Finance Committee on Feb. 27th, 2007

[Marvin Romanow]

What I would add to it is that the way you create environments for people to make these investments is by creating a vibrant and healthy industry. If you do that, people will make the investments in conservation. That is the number one mechanism to reduce carbon emissions into the environment.

What I tried to frame was that we have an awful lot of this resource. At current production rates, we have 500 to 1,000 years of resources there. We are not at all at risk in over-developing this at the expense of future generations. This asset is needed for the world today and it should be developed today, and we have the skills in Canada to do it.

[The Vice-Chair, Liberal, Massimo Pacetti]

Thank you, Mr. Romanow.

Thank you, Mr. Del Mastro.

Here's a quick question, Mr. Stringham, based on the example you have in your slide, that the accelerated capital cost is going to be over a twenty-year period. It can run anywhere, actually, from a seven-year to a twenty-year period. Then I think you stated it again when somebody asked you a question.

Does this mean it wouldn't bother you if we changed the accelerated capital cost allowance, because it wouldn't make a difference in your business?

[Greg Stringham]

Oh, it would definitely make a difference in the business. He asked me whether it was a subsidy. It's the same cost that's being deducted, but to have it deducted—

[The Vice-Chair, Liberal, Massimo Pacetti]

It's in one of your slides, and one of the members asked you a previous question, to which you said that the accelerated capital cost is only utilized over a seven- to twenty-year period. You gave the twenty-year period, and up to a twenty-year period you're only matching the accelerated capital cost when revenues come in, depending on the project. So you don't obviously utilize all that accelerated capital cost in the first year.

[Greg Stringham]

That is correct. But what that does is level the playing field for all the mining industry, because if you have sufficient revenues within your company—

[The Vice-Chair, Liberal, Massimo Pacetti]

I understand the mechanics. Because time is limited here, I'm just wondering: then you wouldn't necessarily have a problem if we changed the accelerated capital cost to “useful life”.

[Greg Stringham]

Oh, absolutely. That would change the risk profile associated with all these projects, for sure.

[The Vice-Chair, Liberal, Massimo Pacetti]

Is that the case even though, according to one of your slides, it would take, let's say, from a seven-year up to a twenty-year period to write off some of your assets?

[Greg Stringham]

That's correct, because the recovery of that capital affects the financing, in particular for small Canadian companies.

[The Vice-Chair, Liberal, Massimo Pacetti]

Mr. Van Iterson, in your presentation, you stated that we should be moving to a green economy. How do we do that? We heard that it takes five to six years to set up a mine, so how do we move overnight? We can't just move to a green economy overnight, so how do we do it so that there's the least amount of pain possible for the economy?

[Andrew Van Iterson]

I'm not suggesting that we can do it overnight, but we need to start launching a long-term plan to do it. Mr. Caccia touched on one of the important elements. We need to harmonize our tax system and our fiscal policy with long-term environmental sustainability. We should move to a point where our market prices incorporate full environmental costs and health costs. For example, when we drive a car, we hurt the health of people around us, but we don't pay that cost. Our friends incorporate that cost.

[The Vice-Chair, Liberal, Massimo Pacetti]

This is the last question.

Also in your presentation, you were saying the operating costs were as high as 64% in 1995 when you compared it to a barrel of oil. You say it now represents 44% in 2006. Is there a number we should be using, or should we just say that it doesn't matter what the cost of oil is going to be?

[Andrew Van Iterson]

Could you repeat that?

[The Vice-Chair, Liberal, Massimo Pacetti]

In your presentation, you have the operating costs in 1995 at 64% when compared to the sale price of a barrel of oil. In 2006, they represent 44%. Does that really matter? Do we need to set a rate? Do we say a tax incentive, tax subsidy, tax policy, or call it what you want, should be based on the selling price of a barrel of oil, or should we just do away with it? I know you're going to say to just do away with it, but should there be a price point there?

[Andrew Van Iterson]

I would say the investments should be justified on their economic basis alone, but the industry is saying there are risk issues and capital investment issues. If their relative cost has dropped by 30%, then I think that substantially reduces the justification for the incentive, subsidy, or whatever they want to call it.

