Recently in Politics Category

Yesterday I provided some thoughts with regard to Saudi Oil Conference. Robert F. Worth and Jad Mouawad wrote an excellent article At Oil Conference, Saudis Offer Slight Rise in Production (free registration is required) for The New York Times. I will just offer a teaser quote and encourage you to read the article in full.

Some analysts and oil traders had expected a much larger production increase from Saudi Arabia, the world’s top oil exporter.

But King Abdullah and the British prime minister, Gordon Brown, who walked into the high-ceilinged hall together as a military band played, soon offered totally different perspectives on the problem and how to approach it.

The king spoke of the “selfish interests” of speculators as a main reason oil prices have risen 40 percent this year, urging the gathered ministers to “rule out biased rumors and to reach the real causes for the increase in price.”

But Mr. Brown squarely pointed to fundamental economics and “oil demand rising faster than supply.” The U.S. Energy secretary, Samuel W. Bodman, put it more bluntly in a meeting with reporters, saying “there is no evidence we can find that speculators are driving futures prices.”

I am firmly in the camp of not blaming the speculators and instead blaming fundamentals. The demand is outstripping supply. Until either we reduce our consumption or we find more oil, prices will continue to remain high.

For those considering investing in oil companies, you might wish to consider investing in oil futures or an ETF such as USO). Often companies will have other challenges such as increased royalty and taxes as oil prices rise. Companies will often face increased costs and have difficulty replenishing their reserves. But with futures or an ETF that mimics oil prices, you can focus solely on oil prices and not have to worry about company specific issues.

My photograph of the View From Icefields Parkway is hosted at Flickr. If you click on the picture, you will be taken to my Flickr account where you can see more pictures.

The article Oil Summit to Take on Speculators (subscription required) in today's Wall Street Journal mentions that high powered officials are looking at the role of speculators.

Officials from around the world, including U.K. Prime Minister Gordon Brown and U.S. Energy Secretary Samuel Bodman, along with the chief executives of major oil companies, will meet Sunday to discuss oil prices, investment, and the role of speculators.

"From a global perspective, we definitely think it's time that financial markets and their regulators take a tough look at how transparent is this market and what needs to be done to improve it," a contributor to the working paper said Saturday, "and if there is a need for regulation, how that regulation should tackle the issues."

Seeking diversification and a hedge against inflation, institutional investors such as pension funds and endowments have invested some of their billions into financial contracts passively following indexes composed of a basket of commodity futures.

...

Governments must help stabilize the oil market, by taking action against speculators, Saudi Arabia's deputy oil minister Prince Abdel Aziz bin Salman was reported as saying, according to remarks re-published from Asharq Al-Awsat newspaper by the state-run Kuwaiti news agency Saturday.

The reality is that speculators are not to blame. Typically, when speculators push the price of a good beyond a reasonable level, producers begin producing to capture excess profits. However, in this instance, producers are not producing. Moreover, producers are not showing their cards as to what they can or cannot produce. That is, Saudi Arabia does not allow independent assessments of its oil fields. Thus, investors and speculators can only guess.

If OPEC had the ability to open the spigots, I believe it would. It would do so to unsettle the backers and supporters of large scale mega projects, such as Alberta oil sands mega projects. If prices were to plummet dramatically for a year or two, investors would think long and hard before spending billions to develop these massive and capital intensive energy projects.

The oil summit on 22 June 2008 could prove counterproductive. After the jawboning by Saudi Arabia earlier to increase its production by a measly two hundred thousand barrels per day, and after many Asian countries have reduced their fuel subsidies, fuel prices remain stubbornly high. Should the summit produce some important pronouncements with no noticeable effects, then it will be that much more difficult to convince speculators and others that oil remains in plentiful supply and that speculators are to blame for the current mess.

Blaming speculators is easy. Fixing the root cause of high oil prices is not.

There were two articles in the Wall Street Journal this past weekend that caught my attention. First was A Hostage to Fame: After Six Years of Captivity in Colombia, Ingrid Betancourt Is a Global Celebrity -- and Too Valuable for Rebels to Release (subscription required), a front page article concerning Ingrid Betancourt who is a courageous and strong woman being held captive by communist Revolutionary Armed Forces of Colombia, or the FARC. I have written about Ingrid before here and here.

Ms. Betancourt, a minor presidential candidate when she was abducted in 2002, is one of about 700 hostages held by the FARC, Latin America's oldest and largest insurgency. The FARC, estimated to number about 9,000 fighters, funds itself largely through drug trafficking and kidnapping. All but about 40 of its hostages are held for ransom. The rest include Ms. Betancourt, three U.S. defense contractors abducted in 2001, and Colombian policemen, soldiers and politicians whom the rebels consider prizes of war to be deployed to strategic advantage.

