Resource Revenue Retention: New Twists on an Old Idea?

In a post on iPolitics, author and journalist Madelaine Drohan discusses the move by the PQ government in Quebec to embrace the Generations Fund - a sovereign wealth fund created by the Liberal government of Jean Charest in 2006.  The original plan was to invest water power and mining royalties into a fund whose income would be used to pay down the provincial debt.  The fund was apparently valued at 4.3 billion dollars at the end of March 2012 and the recent PQ budget has directed that starting in 2015-16, all mining royalty revenues – about 325 million dollars a year – would go into the fund.  Given the prospect of future mining development in Quebec’s North under the auspices of the Plan Nord, this fund could grow substantially in the future.

Of course, as Drohan points out, this is not a new idea.  Internationally, Norway, Alaska and Kuwait have these funds.  Alberta also has its Heritage Trust Savings Fund, which initially was supposed to receive 30 percent of oil and gas revenues.  Yet Alberta has not been that persistent in saving for the future, preferring to spend most of its resource bounty on current consumption.  Since 1990, Norway has used its oil natural resource revenues to build a fund that now approaches $660 billion dollars US.  However, Norway saves 96% of its resource revenues as opposed to estimates of up to 30% for Alberta and also levies much higher tax rates to provide current services.  Indeed, Herb Emery and Ron Kneebone in a May 2011 Policy Options piece maintained that the provincial government in Alberta saved less than 10 percent of the $130 billion of natural resource revenue collected between 1970 and 2004. 

Investing a portion of resource rents rather than using them entirely for current consumption is the responsible long-term thing to do especially when those resources are non-renewable.  Alberta could certainly do better given that the Heritage Trust Fund presently contains only about 16 billion dollars.  Drohan points out that other Canadian provinces could do better also as with the exception of Prince Edward Island, they all have significant royalties from mining, oil and gas.

I concur.  Two specific points are worth making here.  First, Ontario is poised to embark on a massive expansion of its mining development in Northern Ontario.  While successful development is probably still years away, in all the discussion and debate, there is little mention of planning for the future by retaining a large chunk of the future resource royalty revenues and investing them in a sovereign wealth fund.  You would think Ontario might have learned from its past.  In the late 19^th and early 20^th century, forests in Northern Ontario were the equivalent of oil today as bonuses, dues and ground rents generated as much as 25 percent of Ontario government revenues.   Yet, these revenues went into current consumption.  Placing a portion of these revenues into a long-term endowment would have been a positive form of economic stewardship.  Making the same mistake again is downright irresponsible to future generations.

Second point.  Ottawa is currently embroiled in decision-making on whether or not to allow foreign purchases of Canadian petroleum companies Nexen Inc. and Progress Energy Resources Corporation.   The complication of course is that these are not private companies but state owned companies – in particular – China’s state oil company CNOOC and Petronas from Malaysia.  These are not private companies so I suspect that the usual rules do not need to necessarily apply.  At the risk of being told by China’s Ambassador to Canada to "shut up”, how about the following suggestion: If Ottawa decides to allow these state-owned companies to purchase private Canadian oil companies, why not increase the net benefit to Canada by placing a special and substantial federal resource revenue charge on their Canadian production that goes into a Canadian federal sovereign wealth fund?  It will be difficult for these companies to complain that they are being placed in a non-level playing field compared to other private investors given that they are state-owned companies.  Private energy companies in Alberta need not fear the return of a national energy policy as these charges would apply to foreign "state-owned" companies investing in Canadian energy resources.  Can you  argue that the charge is a form of tariff or protectionism?  Maybe.  But, we would simply be treating all state-owned companies that choose to buy Canadian energy and resource assets the same while treating them differently from private companies.  We would be arguing that a state owned company represents a different form of investment in our national economic space than one representing private shareholders. Intriguing proposal or merely a half-baked idea? 

Comments

[Bob Smith]

The private companies (and their shareholders) mights care if they're the target of the state-owned acquiror, since at least some of that resource charge would be borne by them through a lower share price. Also, I don't know if the ICA catches indirect acquisitions. Could you get around that with a two step transaction? First have a "private" Chinese (say) company acquiror the target then have the state-owned company acquire the Chinese acquiror.

I'm not so sure why we're fussed about state-ownership in the resource sector - the resources aren't going anywhere and can always be subject to Canadian law.

[Determinant]

I don't get this post. Specifically this:

The original plan was to invest water power and mining royalties into a fund whose income would be used to pay down the provincial debt

Why on earth would anyone use money to earn interest to pay off debt when they can simply repurchase the bonds on the open market, retire them and save the province the future interest?

If Ottawa decides to allow these state-owned companies to purchase private Canadian oil companies, why not increase the net benefit to Canada by placing a special and substantial federal resource revenue charge on their Canadian production that goes into a Canadian federal sovereign wealth fund?

I may be having an NDP moment, but GATT and every trade agreement going would probably say that's discrimination and illegal. Of course we can always rip up the offending agreement, but that is a separate political calculation.

