That's correct.
Evidence of meeting #70 for Finance in the 39th Parliament, 1st Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was industry.
A recording is available from Parliament.
Evidence of meeting #70 for Finance in the 39th Parliament, 1st Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was industry.
A recording is available from Parliament.
February 27th, 2007 / 12:55 p.m.
Marlo Raynolds Executive Director, Pembina Institute
That's correct.
1 p.m.
Executive Director, Pembina Institute
Thank you.
Good afternoon, ladies and gentlemen. Thank you for allowing us to appear before you today.
My name is Marlo Raynolds, and I am the executive director of the Pembina Institute. I am joined by Dan Woynillowicz, a senior policy analyst and an expert on the oil sands. Normally our senior economist, Amy Taylor, would be here today, but unfortunately she is out of the country. It takes two of us to replace our one senior economist. She did submit a written submission to the committee, and I hope you all have copies of that.
As many of you know, the Pembina Institute is a non-profit organization, often described as a think tank, focused on energy and environment issues. We are a national organization with just over 55 staff across six offices. We grew up in Alberta, and we consider ourselves to be still very much Alberta-based.
Today the focus of our discussion is the tax treatment of the oil sands and specifically, the accelerated capital cost allowance. We respectfully recommend to the committee that the Department of Finance eliminate the 100% accelerated capital cost allowance for the oil sands and return the rate to the standard 25%. We believe that the 100% ACCA for oil sands is an irresponsible use of the taxpayers' money.
The oil sands sector is mature by all measures: by the presence of all major multinational oil companies; by its international recognition; by the scale of capital investment, which was over $40 billion over the past 10 years; by the scale of approved projects and associated capital in the order of $40 billion to $60 billion over the next decade; by today's production of 1.2 million barrels per day, a target that was set for the year 2020 but achieved in the year 2004; by the fact that approved projects today will take us beyond two million barrels per day; and by the fact that all the companies with high stakes in the oil sands are among the most profitable companies in Canada. For all these reasons, it is very clear that the oil sands sector is a mature industry.
There is a clear establishment of the industry and there are strong drivers for continued growth, including continued demand for oil from our neighbours to the south and from our Asian partners. We have the second largest proven oil reserves in the world, second only to Saudi Arabia. We are the single largest oil reserve in a democratic country, and we have highly skilled workers who want to live in our country because it is a modern and safe country. For all these reasons, it's very clear that we have very strong investment opportunities in Canada in the oil sands sector.
In a market-based economy, there will be winners and losers. Given all these favourable market conditions, there will surely continue to be investors who will win. In other words, access to capital and investments in the oil sands will continue to be strong.
Canadians should be equally if not more concerned about developing this resource too fast, without adequate protection of the environment. The oil sands are not only the fastest growing industry in Canada, but are also the fastest growing source of greenhouse gas pollution in Canada. Any subsidy to the oil sands is really a subsidy to the production of pollution.
The 100% ACCA for oil sands, when established, was severely flawed in its original design. Any targeted subsidy to a particular sector should have a sunset clause. It should end when economic conditions have evolved to the point where the industry has matured. Because such a sunset clause was not included, the committee is now having to investigate the matter to ensure that taxpayers are getting value for their investment.
In 1995, the cost of production of the oil sands represented 64% of the value of a barrel of oil. In 2006, only 44% of the value of a barrel of oil was spent on production. Given the profits of oil sands companies--in the order of $2.6 billion in 2006 for Imperial Oil; $2 billion for Shell Canada--these companies no longer need the help of the taxpayer. Clearly, profits are good. It is why individuals invest. You and I no longer need to add to those profits with our tax dollars, especially since a growing number of shareholders are not Canadian. In other words, Canadian taxpayers are subsidizing profits for shareholders outside of Canada.
It is therefore our recommendation that in the interest of the responsible use of taxpayer dollars, we eliminate the 100% ACCA for oil sands and invest those dollars in 21st-century energy sources, such as low impact, renewable energy.
Thank you very much.
1 p.m.
Liberal
The Vice-Chair Liberal Massimo Pacetti
Thank you, Mr. Raynolds.
We have, from TD Securities Inc., Mr. Roberts.
If you can keep it to five minutes, I'd appreciate it. Go ahead.
1 p.m.
Bill Roberts Vice-President, Investment Banking, TD Securities Inc.
Thank you, Mr. Chairman, and good afternoon, honourable members of the committee and fellow speakers.
I'm pleased to be here today to discuss the current economic environment surrounding Canada's oil sands industry and some of the trends that are expected to impact its future development.
With recently high oil prices of $60 U.S. per barrel and above, and given the level of activity in the oil sands sector, one would think that the economics for oil sands projects are strong. However, I can tell you that the returns the project sponsors are seeing today are not materially different from those they saw seven years ago when oil was trading at $20 U.S. per barrel.