Ms. Betancourt, who holds dual Colombian and French citizenship, has become the face of Colombia's captives and their heart-breaking suffering. In Europe, she is a cause célèbre, so famous that she is simply known as "Ingrid." Her portrait hangs on the facade of the Paris city hall and in Milan's main piazza. France stages marches to demand her release, and Italy holds midnight vigils. Across the world, more than 1,000 cities and towns have declared her an honorary citizen.

But in becoming so famous, the 46-year-old Ms. Betancourt has also become more valuable to the FARC, which has suffered a string of major setbacks in the past few months. Only days after he complained about Ms. Betancourt in the email, Mr. Reyes, the rebels' second-in-command, was killed in an airstrike by the Colombian military on his camp in neighboring Ecuador. Weeks later, the group lost its legendary leader Manuel Marulanda, who apparently died of a heart attack.

The article goes on to discuss Venezuela's president Hugo Chavez's possible role in assisting FARC to destabilize Colombia.

The second article Venezuela's Chávez Urges End to Colombia Insurgency: In Sharp Reversal, Guerrillas Are Asked To Release Hostages (subscription required) shows Chavez changing course.

In a surprising turnaround, Venezuelan President Hugo Chávez urged Colombian guerrillas to free hundreds of hostages, put down their weapons and end their almost 50-year campaign to overthrow Colombia's government and install a communist regime.

Speaking on his weekly television program, Mr. Chávez, who has been a public ally of the 9,000-strong Revolutionary Armed Forces of Colombia, or FARC, said the group's efforts to overthrow Colombia's democratically elected government were unjustified. "The guerrilla war is history," Mr. Chávez said.

The president has been lobbying friendly governments to grant de facto democratic diplomatic recognition to the FARC. "At this moment in Latin America, an armed guerrilla movement is out of place."

I am always drawn to people of principle who struggle against seemingly insurmountable challenges. And thus, I admire Ingrid and hope that she and her fellow captives are released soon. She has suffered far too much.

With regard to Hugo Chavez, while I appreciate any effort to help free the FARC hostages, I have strong concerns about his role in assisting FARC and helping to destabilize the region. Unfortunately, the high price of oil is helping to stabilize his regime and allow him to continue to wreak havoc. That is truly unfortunate.

I have long held a strong interest in South America and am drawn to people with strong principles and convictions. Thus, Ingrid Betancourt's story has captured my interest and attention.

My photograph of the downtown Calgary is hosted at Flickr. If you click on the picture, you will be taken to my Flickr account where you can see more pictures.

Although I have been busy recently and not trading much, I recently finished A Bull in China: Investing Profitably in the World's Greatest Market. I thoroughly enjoyed Jim Rogers' latest book. I am a Jim Rogers fan who has also read his prior books:

• Investment Biker: Around the World with Jim Rogers;
• Adventure Capitalist: The Ultimate Road Trip; and
• Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market.

Jim Rogers' prior books serve as a good background to his latest book. His early travel, adventure and investment books discuss different themes as he traveled around the world, first by motorbike with his then girlfriend Tabitha and second by his customized Mercedes car with his then girlfriend now wife Paige. Regarding his second trip, I strongly urge you to visit Jim Rogers — The Millennium Adventure website to see Jim's and Paige's phenomenal trip. His third book discussed commodities, in which China plays an important role as a user of commodities.

A Bull In China has the following sections and chapters:

• Introduction: Catching the China Ride;
• Investing: From Mao Caps to Small Market-Caps;
• Risk: The Perils of Success;
• Companies: Let a Thousand Brands Bloom;
• Energy: Not So Black;
• Transport: Paving the Way;
• Tourism: Up, Up, and Away;
• Agriculture: Have You Invested Yet?
• Health, Education, Housing: Serve the Masses;
• Emerging China: The People's Republic of Tomorrow; and
• Appendix.

Introduction: Catching the China Ride quickly sets the tone of the book by recapping some key points from his prior books. Again, reading his prior books is helpful, though not required, to appreciate better his current book. Jim lets you that he is big believer in China's future potential—so much so that he brought a Chinese nanny to teach his daughter Happy, born in 2003, Mandarin. Jim also informs you that he is not going to provide hot stock tips, but rather to help provide you with a start on your research. The companies he discusses may or may not be successful. They are merely starting points for you to do further research.

