decision on the royalty rate, new fees and taxes was made by cabinet behind closed doors. Though Lougheed decided against a straightforward royalty hike, by the end of the 1970s the government’s total take from all sources of natural resource income had grown to a share comparable to what OPEC took. A government statement read: “The Plan enables the Provincial Government to obtain for the citizens of the Province a fair and reasonable return from the recovery of this depleting resource.”

From the 1950s to the early 1980s, Alberta claimed an ever-larger portion of the resource income pie while new discoveries, access to additional markets, growing production and wildly escalating world oil prices increased the size of the pie. The 1980 price of oil peaked at C$44.66—adjusted for inflation, $108.67 in today’s currency. 

Then came the bust. During the downturn of the 1980s, Alberta cut royalty rates and other oil and gas revenue programs by $5.4-billion in response to the crisis. They worked closely with industry to save as many jobs as possible. Through the 1990s, the Conservative government continued to cooperate with industry.

Former premier Ralph Klein’s reference to the petroleum royalty as a “pound of flesh” reflected a new outlook. The term, of course, refers to the vengeful creditor in Shakespeare’s The Merchant of Venice who demands the lawful repayment of his debt in a grisly form—a pound of flesh carved from the living debtor. Klein’s alliance with industry emboldened oil companies in their sense of entitlement to a publicly owned resource.

Since 2000, natural resource income has once again ex-ceeded personal income taxes; in 2005 resource revenue was more than $14.3-billion, or more than triple the $4.7-billion collected in personal income tax. The value of our communal asset has steadily risen, to a point that in early 2007, oil reached $100 per barrel. Premier Ed Stelmach’s 2007 royalty review revealed that royalty rates had slipped for many years, even while total government oil and gas revenue increased because of the economic boom. Stelmach recommended new rates—to come into effect in 2009—that he predicted will earn Albertans an additional $1.4-billion per year.

Far from a given, these proposed rates could change depending on many factors, not the least of which is the outcome of the 2008 provincial election. How will the players in the great Alberta oil game characterize the process this time? 

High costs, a strong Canadian dollar, government budget surpluses, a booming economy and a fashionable distrust of large government may give credence to the idea that the province is trying to claw an unreasonable or even unfair “pound of flesh” from the body of an already wounded and struggling petroleum industry. Industry has “cried wolf” yet again, but perhaps this time the wolf is at the door. After all, the pie can’t keep growing forever.

On the other hand, a high oil price, two decades of shrinking royalty rates, increasing overall production and ready access to thirsty oil markets may convince the provincial government to once again change the rules of the oil game and slice a larger piece of the resource income pie on behalf of Albertans.

Historically, the petroleum industry has always resisted government efforts to increase the royalty rate. And, historically, rates have always gone up—until the 1980s and Klein. This oppositional stance is just a negotiating tactic industry uses against an owner who always has the power—and the right—to collect an increased share. 

David Finch has observed the oil industry for decades. His latest book, Pumped: Everyone’s Guide to the Oil Patch was published by Fifth House in Fall 2007. 

 

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