[Livio Di Matteo]

@Determinant
The general intent of these funds is to bank a portion of natural resource rents until the day they run out at which point the endowment generates investment income that generates a benefit in perpetuity - even after the resources are gone. Using them to pay down the provincial debt seems to be a Quebec variant.

[Simon van Norden]

I think I get the point that using revenue from non-renewable resources to finance current consumption is a (possibly very big) transfer from future generations to current ones, and I agree that this is probably a Bad Idea. (I have not gotten my brother-in-law, the former forestry company executive, around to this point of view yet, however.)

But I'm less certain that I understand the economic basis for discriminating between state-owned and privately-owned natural resource companies. Is the argument here just that half a loaf is better than none? Okay.

Is this policy enforceable? Can state-owned enterprises get around it by simply buying controlling interest in publicly-traded natural resource firms? If it is enforceable, do we agree that this policy will likely be costly to owners of Canadian natural resources, as it reduces the value of those resources to pubicly-owned bidders?

[Livio Di Matteo]

@Simon
Well: 1) With respect to an economic argument, one key question I would have is whether these state-owned companies have access to capital and financing from their governments at below market rates. In such a case, this might provide them with an advantage in the Canadian market that would operate to the detriment of our private sector companies who have to borrow on more competitive financial markets. 2) As for whether such a policy would be enforceable, good question. But if a state-owned company can buy the shares of a private company while a private company cannot buy into a state-owned company, you have another advantage of the state-owned company within the Canadian economic environment and another argument for differential treatment of some type.

[Bob Smith]

Determinant,

I don't think GATT has anything to say on the point and in any event, it isn't enforceable under domestic law, but you're right that under NAFTA and other investment treaties such an action might be problematic (alhough not that legally problematic, since treaties can be overridden by domestic law). The real issue is likely to be a political one, and that's an issue regardless of what treaties we've entered into (a point the NDP has never understood).

[Stephen Gordon]

It had never occurred to me to think of the Generations Fund as a SWF. I always thought it was essentially a margin account whose goal was to generate returns greater than the interest the Quebec govt has to pay on its debt.

[Edeast]

Gov companies not only get access to their own gov capital, but foreign capital as well below market. http://www.bloomberg.com/news/2012-10-15/cnooc-slashes-costs-as-foreign-banks-vie-to-lend-china-credit.html

80pts above Libor vs 265pt average above Libor

[Jacques René Giguère]

Stephen: if you don't have your own currency, investing in "foreign" (in that case private or othet gov'mts) assets is a SWF. Anyway, as long as you run a deficit, it turns out to be an accounting gimmick that will trick journalists and other LI peoples. Like the good ol'practice of having less retained earnings at Hydro-QC and finance more investment trough borrowings while paying yourselg dividends and booking them as income. Though is it ennobled by the fact that it is Bain Capital modus operandi?

[Edeast]

I think this suggestion is too resource specific, if we are discriminating based on state ownership. I think there might be a better more general framework.

[Edeast]

In case anyone is waiting, I don't know what it would be, but I'm hoping Nigel Wright and the gov departments, came up with something.

[Andrew F]

Any comments on whether this makes sense when the jurisdiction has existing debt/deficits? It is, after all, like running a margin account. Hoping that the government can earn a risk premium over its own debt yield.

In that case, why should it be based on resource revenues? Why should a government not borrow funds and invest them in a SWF? Say Ontario did it to make up for the timber it plundered a century ago without leaving an endowment for future generations.

[Livio Di Matteo]

@AndrewF
The case for basing the SWF on resource revenues especially if they are non-renewable is that it allows for some of their benefit after harvest to also accrue to future generations. As for why a government should not borrow funds and invest them in a SWF, I suppose they could do that. However, for it to make financial sense, the rate of return on the SWF need to exceed the rate of interest the money was borrowed at.

[Simon van Norden]

Thanks for the response, Livio.

So I understand that if foreign state-owned corporations can borrow more cheaply than Canadian private corps, this will give them an (unfair) advantage. Is that bad for Canadians? Usually when I teach about capital market segmentation we see the ability to tap cheaper foreign sources of capital as a Good Thing(tm) that moves our Canadian production-possibility-frontier out and is potentially Pareto-improving.

I'm trying to understand why it might be good to allow foreign private multinationals with cheaper access to capital buy Canadian resources, but not foreign state corporations. I'm wondering whether there is a behavioural assumption here that I'm missing...

[Livio Di Matteo]

@Simon:
I suppose it all depends on what the motivation for the foreign state corporation may be compared to foreign private corporations. If they are all profit maximizing firms then I'm not sure there is any difference between foreign private and state firms in which case it is difficult to make a case for restrictions or differentiation. I guess the key behavioural assumption I am missing is the following - how different from a Canadian private firm is a foreign state corporation in terms of how they operate and their objectives. I would like to think that private firms maximize the return to shareholders or profit. Whose return is the state corporation maximizing? Any thoughts?

[Determinant]

Political power? That's the usual assumption.