Investing: From Mao Caps to Small Market-Caps discusses the growth and evolution of China's markets. Of particular importance, Jim Rogers discusses The Chinese Alphabet Soup—A-Shares, B-Shares, H-Shares, S-Shares, N-Shares and ADR's, L-Shares, J-Shares, OTCBB, STAQ and NET.

Risk: The Perils of Success; discusses some of China's challenges and potential solutions.

In Chinese, the word "crisis" is made up of a combination of two characters. The first signifies "risk." The second stands for "opportunity."

China could face many crises up ahead. As an investor, the ones I need to examine most closely are those where potential risks—the fears they provoke, the solutions they require—have the best chance of creating value.

Believe it or not, I don't like taking chances when it comes to investing. The thrill of living on the edge has never been part of my portfolio. The same holds true for buying stocks in China, even if its people are among the biggest gamblers on earth. If you do your homework, buy cheap, and remain patient, you should be able to walk over and pick up that pile of cash in the corner that nobody else notices.

In this chapter Jim highlights some military, infrastructure and environment concerns. He then goes on to describing several companies that might be well suited to addressing these challenges.

I should note that Jim provides several key facts about the scenario or situation before mentioning key companies where he provides a quick snapshot of each. This information serves as an excellent backdrop for your own research.

Companies: Let a Thousand Brands Bloom is short chapter where Jim teaches you that many companies in China are still at their infancy yet are already household names. He mentions Baidu, a popular search engine in China, and Lenovo, a popular computer manufacturer. Still more companies are unknowns waiting to be recognized. Which companies will emerge the Chinese equivalents of GE, Oracle, Johnson and Johnson, and Sony?

Energy: Not So Black focuses on companies that supply China's energy, whether it is hydro, coal, oil, or alternatives such as wind. Jim Rogers also discusses companies outside of China that might benefit from China's continued expansion. For example, Bucyrus International, Inc. (BUCY), a Wisconsin based manufacturer of heavy mining equipment, is well poised to benefit from China's needs.

Transport: Paving the Way discusses the transportation industry, from road paving and infrastructure to automotive companies.

Tourism: Up, Up, and Away is a chapter about tourism inside China as well tourism for Chinese outside China. Of course, with greater affluence, Chinese will be enjoying tourism within their own country and in faraway places. Several companies poised to benefit from this trend are identified and discussed.

Agriculture: Have You Invested Yet? discusses how companies will benefit from China's growing appetite for better food and drink. Juice, farm seed, tractor, fast food, wine and other companies relating to the agricultural sector are discussed.

Health, Education, Housing: Serve the Masses focuses—not surprisingly—on healthcare.

As of 2004, China spent only 4.7 percent of GDP on health care, compared with 8 percent or more in developed countries (and 16 percent in the United States). In early 2007, as part of making health care a major priority, Premier Wen Jiabao announced the creation of a trial "co-operative medical service" throughout "80 percent of China" by 2010. The state will double subsidies to US$1.53billion and offer small amounts to pay medical bills for all rural dwellers. This is a first step toward meeting huge increased demands of a population that isn't just currently underserved but that by 2020 will have 170 million people over sixty, in addition to the number with chronic illnesses. Old age pensions and other forms of social security will be bolstered by an added US$35.7 billion in 2007. At the same time, a finance vice minister announced that China will be actively encouraging more private investment in the health care industry, offering preferential tax policies to those who would help improve a nationwide system full of inefficiency and soaring costs. All this should mean benefits for emerging health care providers and those that invest in them.

Emerging China: The People's Republic of Tomorrow discusses other key themes that do not fit easily into the previous chapters. Some key themes that are discussed are high-tech, aerospace, internet, film, sport, plastic money, mobile phones, cable tv, publishing, retail and fashion, currency, and commodities.

Appendix discusses additional sources of information for you to do more research. Throughout all his books, Jim Rogers encourages you to play to your strengths. That is, if you have specialized knowledge in publishing, then follow this industry more closely in China because you are able to see more clearly the developing trends than is the average person.

To help you down the road further, I've gathered in one place the best websites for Chinese listings, brokers, and China-related funds. These Internet resources will offer you the most current and reliable data. When it comes to the specific sectors or companies that seem most sound and compelling, your personal understanding, analysis and experience will have to point the rest of the way. As I've said: you do your research, pick the companies you like, and buy them, or you sit at home and watch the movies.

After all, China won't wait.

As mentioned, I have read all of Jim Rogers' books and thoroughly enjoyed each of them. Because I am a commodities bull, I found this book helpful in better understanding China's enormous growth. Moreover, I agree with Rogers' in his assessment of China's growing importance. In summary, I highly encourage you to read A Bull in China: Investing Profitably in the World's Greatest Market.

