Industry Committee on June 11th, 2007

[The Chair, Conservative, James Rajotte]

Okay, if you could keep your presentations to about five minutes, it would be very helpful to the committee. As you can tell, there are a lot of questions from members. So could we have five minutes from Finance and five minutes from Natural Resources.

Ms. Potvin.

[Lise Potvin]

Good afternoon. I am here today to provide the committee with a brief overview of federal taxation as it applies to petroleum products, including gasoline.

Federal taxation of petroleum products consists of two elements. First, there is the federal excise tax levied at a fixed rate on certain petroleum products. Second, the goods and services tax, or GST, is applied on a general basis to petroleum products in a manner similar to most goods and services consumed in Canada. I would first like to discuss the excise tax and then proceed to discuss the GST.

With regard to excise taxes, the federal government levies excise taxes on gasoline, aviation gasoline, diesel and aviation fuel. There are no federal excise taxes applicable to other kinds of fuel, such as home heating oil, propane, natural gas or electricity.

The federal excise tax on gasoline and aviation gasoline is levied at a rate of 10¢ per litre, while the federal excise tax on diesel and aviation fuel is imposed at a rate of 4¢ per litre. Those are fixed amounts that do not vary with changes in the retail price of fuel.

This means that federal revenues from federal excise taxes are a function of the volume of fuel that is sold, but not the retail price. Accordingly, the recent increase in retail price for gasoline and diesel fuel does not have a direct positive impact on federal excise tax revenues. In fact, to the extent that higher pump prices cause motorists to drive less and reduce their consumption of motor fuels, federal excise tax revenues could actually decline.

Revenues from federal excise taxes form part of the Consolidated Revenue Fund and are used to support a broad range of programs and services for Canadians. There is also a link between excise tax revenues from gasoline and recent federal investment in infrastructure.

Budget 2007 announced an investment in infrastructure of more than $16 billion over seven years. Including the funding that was announced in budget 2006, federal support under its long-term plan for infrastructure will total $33 billion from 2007-08 to 2013-14. A key element of this plan to invest in infrastructure is a gas tax fund, which provides significant stable long-term funding for municipalities. Budget 2007 included $8 billion to extend the gas tax fund at $2 billion per year from 2010-11 to 2013-14. Notionally based on an amount equivalent to 5¢ per litre of the federal excise tax on gasoline, this gas tax funding represents more than one-third of the $33 billion investment in infrastructure.

That concludes my overview of federal excise taxation of fuel. I would like to now turn to the goods and services tax.

The goods and services tax, or GST, is levied on most goods and services consumed in Canada, including petroleum products such as gasoline, diesel fuel, home heating oil, natural gas and propane.

The GST is levied on an ad valorem basis, on the final selling price for goods and services. Maintaining a broad base allows the GST to be levied at a relatively low rate and makes compliance with the tax easier for businesses. Of note, the GST was reduced from 7% to 6% on July 1, 2006.

One of the key features of the GST is that businesses are able to claim full refunds, called input tax credits, with respect to the GST they incur when purchasing goods and services that are used to make taxable supplies. This means that most commercial enterprises are able to recover the GST they pay on their purchase of petroleum products through a full input tax credit, including on gasoline and diesel fuel. For consumers there is a GST low-income credit, which is designed to help offset the impact of the GST for those most in need.

Because the GST is levied as a percentage of the final price, GST revenues vary with changes in the final selling price of goods and services. For example, an increase of 10¢ per litre in the retail price of gasoline will lead to an additional amount of GST of roughly 0.6¢ per litre.

This additional GST does not necessarily imply that the overall fiscal impact on federal revenues is positive. To the extent that increased spending on one commodity, such as gasoline, results in reduced consumption of other goods and services, the net impact on aggregate GST revenues may well be negligible.

In addition, increases in the selling price of certain goods, including gasoline and home heating fuels, affect the Consumer Price Index, which in turn results in increased benefits payable by the Government of Canada under programs such as the GST Low Income Credit, the Canada Child Tax Benefit, Old Age Security, and the Guaranteed Income Supplement.

That concludes my remarks on the federal taxation of petroleum products.