[Robillard]

I think resource royalties are a provincial perogative, from mining, logging, oil and gas. I don't think the Federal impose its own levies. Arguably, the Federal government gets a fair share of the revenues through the collection of income taxes on labour income and the collection of corporate income tax.

The only argument I can think of against saving the lion's share of resource royalties and rents (which I support), is that the resources subject to the royalties or rents, although technically is fixed supply, are really only fixed by current technology. In future, technology (combined with higher commodity prices) will likely allow the economic exploitation of currently marginal land for mineral and hydrocarbon extraction. So, even when the current reserves of commodities are exhausted, there will be additional reserves added, as they become economical to exploit. In the case of Alberta, this means that it will probably still have an oil & gas industry long after the current reserves of hydrocarbons are sucked out of the ground. The purpose of the saving the royalties/rents should not be only for divesifying the provincial economy in the expectation that the oil & gas industry will disappear once the current reserves are pumped out.

[Robillard]

Pardon the typo-ridden posting above.

The first section should say:
I think resource royalties are a provincial perogative, from mining, logging, oil and gas. I don't think the Federal government can impose its own levies. Arguably, the Federal government gets a fair share of the revenues through the collection of income taxes on labour income and the collection of corporate income tax.

[Determinant]

Actually the contrary is the case, Robillard.

http://www.nrcan.gc.ca/minerals-metals/business-market/budget-fiscal/3383

http://www.nrcan.gc.ca/minerals-metals/business-market/mining-taxation-regime/4098

Ownership of Crown Lands and the resources on the surface or in the ground is vested in the Province, but taxation on resource extraction can be levied by either level of government. The Federal Government can tax anything or anyone it likes by whatever method it wants under Section 91(2).

Provinces may collect resource royalties and impose direct taxes, which specifically includes property and income taxes. Sales Taxes and VAT-style HST/GST taxes are understood as direct taxes for legal purposes.

The Federal government actually has broader taxing powers than provinces have. The Federal Government does not levy resource royalties currently, but did before 1986. The fact that the Federal Government does not collect resource royalties right now is a political question, not a constitutional one. There is no legal barrier to Ottawa levying resource royalties.

[Robillard]

Determinant,
I didn't realise that that the federal government could levy taxes directly in relation to natural resources. Thanks

[Simon van Norden]

Livio;

I think you can find strong arguments from many different angles that neither domestic private corporations, nor foreign private corporations, nor foreign state-owned enterprises have the best interests of Canadians foremost in mind in their management of Canadian natural resources. (For that matter, I'm sure some will make the same argument about Canadian crown corporations.)

I get the feeling that you want to make an argument that somehow Chinese control of our natural resources is worse than, say, American control (or control by a multinational like BP or Shell.) I have trouble finding that argument compelling, so far, in part because I'm not sure that the alternative is particularly re-assuring.

[Edeast]

On state control, I'm specifically against china due to the communist party control of the government, not a Canadian malmotive concern. More enabling dictator type of thing. I haven't though enough about state companies in general.

[Livio Di Matteo]

@Simon
China has a growing demand for our resource products and may very well become our most important trade partner by the end of the 21st century if not sooner. Investment by Chinese state corporations in Canada is going to be a recurring issue so we need to get a handle on what exactly that might mean for Canada as a national economic space. It's not that we should not welcome such investment but what does it mean? Is a Chinese state corporation the same as say the CBC? Would the CBC be allowed to buy parts of the Chinese broadcast industry without any questions asked or concerns raised in China? I frankly cannot say what the benefits and costs of resource investments by Chinese state corporations are relative to them being made by Canadian or American or Norwegian firms for that matter. However, I would hope that someone in Ottawa is working on answering that question and providing answers soon.

[Jacques René Giguère]

A slightly disturbing aspect is how people who are in favor of CNOOC are against nationalization or even high royalties ( which is basically the same thing). It seems that Chinese gov't good, canadian gov't bad.
Anyway, why would the Chinese pay for the physical, immoveable plant when they can contract for a long term, which should provide agarantee to cdn. investors? After all, we could cut off the flow anytime...
Anyway, as a high-level guy in the U.S. State Dept. once said: " The Chinese don't realize that canadian oil belong to us. Neither do the Canadians."

[Determinant]

He was channelling the spirit of William Seward (Secretary of State in the 1860's) who felt Canada would fall into the "Magic Circle of the Union" like "Ripe Fruit". :roll eyes:

[Simon van Norden]

"I frankly cannot say what the benefits and costs of resource investments by Chinese state corporations are relative to them being made by Canadian or American or Norwegian firms for that matter. However, I would hope that someone in Ottawa is working on answering that question and providing answers soon."

Livio, why do you think that someone in Ottawa can provide the right answer to that question? There are no crystal balls there. Why would you even expect that people in Ottawa will agree on the right answer to that question?

Look, if you want an answer, there is no shortage of people who are eager to offer you their preferred answer. But I would think that this questions depends in important ways on the future of Canada's international relationships (which are political decisions and therefore expecially hard to foresee) and on the management of specific Chinese state enterprises (which are heterogeneous, and to the extent that the government controls them, govt. policy towards them is subject to change.)