First, I work with TD Securities, which is the most active investment dealer in the oil sands. TD has led approximately $8 billion of debt and equity financings for new oil sands projects over the last seven years, is a top trader of oil sands stocks in general, is a leader on providing research on the sector, and has advised on over 25 oil sands financial advisory assignments over the past two years.
Canada's oil sands have recently taken on more significance as a result of security-of-supply concerns, low geological risk, and a growing scarcity of new oil resources worldwide. Given Canada's diminishing conventional oil production, the oil sands are expected to become an increasingly large percentage of Canada's overall oil production. Despite this increased significance and resulting rapid pace of development, the oil sands sector has recently been showing signs of slowing, including delays in announced development plans, with the start-up of a number of projects being pushed back one or more years, weakening equity capital in M and A markets, and asset transaction prices that have declined from the pace of a year ago.
This slowdown has been the result of a number of factors, including: increasingly overheated construction and labour markets; higher capital and operating costs; higher natural gas costs; reduced diluent supply, which is used for blending with bitumen from oil sands for transportation; concerns over water access; concerns over the potential costs of complying with a future carbon dioxide emissions system; concerns over our changing fiscal regime, both in terms of royalties and taxes; and a higher Canadian dollar.
These challenges to the development of the oil sands have resulted in increased risks of significantly lower returns. Assuming long-term oil prices in the $40 U.S. per barrel range would render many of them uneconomic, and that sort of number is what a number of companies will use in their long-term planning.
Although no new projects have yet been terminated, continued pressures resulting from these factors will most likely yield that result. At the very least, a number if not the majority of announced projects or expansions will not proceed according to their currently disclosed time frames.
Oil prices have been a significant catalyst to the growth in the oil sands; however, they have weakened over the last 12 months, and industry cannot rely on continued increases in commodity prices to justify billions of dollars of investment in the sector.
Furthermore, the gap between light and heavy oil prices has widened significantly over the past three to four years, and therefore the price the oil sands producers receive for their bitumen production has not kept up with increases in global oil prices. While the future growth of oil sands production may provide assurances of a secure source of long-term supply for Canada, that production may also further depress heavy oil prices as the market adjusts to the significant increase. Oil sands producers will also have to bear this risk.
Along with increasing prices, capital costs have increased dramatically, with the last three major projects completed experiencing cost overruns of their initial budgets of 60%-plus.
Among oil sands projects with abilities to upgrade bitumen to synthetic crude oil that were completed between 2001 to 2004, capital costs averaged approximately $33,000 per daily flowing barrel of synthetic crude oil production. The average announced capital costs for similar projects that have been recently built or are currently under development has increased 125% from that level, to $74,000 per daily flowing barrel of synthetic crude oil production.
The cost increases for some projects have been well above that level. For instance, the industry's latest project to start development, Shell's Athabasca oil sands project, announced capital costs on its next expansion phase, expected to be producing by 2010, of over three times the cost per barrel of daily production in its first phase, which was completed in early 2003.
In situ projects that used to cost $10,000 per barrel of bitumen production now cost $25,000 to $30,000 per barrel of bitumen production. Project returns of 10% are now difficult to come by, and with the continued increase in costs, they're becoming harder still. Capital cost pressures have become particularly damaging for oil sands projects in the past, with projects such as Fort Hills and Petro-Canada's Edmonton refinery conversion being mothballed three to four years ago, primarily as a result of higher capital costs.
Likewise, operating costs have also increased dramatically over the last several years. Suncor, for instance, announced cash operating costs in 2006 of approximately $22 per barrel, which is approximately 80% higher than its operating cost of about $12 per barrel in 2004.
Based on the various oil sands projects that have been announced, the Construction Owners Association of Alberta has estimated that the number of construction craft personnel among industrial construction projects over $100 million is expected to increase from 16,000 people currently to 36,000 people in 2010. This is expected to result in continued pressure on operating costs.
In conclusion, while several factors have encouraged the development of Canada's oil sands, after many years of largely remaining dormant, significant cost increases and other industry pressures are already threatening the survival of a number of these projects. Through TD Securities' capacity as a financial advisor to a number of these companies, we are seeing these pressures continue to mount, and they will ultimately result in only some of these projects getting built. We are seeing huge warning signs in the industry--not necessarily public--that convince us that the pace of development is going to be much slower than currently anticipated. The continuation of existing federal tax and provincial royalty regimes, which have been key to encouraging development of Canada's oil sands in the face of much longer project lead times and much higher capital costs, typically, than conventional oil projects face, may therefore continue to be very significant to assuring the industry that a stable fiscal system exists in Canada and that it is worth bearing the risks of these increased economic pressures.