[The Vice-Chair, Liberal, Massimo Pacetti]

This is a complex issue.

Thank you very much to the witnesses for taking time out of your day.

Thank you to the people out in Calgary. It worked out well and we hope we have this success on the next panel.

If we can break for five minutes, we're going to start again when I get back. We want to end the second panel ten minutes before time expires, to discuss what we're going to be doing and if we have to write a report or not.

Thank you.

The meeting is suspended.

[The Vice-Chair, Liberal, Massimo Pacetti]

Good afternoon.

Pursuant to Standing Order 108(2), the committee is conducting a study on taxation of the oil sands industry.

I'm going to allow the witnesses five minutes, if possible.

For the people from Calgary with whom we're video-conferencing, we have good sound and video, so I don't think there should be a problem.

If we can start with Mr. Wilkins, from the Sierra Legal Defence Fund, you have five minutes, please.

[Hugh Wilkins, Staff Lawyer, Toronto Legal Team, Sierra Legal Defence Fund - Toronto]

Thank you very much, Mr. Chair.

Ladies and gentlemen, thank you very much for having me here today. The main message of my presentation focuses on accountability—accountability to present and future Canadians, as well as to the international community.

We have heard strong pronouncements from government about taking action on climate change, but when we get to the real indicator of action, the finances, we see a system of subsidization and tax breaks that does not match the rhetoric. The Canadian development expense program, the Canadian exploration expense program, and the accelerated capital cost allowance bring together a system of subsidization that is not only unnecessary, given the profitability and growth of the oil sector, but one that is also irresponsible, in that the programs are counterproductive to the goal of reducing greenhouse gas emissions. It is time that words be matched with action. It is time for accountability.

Because many environmental goods and services, such as carbon sequestration through the maintenance of our forests, are not generally valued or traded in Canadian markets, we fail to provide appropriate signals that might otherwise contribute to efficient allocation and sustainable resource use. The 2001 Nobel Prize in Economics winner Joseph Stiglitz emphasizes that these services must be accounted for through mechanisms such as carbon emissions trading so that these environmental services are recognized by the market, and so that the maintenance of ecosystem integrity and the benefits generated therefrom can be rewarded. Without such mechanisms, even if they are aware of the services provided by ecosystems, they're neither compensated for providing these services, nor penalized for reducing them.

The OECD defines “subsidy” as “any measure that keeps prices for energy consumers below market levels or for energy producers above market levels, or that reduces costs for consumers or producers”. The International Energy Agency defines “energy subsidies” as “any government action that concerns primarily the energy sector that lowers the cost of energy production, raises the price received by energy producers or lowers the price paid by energy consumers”.

Economic and financial interventions are powerful means to regulate the use of environmental goods and services. In their worst form, subsidies can substantially increase rates of resource consumption and increase negative externalities.

In its recommendations to lessen the severity of these problems, the UN millennium ecosystem assessment stressed the need for the elimination of perverse subsidies that promote excessive use of environmental services and the reallocation of these subsidies to payments for non-marketed environmental services. These sorts of recommendations are not new. In 2004, the OECD called on Canada to systematically review its environmentally harmful subsidies in sectors such as energy, and to phase out environmentally harmful subsidies, including subsidies in the form of tax incentives for the resource-based economic sectors. Moreover, under the Kyoto Protocol, Canada committed itself to implementing measures for the progressive reduction or phasing out of subsidies in all greenhouse-gas-emitting sectors.

Today, the federal government is unfortunately going in the opposite direction, through its subsidies to the oil industry. Not only do these actions not account for the value of the environmental goods and services lost due to the destruction of the boreal forests above the tar sands, they provide dramatic incentives for the acceleration of greenhouse gas emissions through high-emissions-intensity tar sands oil extraction and through consumption of the oil produced from these activities. Instead of accounting for environmental goods and services, we are rewarding their neglect.

In his recent report for the U.K. Treasury, former World Bank chief economist Nicholas Stern addressed the issue of the cost of increasing greenhouse gas emissions and the issue of energy subsidies. He emphasized that these subsidies “are a source of economic distortion and loss” providing “a strong historical bias toward the more polluting fuels.”