I would be very pleased to address any questions you may have concerning this topic with my colleagues Geoff Trueman and Sandy MacLaren.

[The Chair, Conservative, James Rajotte]

Thank you very much, Ms. Potvin.

Mr. Brown, I believe you'll be presenting on behalf of the department.

[Howard Brown, Assistant Deputy Minister, Energy Policy Sector, Department of Natural Resources]

I'm going to ask my DG, petroleum resources, Phil Jennings, to do the presentation, if that's okay.

[The Chair, Conservative, James Rajotte]

Sure.

Mr. Jennings.

[Philip Jennings, Director General, Petroleum Resources Branch, Department of Natural Resources]

Great. I've sent out a presentation deck. Hopefully everyone has a copy of it.

Good afternoon, and thank you for inviting us here today to discuss gasoline prices and the factors that influence them.

First, I'd like to talk briefly about the policy context within which gasoline markets function in Canada.

By agreement with the western provinces, the Government of Canada has been committed to a market-based energy policy since 1985. This means that Canada relies upon competitive markets to determine prices. The basis of the policy is that prices set in free and competitive markets represent the best signal to producers and refiners in terms of their investment decisions and to consumers in terms of the type of energy they use and how they use it. This market-determined pricing of oil helps to ensure that sufficient supplies are available at the most competitive prices. In the absence of a national emergency, the Government of Canada has no jurisdiction over the direct regulation of energy pricing. Under the Canadian Constitution, the provinces have this authority.

Turning now to the factors that influence retail gasoline prices, crude oil remains the single largest cost component of the price of gasoline at the pump. This is stating the obvious, but any developments that affect supply and/or demand for crude oil will affect oil prices. This includes geopolitical events that constrain production or, alternatively, put supply at risk; weather related events, such as a warmer or a colder winter; and the commodity market, which reacts to perceived supply and demand changes.

However, gasoline markets have their own supply and demand pressures that also influence the retail price, in addition to consumption taxes. These factors are often directionally the same as crude oil prices but can occasionally move in the opposite direction. Examples of this were the recent refinery problems in North America, as well as Hurricane Katrina, when you had an effect on the gasoline prices but not on the price of crude oil.

The next slide compares the major components of the average gasoline price in Canada for the years 2003 and 2006. There are four principal components that make up the pump price, as you can see on the graph. The first is crude oil, which, as I said, is the largest component and accounts for almost half the price in 2006. Consumption taxes at the federal, provincial, and municipal levels represent about one-third of the price. Next are the refining margin, which is the difference between the cost of the crude oil and the wholesale price of gasoline, and the retail or marketing margin, which is the difference between the wholesale price and the retail price of gasoline. Together these two margins account for about one-fifth of the price at the pump in 2006. I will discuss each of these components in turn.

First is crude oil. Canadian oil producers are price takers. They price their oil, like the Edmonton Par crude, to compete with West Texas Intermediate and Brent in the North Sea. The prices of all types of crude track each other, adjusted only for quality differences and the cost of transportation to major markets.

The world price of crude oil has tripled since 2002. The oil price hike is driven, in part, by increasing demand fuelled by North America and the emerging markets, such as China and India, as well as by geopolitical events in the Middle East and Nigeria, areas that contribute to the global oil supply.

While there's an obvious link between recent retail increases and the record levels we are witnessing in crude oil prices, as shown previously, the price of crude is not the only determinant of what Canadians pay at the pump.

The next slide compares the taxation levels at the pump in different cities. As you can see, in terms of taxation, there's a federal excise tax, which is set at 10¢ a litre and has been unchanged since 1995. The ad valorem taxes include the goods and services tax of 6% federally, and in Newfoundland, Labrador, Nova Scotia, and New Brunswick, a harmonized sales tax of 14%. In Quebec we have a retail sales tax of 7.5%.

Each province and territory also levies a per-litre tax. These vary widely, ranging from a low of 6.2¢ in the Yukon to a high of 20.2¢ per litre on Prince Edward Island.

Some municipalities also have taxes. These include Montreal, Vancouver, and Victoria.