Yesterday, I mentioned what a difference a few days can make with regard to the likelihood of either Hillary Clinton or Barack Obama becoming the Democratic Presidential Nominee. According to Intrade.com, both senators have swapped positions again, with Hillary Clinton at $61.50 and Barack Obama at $36.00. With Clinton having won the New Hampshire primary, she has resumed her position as the Democratic front-runner. Indeed, what a difference a few days can make.

Because I am Canadian, I have no dog in the United States elections. That said, I still find the U.S. elections interesting and important. They are interesting because they are so much more passionate than our Canadian elections. And, of course, because of the prominence of the U.S. in international affairs, the U.S. elections have significant importance for all of us, Americans or not.

I just finished reading a Wall Street Journal article Clinton Braces for Second Loss; Union, Senators May Back Obama (subscription required). I am amazed at how fast Hillary Clinton went being the leader to a follower behind Barack Obama. After reading the article, I went to an online site Intrade.com where individuals can place wagers on different events and outcomes. If you go the left hand margin and choose 2008 US Election, then scroll on the right to 2008 Democratic Presidential Nominee, and then choose the detailed graphs for both Hillary Clinton and Barack Obama, you will note that the graphs are almost complete mirror images. A few days ago, Hillary Clinton had a bid of $75.00 and now it has fallen to $26.10. A few days ago, Barack had a bid about $21.00 and it is now $70.10. These bids can be thought of as odds. What a difference a few days make.

So for those of you that are political or news junkies, you might find watching the Intrade results informative. Here, people are putting their dollars where their beliefs are. These beliefs are not those political views that they espouse, but rather their views on who will win. Thus, I view the Intrade results as an on-going and live poll.

Today I saw a great Jim Rogers interview on Bloomberg Television on the internet. I am not sure how to link directly to video replay. Instead, beside the feature article Rogers Says U.S. to Have Worst Recession `in a While' (Bloomberg) in the upper right hand corner of the screen is Related Media On Demand. Underneath that banner is a Bloomberg link to the video. The video plays for about 15 minutes.

As the article title suggests, Jim Rogers believes that the United States is headed a strong recession because of numerous excesses. Moreover the U.S. currency is a flawed currency. Regardless of what the dollar does, Jim Rogers continues to like commodities, though not all commodities. Those commodities that are near term highs—such as oil—are not his current favorites. Instead, he prefers agricultural commodities.

Rather than recap the entire video, I encourage you to view the video yourself.

On a tangential note, I am almost finished Jim Rogers' book A Bull in China: Investing Profitably in the World's Greatest Market. After I complete the book, I will have more to say; however, even now I highly recommend Jim's book.

Slightly over two years ago, I wrote a brief article about a documentary shown on Canadian Broadcasting Corporation (CBC) concerning the kidnapping of Ingrid Betancourt.

I noticed today on the BBC New website an article that Hugo Chavez, the president of Venezuela, might play an instrumental role securing her release.

Mr Chavez repeated his conviction despite the lack of proof that Ms Betancourt, kidnapped in February 2002, was still alive.

"Ingrid is alive. I'm absolutely certain," Mr Chavez said.

"We will do everything humanly possible to achieve (her) release and not only hers, but the release of all the candidates."

Despite my misgivings toward Chavez's leadership of Venezuela, I applaud his work toward freeing Colombian hostages. I hope he is correct that Ingrid Betancourt is alive. According to the article, FARC is supposed to provide evidence by yearend that the hostages are alive. And one can hope that the freeing of the hostages can lead to further improvements.

Great minds think alike. Below are the links to two great minds on the outlook for the American currency:

• Wall Street Journal Video Interview With Pimco's Bill Gross; and
• Bloomberg Transcript of Beeland Interests Inc.'s Jim Rogers.

Both individuals are extraordinarily bearish on their outlook of the American dollar. Whether you agree with their assessments, both sources are worth investigating further.

The new royalty structure is largely a nonevent (see New Royalty Framework document (PDF, 950kb)). I expect that most oil companies have long term oil price projections of $55 to $65 WTI, with $55 being the more likely target. Companies are conservative by nature.

At $60, the terms are very nearly back to 1% gross revenue royalty and 25% net revenue royalty. So in terms of future development, the net effect should be muted. At higher prices, new entrants are discriminated against relative to existing players.

It is only at significantly higher prices that larger provincial takes kick in.

