November 28, 2023

Investment Banking

Let Your Investment Banking Do The Walking

Who needs a windfall tax? Oil and gas companies poured $48 billion into government coffers this year, says RBC



Unanticipated revenue from energy royalties and corporate taxes are pouring into government treasuries, offsetting the need for a Canadian version of a “windfall tax” on oil and gas companies that is high on the political agenda in Europe and elsewhere, a Royal Bank of Canada analyst argues in a new report.

Surging energy prices have propelled the taxes and royalties paid by public Canadian energy companies to around $48 billion this year, a 200-per-cent year-over-year increase, Michael Harvey, an analyst at RBC Capital Markets, the investment banking arm of Royal Bank, calculated.

Harvey estimated that the contribution of Canada’s publicly traded oil and gas companies to federal and provincial revenue will increase to $64 billion in 2023. That should deter politicians from following the United Kingdom’s lead and claiming an additional share of surging energy prices.

“The mechanisms are already in place — in both the royalty and tax systems — to provide windfalls for governments when prices are high,” Harvey said in an email.

In his research note, which was sent to RBC clients on July 19, Harvey said higher crude and natural gas prices were driving corporate profitability and setting the stage for higher royalties, taxes, and energy-related fees to all levels of government.

“We present these figures to contextualize the ‘windfall tax’ which we see as already established, and to help frame the conversation as it relates to the impact of Canadian energy policy decisions on Canadians,” Harvey wrote in the note to investors.

The projected $64 billion in royalties and taxes in 2023 is based on the bank’s assumption that North American benchmark West Texas Intermediate (WTI) crude could average US$114 per barrel next year. That estimate could be on the low side, as Harvey’s figures exclude taxes paid by private companies and international majors not within RBC’s coverage universe.

Oil and gas royalties are typically based on sliding-scale formulas that see rates increase significantly at higher commodity prices.

The war in Ukraine, resulting in international efforts to curb Russian energy exports, and a surprisingly strong global recovery from the COVID recession have driven prices because demand has exceeded supply. Oilsands royalties have also been supercharged because a number of major projects have reached “payout” status, where rates increase after capital costs have been recuperated. In Alberta, where 90 per cent of royalties are payable, the province could potentially see provincial budget surpluses exceed $15 billion, Harvey wrote.

“It’s hard to understate how significant the increase in revenues have been for Alberta,” said University of Calgary economist Trevor Tombe. “The turnaround in (Alberta’s) budget balance from deficit to the pretty massive surplus that we’re looking at this year is easily, by a wide margin, the largest swing in a provincial budget balance in Canadian history – and that’s entirely because of the swing in resource royalties.”

Canadian energy companies are also expected to pay around $9 billion in federal corporate taxes this year, representing 13 per cent of the federal government’s total corporate income tax forecast, according to Harvey.

The analysis from RBC Capital Markets comes as governments around the world have been experimenting with temporary windfall tax schemes on the profits of oil and gas companies amid rising inflation and soaring energy costs.

The British government introduced a temporary 25-per-cent tax on oil and gas profits in May to help pay for a multi-billion-dollar emergency aid package aimed at offsetting increases in the cost of living. Italy implemented a similar one-off tax this spring, and Spain followed Italy’s lead earlier this month.

Progressive lawmakers in the U.S. have been calling for an additional levy on the profits earned by American oil and gas firms since prices began to surge last year. In June, NDP Leader Jagmeet Singh proposed taxing excess profits from oil and gas and other sectors and redistributing the money directly to Canadians.

Prime Minister Justin Trudeau’s government so far has avoided a windfall tax on the oil industry, although it did slap big banks and insurers with a 15-per-cent tax on income above $1 billion in 2021 to help cover pandemic recovery costs.

Some economists say that windfall tax measures are blunt instruments that can sometimes exacerbate the conditions they’re meant to alleviate. Critics warn that windfall taxes on oil and gas will only deter capital investment in the sector at a critical moment when energy is in high demand globally.

To be sure, that argument is less compelling during the current price boom, as companies deploy profits for buybacks and dividends, rather than capital projects.

Still, the more reasonable approach for governments seeking to raise resource revenues is to raise the ceiling on corporate tax rates or royalty frameworks, said Tombe. “We already have in the royalty system a tax rate that increases as oil prices rise,” he said. “So in a sense, that’s got some of the flavour of ‘windfall taxes’ — it’s just not done in an ad hoc way. It is explicit, it’s formula driven, it’s transparent.

“That’s where I think the problem lies (with a windfall tax): having a government just enact an ad hoc tax out of nowhere based on just whatever they think the rate should be — that’s problematic because it creates uncertainty,” Tombe said.

Past oil price spikes have tempted the federal government to impose taxes that have provoked the ire of industry and oil producing provinces, particularly Alberta.

During the energy crisis of the 1970s, Pierre Trudeau’s government introduced a budget provision that made provincial resource royalties a non-deductible expense for federal income tax purposes, inflaming relations between Ottawa and the Prairie provinces over resources.

The notorious National Energy Program (NEP) in 1980 saw a range of new taxes imposed directly on the oilpatch, including a petroleum and gas revenue tax of eight per cent. The program lasted five years, siphoned billions of dollars out of Alberta, and fuelled western alienation for decades.

Last month, Alberta Energy Minister Sonya Savage said that if Ottawa enacted a windfall tax on oil and gas, it would be considered an “extreme act of aggression” against provincial constitutional authority.

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