Turning now to the next slide, we should demonstrate how the margins have changed over time for both refining and retail. What you see, in terms of the refining margin, is that it represents about 14% of the pump price in 2006. The margin does not reflect the profits but essentially covers the cost of refining the crude oil and provides the refinery with a rate of return on capital investment. Refining margins are typically volatile and generally seasonal.

As the graph indicates, refinery margins have increased significantly in the first few months of 2007, reflecting the supply-demand imbalance for gasoline across North America this spring. There have been over 30 separate events that we've tracked in Natural Resources Canada so far this year that have reduced the refining capacity use in Canada and the United States.

Finally, we have the retail margin, which represents the smallest component of the price at the pump, which is about 5¢ of the pump price in 2006. This has been relatively steady over time. You actually have a bit of a decrease historically, because a lot of the people who sell gasoline are now getting into selling other things, with convenience stores, car washes, or food outlets related to their operations. So they're able to operate with a lower margin.

The next slide shows the historical trend of the major components of the Canada average gasoline price and how it has varied over the last decade. I've already discussed the events that have driven up the crude oil component. The tax components have increased about 3¢ per litre over the period, primarily reflecting the ad valorem taxes that increase with the higher prices. At the federal level, this is partially offset by the one percentage point reduction in the GST last year.

In examining the margins, it is important to remember that margins, as I've said before, are not profits, and higher margins do not necessarily translate to higher profits. Margins cover the costs associated with refining, distributing, and marketing the product, as well as providing a rate of return on the investment. Increasing margins partially reflect the increased costs of producing fuel, including compliances with environmental regulations.

The next chart provides recent crude and gasoline price trends in Canada. The seasonal increase in gasoline demand, which is typically April through September, traditionally results in higher gasoline prices during the summer. However, as noted in the previous sections, this year a number of supply issues across North America are adding to the upward pressure on prices. This year extremely low inventories in the U.S. due to unanticipated refinery problems have bid up wholesale gasoline prices across North America to record levels heading into the summer driving season.

On the next slide, there are a number of reasons for price differences between markets. This compares different cities across Canada. I'll just go through them very quickly.

The first is taxes, as I mentioned, so there's a difference between provinces, and in some cases between cities, in terms of the taxation levels on gasoline. For markets that are more remote, there are higher distribution costs. There are economies of scale in terms of how much is actually sold at each outlet. And the local markets can sometimes play a role in terms of different pricing.

There are five provinces that currently regulate prices: Quebec, New Brunswick, Prince Edward Island, Newfoundland and Labrador, and Nova Scotia.

One last point is that while there's no evidence that the prices are lower because of regulation, it has reduced volatility. As we saw with Hurricane Katrina, the regulator prices are not blind to market forces. Newfoundland and Labrador, for instance, had to adjust their prices three times within six days following Hurricane Katrina to reflect the market reality.

I'll just speak very quickly to the next slide. It gives the differences over time between the taxation levels and the margins. What you see, as I mentioned earlier, is the fact that the margins have actually decreased over time from the 1980s.

The last slide just makes a comparison between Canada and other G8 countries in terms of the price at the pump. What you see is that with the exception of the United States, which is explained by taxation levels, Canada has a relatively low price at the pump.

I guess the last thing I'd say is that this information and other useful information is available on the Fuel Focus website, which is linked to Natural Resources Canada.

I'd be happy to take any questions you may have.

[The Chair, Conservative, James Rajotte]

Thank you very much.

We will go to questions from members. Just to indicate for the witnesses, members have five or six minutes in total, so perhaps we could keep our responses as brief as possible. The first round will be six minutes.

Mr. McTeague.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

Thank you, Chair.

Mr. Jennings, Mr. Brown, Madam Potvin, Mr. Trueman, Ms. MacLaren, thank you for being here today.

Mr. Jennings, I want to follow up very quickly on your offer for questions. Can you give an illustration to this committee today of the difference between light and heavy crude, the difference in prices varying as much as...? How much a barrel are we talking about, between West Texas Intermediate, Brent crude, and the light sweet? Do you have that information?

[Philip Jennings]

I actually don't have that number with me.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

But it's fair to say it's all the same today.

[Howard Brown]

It would be $20 to $25, I think, potentially, on the discount on heavy crude.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

So we could be talking about a substantial amount of variation, depending on the kind of crude that you put in.