The markets, despite all the hoopla, have largely shrugged off this event. Suncor Energy Inc. (SU) and Canadian Oil Sands Trust (COS-UN.TO) were off less than 1.5% combined—easily within daily trading noise—yesterday, the first business day after Premier Stelmach's proclamation.

Some might think that these Suncor and Canadian Oil Sands were already down in anticipation of the royalty review. Not so, this link to a Yahoo price chart shows Suncor in U.S. dollars and Exxon Mobil Corporation (XOM) in U.S. dollars. You will note that Suncor has outpaced Exxon during the last three months. It did not tank prior to or after the Panel's published report.

Without crunching the numbers, a worthwhile exercise, I think the terms that existed during the mid 1990s were possibly harsher with the higher provincial and federal taxes that were about 50% higher than today's percentages. It is only under significant and sustained high prices, say $75+, that the new regime might be more punitive. And even that might be moderated going from synthetic crude oil to bitumen royalty regime. This entire last paragraph is intuitive guesswork that should be more thoroughly investigated.

With regard to the royalty percentages exceeding 25%, I would not be surprised to see the federal government cap royalty deduction at 25% of resource income. If that happens, then there will be a slight further hit to the oil companies. I remain skeptical that the federal government will offer to pay about 20% of the oil companies' increased royalties.

Given the final outcome, I am disappointed with the Panel's work. They had the opportunity to create a meaningful and workable royalty regime. Instead, they presented a wonky royalty regime with an oil sands separation tax, which was not tax deductible and extraordinarily difficult to pass politically. That combined with a royalty rate above 25% would have been very punitive on the oil companies.

After I think more about the Premier's new framework, I will likely comment further. I might even run some numbers through my economic models and discuss the comparisons. At present, however, I think the new framework is largely a nonevent.

I also urge you to read two other weblogs that discuss the new framework: WTF Journal by Ian Langdon and Ken Chapman by, you guessed it, Ken Chapman. My view differs from those of both writers. And that is okay. Blogging should be about informing. Our differing views will allow others to see arguments from different perspectives—a good thing.

Calgary model Jennifer Nguyen is featured in the photograph, which is hosted at Flickr. If you click on the picture of Jennifer, you will be taken to where you can view a larger version and see even more pictures of her.

In this article, I will briefly highlight major points raised in my prior articles. To help keep this article brief and easy to read, I will use bullet points throughout most of the article. If you want more depth, please read my individual articles leading to this summary. Please note that my summary will not necessarily follow the same order of the original articles.

 

Spacing added for weblog formatting purposes.

 

 

 

 

1. Royalty Review Terms of Reference
   • A quote from page 101 of the Report:

     An independent Panel of experts will review all aspects of the oil and gas royalty system, including conventional and oil sands. The Panel will also examine the tax regime faced by the resource companies, including income tax and freehold mineral rights levied on freehold mineral rights holders.