Investors, operators, and consumers in a liberalized energy market should face the full cost of their decisions, but this is not the case in the Canadian energy sector. Federal subsidies distort the market in favour of existing fossil fuel technologies despite the greenhouse gas and other negative externalities that they create. As noted by Stern, these subsidies compound failures to internalize the environmental externality of greenhouse gases and affect the incentive to innovate by reducing the expectation of innovators that their products will be able to compete with existing choices. They also detract investment from more sustainable energy supplies and conservation initiatives.

Canada has signed and ratified the Kyoto Protocol, committing this country to reduce its greenhouse gas emissions by 6% below 1990 levels by 2008 to 2012. However, ladies and gentlemen, as you well know, our emissions have increased dramatically since that time, and we need to take more effective action.

Since 1997, when the Kyoto Protocol was created, the federal government has spent more than two dollars in tax subsidies to oil companies for every one dollar spent on meeting its Kyoto targets. Canadian oil and gas companies have been making billions of dollars in record profits over the past several years, yet these companies annually collect about $1.4 billion in government subsidies.

[The Vice-Chair, Liberal, Massimo Pacetti]

Can you wrap up, please?

[Hugh Wilkins]

It is time for accountability, sustainability, and responsibility in tax policy relating to the tar sands. We need to substantially reduce the incentives provided to oil companies, especially as regards the development of the tar sands, replace these with measures that take into account the value of environmental goods and services, and focus on renewable energy supplies.

Thank you very much.

[The Vice-Chair, Liberal, Massimo Pacetti]

Thank you.

From Club Sierra du Canada, we have Monsieur Langlois.

[Jean Langlois, National Campaigns Director, Sierra Club of Canada]

Thank you, Mr. Chair.

Good afternoon, everyone.

I'm going to start by emphasizing that we're making two recommendations today and that they are related to each other.

First, we are recommending advancing a sustainable energy future for Canada by implementing a capital cost allowance for the oil sands industry that is consistent with conventional oil and natural gas, that is 25 percent, rather than 100 percent. We talked a lot about this this morning.

Second, since that gives us some fiscal flexibility, we recommend that this retained benefit be reinvested to accelerate growth in the renewable energy and energy efficiency sectors rather than simply being absorbed.

The Green Budget Coalition proposes specific measures for doing this.

We also heard this morning a vision for Canada that saw our economy being almost exclusively dependent on fossil fuels for the next 100 years. I would posit that it's not the role of the Parliament of Canada to sit back and be told what Canada will look like in 100 years.

In fact, that's not what other governments have done. That's not what other signatories to the Kyoto Protocol have done. I'll refer committee members to the Sierra Club report on Kyoto that was issued a couple of weeks ago, in which we outlined the steps taken by the U.K., Denmark, Sweden, and several other countries that are kicking their petroleum habit and are meeting and exceeding their Kyoto targets.

This remains the goal of Canadians and one that I think can be achieved if our fiscal policy, as we've heard over and over today, matches the goals of Canadian society.

I'll leave my comments at that. Thank you.

[The Vice-Chair, Liberal, Massimo Pacetti]

Thank you.

From the Canadian Imperial Bank of Commerce, we have Mr. Plexman.

[Robert Plexman, Managing Director and Senior Oil and Gas Analyst, Canadian Imperial Bank of Commerce]

My name is Robert Plexman, and I'm the senior oil and gas analyst and managing director at CIBC World Markets. I've worked at CIBC for the last 11 years, and I've worked as a petroleum analyst for over 30 years.

My responsibilities as an oil and gas analyst are to determine the fair stock market value of the shares of the larger Canadian oil and gas companies. As far as accountability goes, everyone is accountable to somebody. I'm accountable to CIBC World Markets' institutional and retail investing clients.

I want to thank you for your invitation here today.

My understanding is that the purpose of today's meeting is to review the issue of tax incentives, specifically the accelerated capital cost allowance. How I can help today to make a contribution is to provide a capital markets perspective, as you haven't had someone talk about the capital markets yet, and to deal with this issue of whether the industry needs this incentive or not.