One thing is very clear. You have analysis that has been done. It's a relief to see that it's from Natural Resources Canada. I think it's the first deck I've seen from Natural Resources Canada that doesn't have M.J. Ervin and Associates or other sources on it, so I'm pleased to see that. It's kind of nice to be able to see the government providing its own views on this.

I'm wondering if you could tell us, sir, how much gasoline is produced annually in Canada, how much is sold to the United States, and how much demand there would be in the same year.

[Philip Jennings]

Let me just find those numbers for you. I have them.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

While you're doing that, sir, I'll just point out for the benefit of committee members that the price of gas will be up 2.2¢ a litre tomorrow in the Ottawa region, and that the wholesale price for Ottawa is 65.4¢.

In the United States, at $2.15 a U.S. gallon, that works out to 60.2¢ a litre, so there is a 5.2¢ variation, if you will, between the wholesale price in New York and what it is here in Ottawa.

With reference to the bureau's comments that they are identical, they are not. Clearly, this is why we need better reference points.

Mr. Jennings.

[Philip Jennings]

In terms of gasoline, the production in Canada in 2006 was about 725,000 barrels a day. In terms of domestic sales, it is almost comparable: 705,000 barrels a day.

Imports of gasoline products were 108,000 barrels a day, and exports were 136,000 barrels a day. That would mean that the net exports in terms of gasoline were 30,000 barrels a day. That's gasoline. If you include diesel and furnace, we actually had a higher net export balance.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

The Energy Information Administration in the United States is a benchmark for pretty much anyone who understands and wants to know a little bit more about this industry. They usually give a five-year average. And those five-year averages on pretty much every energy commodity are well known, and we're within that.

Do you do the same? Does the Department of Natural Resources also have a five-year comparison of prices for energy commodities?

[Philip Jennings]

For gasoline prices, we do, and the Fuel Focus report comes out every two weeks. But we also have an annual report that came out in 2006, and we do comparisons over time. And we also, as I say, have rolling averages in terms of where those prices have been.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

I understand there is a consumer section within your department; it may be in Industry, but it's gone back and forth over some time. If the Department of Natural Resources wanted to inform Canadians, consumers in particular, what would be the difficulty in determining or acquiring the wholesale prices that the oil industry from region to region posts at three o'clock every day, which allow little backbenchers like me to be able to come up with the precise price for tomorrow? What's preventing the department from doing exactly the same thing, as opposed to going through this—and you'll pardon my expression—tawdry comparison with Buffalo, which produces no gasoline and which follows the Toronto rack? What prevents the department from doing that? Is it something you've considered?

[Philip Jennings]

Essentially, the reason we collect the information is really to provide a snapshot to Canadians in terms of the trends. And we made a decision in terms of the Fuel Focus that once every two weeks was what we were aiming for in terms of that information. We do collect the rack prices on a weekly basis, so we are able to provide that information to Canadians.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

Do you have rack prices region to region, city to city, Mr. Jennings?

[Philip Jennings]

We have done it by region. I actually don't think we do have it city by city, but we do have it by region.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

I'm wondering if it might be possible to provide the public with an opportunity to get access to that information, given that it's publicly posted. If it were not publicly posted, I would yell that this may be a question of collusion. But I see Toronto's posted price tomorrow will be 65.5¢ a litre. Ottawa will be 65.2¢ a litre, and I can go down a list of every city.

That's simply available by going on Bloomberg, because those companies are posting their prices and saying to the industry and to shareholders in the United States, this is what we're going to charge Canadians tomorrow.

Why can't you, for a couple of bucks, go online—I think it's $800 a month—find out what that is and post those prices at five o'clock or six o'clock at night so my constituents can know not what happened two weeks ago, but what's going to happen tomorrow morning--if they can even get gas, which they can't in Oshawa?

[Philip Jennings]

The simple answer is that the decision we've made about the Fuel Focus report is that we collect information once a week, and that's the information that we collect as well from the retailers regarding what they sell in 60 centres across Canada. We felt that was sort of an efficient way to provide the information Canadians need to make their decisions.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

But I think Canadians would rely—

[The Chair, Conservative, James Rajotte]

Six minutes.