2. High Level Recommendations
   1. Prepayout
      • 1% gross revenue royalty.
   2. Postpayout
      • 1% gross revenue royalty (treated as a cost) plus,
      • 33% net revenue royalty.
   3. Oil Sands Severance Tax (OSST)
      • Starting at C$40 WTI, 1% gross revenue increasing by 0.1% for every dollar until 9% at $120 WTI.
      • Ineligible for payout calcuation purposes and nondeductible for federal and provincial taxes.
   4. Upgrader Credits
      • 5% of the capital cost for additional upgrader capacity in Alberta/
3. Did the governments and National Oil Sands Task Force (NOSTF) propose fair and equitable terms back in the 1990s?
   • While a thorough discussion of constitutes fair and equitable terms is a good exercise, let us for the moment assume that the governments and NOSTF did propose fair and equitable terms at roughly one third value to each of the following key project stakeholders: developer, province, and federal government.
4. Changes in tax rates since the mid 1990s
   1. In the mid 1990s, the federal rate, including large corporate surtax, was 29.12% and provincial rate was 15.5%.
   2. The federal rate will soon be at 18.5% and the provincial rate is at 10%. The provincial and federal tax rates were approximately 50% higher in the mid 1990s.
   3. If we accept that the sharing of the economic value pie was correct in 1990s, then the fiscal regime must be changed now just to reflect differences in taxation rates, let alone changes in commodity prices and other circumstances.
5. Resource Allowance and Royalty Rate
   1. Resource Allowance was set to 25% of resource income. Resource allowance has been replaced by actual royalty paid.
   2. If the province were to increase its royalty beyond 25%, the federal government is likely to cap the allowable deduction of royalty to 25% (back to resource allowance again) to preserve their portion of the economic value pie.
   3. By not having the federal government involved in the creation of a harmonious oil sands fiscal regime, the current proposal is likely dead on arrival. The federal government is unlikely to support a massive royalty increase, much of which will come at their expense unless the federal government caps the royalty deduction amount. Again, federal government is likely to cap the royalty amount as a federal tax deduction.
6. Support for Federal Elimination of Accelerated Capital Cost Allowance (ACCA)
   1. With ACCA, developers and engineers are more efficient in that they seek to spend the minimum amount of capital to address an issue; they will build infrastructure (capital expenditures) to address an issue because it reduces the project's ongoing operating costs.
   2. With the elimination of ACCA, developers and engineers are more likely to increase operating costs than spend capital dollars to address an issue because operating costs are more tax efficient; the downside is that higher operating costs increase the project's risk to a sustained downturn in oil prices or a sustained upturn in input costs.
7. Royalty Credits for Upgraders is Flawed
   • Royalty credits for upgraders are flawed because it does not consider the profitability of the developer. Imagine if oil prices were to hit all time highs, yet we citizens were subsidizing extraordinarily rich oil companies' investments in new upgraders. It makes no sense.
8. Royalty Based On Bitumen
   1. A bitumen based royalty is challenging because of the challenge of valuing bitumen and creating an open and transparent market for bitumen. Every project produces its own unique concoction of bitumen. All bitumen products from different developers with have different levels of fines (sand and clay), sulfur content, and other impurities.
      • Moreover, each upgrader is specifically configured to process its own feedstock. In other words, Upgrader Z values its feedstock differently than Upgrader Y would.
   2. A bitumen based royalty might kneecap future investments in upgraders when the current large heavy light oil differential disappears and upgraders return to being marginal investments. Upgraders are normally marginal investments. If, in the future, normality returns and a project requires an upgrader, it might be unable to proceed with the overall project because the cost of the upgrader is prohibitive and cannot be used to offset royalties. At present, a developer can elect to its royalty based on synthetic crude oil or bitumen. Because of the wide differential between light and heavy oil, a bitumen based royalty is preferred today.
9. Oil Sands Severance Tax (OSST)
   1. The Oil Sands Severance Tax is very punitive because it kicks in before payout and because it will harm new entrants most.
   2. Having a provincial OSST ineligible for the purposes of the royalty payout calculation and having it non deductible for provincial and federal taxes is poor policy
      1. It might discourage or delay developers from undertaking expansion, debottlenecking or efficiency projects.
      2. It might discourage or delay developers from undertaking additional environmental projects.
      3. It sets a poor precedent for taxation in Canada, giving Canada an unsavory reputation.
      4. Although not mentioned in the detailed article, what if the federal government wants to implement a windfall or carbon non deductible tax of their own? Should these windfall tax programs be coordinated between both levels of government?
   3. A challenge with burdening companies during good times with OSST, do governments come to the rescue during bad times?
10. Undiscounted Cash Flow Graphs for Comparison Purposes
    • In the report, the Panel showed various graphs for fiscal regimes around the world. These graphs, however, usually showed undiscounted cash flows. Perhaps that works well when comparing various conventional resources, but when comparing conventional and oil sands, it does not. Conventional production follows an exponential decline, meaning that most of the cash flow comes early in life, usually within the first ten years. Oil Sands have a steady or increasing production with time, meaning that much of its cash flow comes later in life, usually after the first 15 years. Thus, the sum of undiscounted cash flow charts will overstate the relative value received by oil sands companies.
11. Complexity of Proposed Regime
    • The new royalty regime is complex. The Panel proposed a 1% gross revenue royalty payable before and after payout. Post payout, an additional 33% net royalty is adjusted partially to account for the initial 1% gross royalty. In other words, the 1% gross royalty is treated as a cost in the post payout calculation. As mentioned previously, the OSST is an additional royalty or tax payment that is calculated and applied separately.
12. Open Process
    • I commend the Panel for putting the whole review process into the public domain. That is where it belongs.

I am critical of the Alberta Review Panel Final Report (PDF, 2.25mb). From my understanding, there does not appear to be a harmonious design between royalties and taxes. The Panel appears not to have considered the federal government's role in setting an overall fiscal regime. When it proposed provincial royalties beyond 25%, I knew that amount would be partially paid by the federal government, something that the federal government is unlikely to accept. At that point, I concluded that the Report was dead on arrival.