1:05 p.m.
Liberal
The Vice-Chair Liberal Massimo Pacetti
Thank you, Mr. Roberts. You're way over on your time, and I thought you were going to conclude.
We are ahead on time, so I want to ask a quick question and just a yes or no answer would be helpful.
If a barrel of oil is at $80--I think I understood $60 is what Mr. Plexman and Mr. Roberts were saying, but let's say it's at $80--do we keep the accelerated write-off?
I'll ask Mr. Wilkins, yes or no?
1:05 p.m.
Staff Lawyer, Toronto Legal Team, Sierra Legal Defence Fund - Toronto
I think it's more advisable to invest our money—
1:05 p.m.
Managing Director and Senior Oil and Gas Analyst, Canadian Imperial Bank of Commerce
Yes.
1:05 p.m.
Liberal
The Vice-Chair Liberal Massimo Pacetti
Okay, and if that was down to $40 a barrel...?
Mr. Wilkins, yes or no?
1:05 p.m.
Managing Director and Senior Oil and Gas Analyst, Canadian Imperial Bank of Commerce
Yes.
1:05 p.m.
Liberal
The Vice-Chair Liberal Massimo Pacetti
Thank you. That hasn't solved anything.
Mr. McKay, six minutes.
1:05 p.m.
An hon. member
I think the answer is “on division”.
1:05 p.m.
Liberal
John McKay Liberal Scarborough—Guildwood, ON
I think you could have applied that second vote.
Mr. Plexman, as you know, what's really behind this whole thing is a sneaking suspicion on the part of some Canadians that the oil sands are making like bandits and making an enormous amount of money and really we should get more of it. It's not too much more subtle than that.
I want you to turn to page 10 of your presentation, “Oil Sands Economics”, “Canadian Oil Sands 2007 Guidance For Syncrude”. I want you to help me read this, because it seems pretty impressive.
The revenues of the oil sands--this particular project, I take it--were $2.3 billion. Interestingly, they had purchased energy costs of a little over 10% of their gross revenues--an interesting statistic. Their production costs were about 44% and their gross margin was 56%--pretty healthy. Then they take off their non-production costs, and it includes some royalties and cash taxes and “other”--I'm not quite sure what that means--and that brings them down to total costs of 63%, a cash margin of 37%, which is $881 million. Then you have something called Capex--I don't really understand what that is--so you have a pre-cashflow of $621 million, or 26% of your revenues.
Am I reading this correctly to say that they only have used up 39 million to 44 million barrels on a mid-point production of 40 billion barrels? Am I reading that correctly?
Anyway, your final comment is “COS's expected 2007 cash-on-cash return is 239%...”--that kind of catches your attention--“which we think should rank near the top when compared to conventional oil projects.” It seems to me that on page 10 you've captured the heart of the argument here, and that is, that looks like a pretty fine return. Do I have your presentation correctly, as a general concept? If so, can you give me some explanation as to how, even if we killed the accelerated capital cost allowance today, that would impact on that financial statement?
1:10 p.m.
Managing Director and Senior Oil and Gas Analyst, Canadian Imperial Bank of Commerce
That's a great question. I'm glad you asked me that one, because the thing about the Canadian oil sands is they have a 37% interest in the Syncrude oil sands project. I don't know if you had the chance to visit that one, but that's the second oldest. It has been in business for about 30 years, has a lot of history, and is very profitable. If you look at the bottom here, you have the existing oil sands operations, which are ranked at the top of our list in terms of returns, so that makes them highly desirable investments. Everyone wants to be in this business.
Does the accelerated capital cost allowance impact this return? Well, probably not at this point, because Syncrude is paying taxes. Did it help them get to this level? Yes, probably during their evolution it did.
What makes these numbers work—this is what you have to understand about oil sands—is that they take that raw bitumen and convert it, in the case of Syncrude, into a barrel of high-quality light oil. That's the upgrading process. They add a lot of value to that barrel. They mine it and upgrade it; and as well, what you're looking at with oil sands is large reserves. I forget the exact number of reserves at Syncrude, but when you depreciate those reserves over their life, you get a low investment cost. So if you put the fact that they maximize the value, maximize the revenue, and put that against the cost, which is spread over millions of barrels, the economics look great.
This is mainly historical, and this is the whole key to the oil sands. You have to separate the accounting from the economics of it. For those companies that are in business, this is why they want to be in oil sands. What we're talking about here with the accelerated capital cost allowance are the projects that are to be built. Syncrude and Suncor, to a certain extent, are benefiting from history, because they've been in this business a long time. They have established their resource base over a long time. It's tough to compare these numbers to a new project.