Before I get into the details, let me take 30 seconds to tell you how I do my job, just so that you have a clear understanding. My analysis is based on current trends as well as on my expectations for the future. All the conclusions are based on publicly disclosed information. l don't know what the accelerated capital cost allowance balances are for these companies, or their CEE or their CDE. We are looking at the industry from a bit of a distance, but we normally come pretty close to the mark.

Please don't ask me about ABM fees or interest rates on VISA, because I'm in the investment side of the bank, not the commercial side.

As far as the issue goes, yes, tax incentives are controversial, but I think the most important factors affecting the pace of the Canadian oil sands development are the following. First is the oil price and the oil price outlook. Oil prices drive everything else. Costs, of course, are an important consideration, and I will return to that, and expected returns. I hear a lot of people talking about how much money this industry makes, but it's just like when you go home at night: the money is one thing; it comes in and it goes out, and you try to get a return on your investment. The return is key. This is a big industry with big volumes and big dollars. That is an important part to remember.

In my own work in looking at oil prices, if we start with the oil price, I'm assuming that the west Texas oil price--which is the benchmark for North America--averages U.S. $60 per barrel going forward. In other words, the world tomorrow is going to look like the world today, and we adjust it for inflation going out.

Just for your information, though, over the past 12 months that oil price has been as high as U.S. $77 a barrel, and last month we saw it pushing U.S. $50, so it's a pretty wild ride here. And these oil operations, if you go to the oil sands, they're trying to do their planning around these parameters, so they are looking for stability. We can get into more discussion about the thinking behind the price outlook, but the important point that you take away here is that oil is a highly volatile commodity in more than one way.

As far as valuing the sector, my preferred metric is to calculate the internal rate of return of these projects. In this way we combine these factors. We start off with what we think oil prices are going to be. We make projections about what we think the costs are going to be, and then recognizing that all this happens in the future, we adjust for the time value of money. What we've provided for you today is a summary of a 96-page report we put out last month on the oil sands, which I think is a factor in why I got invited here today. I appreciate that. The point is that when we add up the numbers in today's environment, we think that if we're going to start out to build a new oil sands plant, we'd probably get about a 13% return on investment. That's the internal rate of return. That's not bad. It's not spectacular. It used to be higher.

A couple of years ago, when we were calculating these numbers, when we were using the high oil price forecast and not factoring in the rising cost, the numbers were in the mid-teens to the high teens. But oil is like any other commodity: when prices rise, costs do too. This is what's happening now. That is a very important point to keep in mind.

If we were to use a $45 oil price, we'd be crazy to start up one of these plants. That is the minimum. We calculate about a 10% internal rate of return, the financial term over the cost of capital. That's when these projects start to make sense.

Basically, if I'm going to do one of these things, I'd have to be pretty confident that oil is going to average $50 a barrel. That's when I'd start. At $60 a barrel, I'd get a 13% return. Is that worth the time and aggravation? Maybe. However, the idea of this industry making windfall gains might have been the case a couple of years ago, but my numbers don't show that at all.

I should also say that these estimates are about as precise as I can get them. We're taking them to two decimal places, but we're starting with assumptions and trying to be realistic.

Let me make one last point. One of the unintended effects of changing the accelerated capital cost allowance may be that it has a more negative effect on the Canadian companies. When you look at this industry, you have big players, big names. Every big oil company wants to be in this business. The Exxons and the others are much bigger and much stronger financially, operationally, and technically. They have different time perspectives. The Canadian companies are competing. We have a great Canadian presence and a number of the smaller companies are involved in this. There is a risk, from my point of view, that you could see these Canadian companies put at a disadvantage as this resource is developed, and I don't think that's the intention here.

I'll end with that, as I've probably used up my time.

[The Vice-Chair, Liberal, Massimo Pacetti]

Thank you, Mr. Plexman.

From the video-conferencing in Calgary we have the Pembina Institute.

I understand, Mr. Raynolds, you're going to speak.