From there, I read the Report carefully and found other flaws, some of which are substantial. The Panel had the opportunity and, presumably, the resources to recommend a fiscal regime that would restore fairness to the citizens of Alberta and Canada. To act upon this opportunity in a proper fashion, the Panel needed to have broad wide ranging view. Instead, the Panel's view was rather myopic. It did not think through the implications of its design. It did not even bother to quantify the values to each of the major stakeholders, a fundamental act in any negotiation. Instead, it relied upon wonky international undiscounted cash flow summaries, which do not capture value well, and marginal effective tax rates, which are not effective measures when capital is returned to a developer in an expedient fashion. Moreover, the OSST has a host of issues of its own. In short, I believe the Panel's work is deeply flawed.

As an Albertan, I am disappointed.

Calgary model Judith Aldama is featured in the photograph, which is hosted at Flickr. If you click on the picture of Judith, you will be taken to where you can view a larger version and see even more pictures of her.

I am critical of the Alberta Review Panel Final Report (PDF, 2.25mb). Over the prior articles, I have outlined shortcomings with the report. In this article, I will outline how I would have approached the same challenge of responding to their terms of reference. Below is a quote from page 101 of the Report.

Royalty Review Terms of Reference

An independent Panel of experts will review all aspects of the oil and gas royalty system, including conventional and oil sands. The Panel will also examine the tax regime faced by the resource companies, including income tax and freehold mineral rights levied on freehold mineral rights holders.

If, for a moment, we accept that the National Oil Sands Task Force (NOSTF) in the mid 1990s was correct in splitting the economic value pie into three approximately equal parts for the developer, province, and federal government, then how do we respond given that a) the federal rate was 29.12% then and is 21% now and falling to 18% by 2011 and b) provincial tax rate was 15.5% then and 10% now. In other words, the federal and provincial tax rates were about 50% higher then than they are now or soon will be. Surely, that has resulted in a transfer of the value from economic value pie away from citizens and toward developers. Without much further analysis, we citizens can conclude that our governments have not been safeguarding our interests by maintaining an equitable share of the economic value pie.

As a side note, throughout my discussion in this article, I am deliberately referencing economic value. I find undiscounted cash flow values present specious arguments and are not worthy of serious discussion.

What other key changes have happened since the NOSTF's work back in the 1990? Just thinking quickly, I would rattle off some differences:

• Oil prices have departed from their long run historical US$20 real per barrel pricing and have risen substantially;
• Oil rich provinces such as Venezuela and Russia are no longer welcoming foreign investment on easy terms;
• Brazil, Russia, India, and China (BRIC) are all racing toward becoming modern industrialized countries, soaking up vast quantities of all commodities, including oil and gas;
• According to Alan Greenspan, the United States is involved in a war in Iraq largely centered on oil issues;
• Geopolitical tensions have increased with terrorists waging war against democracies and western civilized world;
• Construction and material costs have risen around the world; and
• Conservation, greenhouse gases, and alternative fuels have become household words as people seek to lessen their environmental footprint and reduce their energy costs.

A lot has changed in only a decade. And, I am sure that I have not captured all the major changes. However, let us look at what I have mentioned and how it might influence our thinking.

Oil prices have increased. There might be the potential for windfall profits. How do we want to address huge profits that are earned by the industry through good fortune? When some of the oil sands companies purchased their leases, they did not foresee these generous prices, not even in their wildest dreams. They purchased the leases at then fair value then, but at bargain basement prices today. Do we want to moderate these windfall profits?

The Panel by recommending an Oil Sands Severance Tax has attempted to moderate windfall profits. While I understand why people might want to capture windfall profits, I remain unconvinced that windfall taxes are good public policy. I remain open, however, to the argument.

Oil rich provinces are not as accessible as they once were. If developers do not like Alberta, they can no longer readily leave and go to Venezuela, Russia or some other countries that are much more protective of their natural resources. Given that Alberta remains a friendly place with good government, adequate infrastructure, and the rule of law, developers should place a premium on working in Alberta compared to many other locations. This is especially true given the size the resource and the lack of geological risk.

BRIC countries and others are racing toward a modern society. As Jim Rogers has argued for a long while, commodities are likely to enjoy a bull run for several more years. Commodities were once considered irrelevant, because you could always easily and readily secure them. That is no longer true. Commodities have become scarcer and countries are hoarding their resources for themselves.

Wars and terrorism and oil. That almost says it all. Oil is no longer a cheap commodity in bountiful supply. There is a race to secure vast quantities of oil as oil becomes increasingly more difficult to find and produce. Much of the oil rich regions are located in more interesting places of the world from a risk point of view. Again, that bodes well for Alberta.

Costs have gone up dramatically. Perhaps surprisingly, this is a non factor for the NOSTF, because its recommendations were focused on economic profits. If a developer feared it would not be profitable, then its correct course of action was to not build. Period. If a developer believed that it would be profitable given the economic landscape, then the economic spoils (economic value pie) were split approximately equally among the developer, province and federal government.

Conservation, greenhouse gases, and alternative fuels all speak to the notion that we have to use fossil fuels wisely because they are scarce and because they do pollute.

Nothing has happened during the prior decade that motivates me to want to reduce the government take. Two larger questions are as follows: Should the government take be increased from the NOSTF's recommendations, and if so, by how much? These questions deserve public consideration and comment.

In addition to reviewing the current events, I would encourage others to compare and contrast alternative regimes in different jurisdictions, with a note of caution. Comparing different regimes is fraught with difficulty. Often, politics enter into the picture. The Gulf of Mexico has very generous terms because the United States wants to encourage exploration and production. Middle East countries have very harsh terms because of the geological risk is comparatively low and because those countries depend heavily upon oil and gas revenues to sustain their economies. Some countries have generous terms, but transportation costs are prohibitive. The key point is that if you torture the data long and hard enough, it will confess to anything.

So while I think it is important to look internationally for comparisons, I think it is equally or more important to look at the risk reward ratio for engaging in oil sands activity. Do developers earn modest, fair, or generous returns given all the risks? And, what defines modest, fair, and generous returns?

So, what have we accomplished thus far? We know that the provincial and federal tax rates were about 50% higher during the 1990s than they are today. (Equally true, I could write that taxes have fallen by about one third from 1990s level to today's level, but that does not sound nearly as dramatic.) So that alone motivates us to want to recalibrate the overall fiscal regime to bring the stakeholders' proportions back into balance. We have also acknowledged that major changes have occurred during the past decade, none of which to my mind would influence me to want to reduce the government take. We should, however, engage all interested parties—including the public and developers—to a vigorous debate as to what is a fair and reasonable government take. And we should probe whether that take should remain constant over a wide range of oil prices or whether the take should reflect oil prices.

Next, I would construct a sample of projects to evaluate. These projects would demonstrate how much the developer, province, and federal government received. The projects I would examine would be as follows:

• Greenfield mining project with and without an upgrader;
• Greenfield in-situ project with and without an upgrader;
• An upgrader;
• Expansion project (increase production by greater than 25%)
• Efficiency project (production remains unchanged, but costs decrease); and,
• Debottlenecking project (a variant of the prior two).

An initial step once these sample projects or scenarios were created would be to run each of these projects under two fiscal regimes with two parameters. Use the royalty and taxation regime that existed in the mid 1990s with the rates that existed in the mid 1990s. Next, do the same exercise, except with today's regime (there have been tweaks during the past decade) and today's rates. This exercise would clearly show how the values shares have shifted.

Then to arrive at a new fiscal regime to rebalance the proportional shares, various fiscal levers would be used to examine the percentage value shares (not the sum of undiscounted cash flows) to the developer, province, and federal government. If, by raising the provincial royalty, the federal portion decreased, then we know that is a likely nonstarter. I discussed this topic at length in a prior article.

Experiment and debate the relative shares to the different stakeholders until a satisfactory regime is reached. As part of that experimentation and debate, use the most efficient fiscal means possible. Recall that different stakeholders have different costs of capital. That allows some economic levers to be more efficient than others.

In summary, if I had been charged with the same assignment, I would have a) shown that the current sharing of economic value has shifted toward the developer and away from governments as the tax rates have decreased during the past decade; b) reviewed current events to set the stage for a dialog to determine the appropriate sharing going forward; c) reviewed risk and return profiles so that everyone has a common understanding of the risks taken by the oil sands industry with the expected net present value shares; d) use different fiscal levers to arrive a new regime that satisfies the agreed upon splits in the economic value pie value; and e) communicate to the public in a transparent manner throughout the entire process.

This is undoubtedly a difficult process to arrive at a fair and equitable fiscal regime. At the end of the process, not all parties will be satisfied. The key is to make the process as transparent and accessible to the public as possible. Given the increasing value of oil sands along with its environmental impacts, the public has right to have a full and open hearing. Creating a new fiscal regime is an extremely complicated process because of the need to consider the vast array of public policy issues and because of the importance to the economies of Alberta and Canada.

Calgary model Judith Aldama is featured in the photograph, which is hosted at Flickr. If you click on the picture of Judith, you will be taken to where you can view a larger version and see even more pictures of her.