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Money for Nothing: The Province vs. Non-renewable resource revenue

Alberta governments have a long history of squandering non-renewable resource wealth. Why that needs to stop – now

May 5, 2014

by Max Fawcett

Illustration Jack Dylan

The first step towards treating an addiction, it’s said, is admitting you have one. But as the last two provincial budgets in Alberta demonstrate, the province has made no such admission when it comes to the government’s dependency on non-renewable resource revenue (NRR). In the latest budget, Finance Minister Doug Horner heralded the fact that the government was honouring its commitment to saving more for the future by creating two new innovation endowments and something called the Alberta Future Fund, which would receive $200 million a year and be used to support big-picture projects as the government sees fit. But as the finer print reveals, the money for these endowments and funds would come from the existing assets in the Alberta Heritage Savings Trust Fund. Net new savings? Zero.

That was on the heels of 2013’s Fiscal Management Act, which committed the government to saving a portion of its non-­renewable resource revenues for the future. It was a move that the Premier’s Council for Economic Strategy had called for in its 2011 report, but here too the devil was in the details. The Fiscal Management Act stipulates that the government must set aside five per cent of the first $10 billion of non-renewable resource revenue , 25 per cent of the next $5 billion and 50 per cent of all NRR in excess of $15 billion. Given that NRR have averaged $9.6 billion a year since 2000, that would amount to less than $500 million a year in savings if the next decade’s ­royalties look like the last. Meanwhile, the province has never reached the $15-billion threshold at which the real savings kick in. Talk about being in denial.

“If we did put 50 per cent of the non-renewable resource revenues into the Heritage Fund, it would be a dramatic change. We’d have to institute some massive reforms to keep the level of services that we have today.” – Keith Brownsey, political science professor, Mount Royal University

This antipathy towards saving for the future is nothing new in Alberta. Indeed, it is so consistent, and so consistently objectionable, that it has actually united the Canadian Centre for Policy Alternatives and the Fraser Institute, two think-tanks that are on opposite sides of the intellectual spectrum. The two organizations are both clear in their dissatisfaction with the province’s inability to save more of its non-renewable resource revenues, and both have published reports to that effect. And no wonder: the province’s track record, after all, is pretty lousy. Despite generating almost $190 billion in non-renewable resource revenues since 1980, the value of the Heritage Fund stood at $17.3 billion at the end of last year.

That’s a reflection of both the government’s failure to contribute to it on a regular basis and its habit of siphoning off the income generated to fund capital projects and operational expenses. Indeed, of the $33.4 billion in income that it’s thrown off, the Heritage Fund has retained just $4.6 billion. Norway, in contrast, has managed to save much, much more of its non-renewable resource revenues. The value of its sovereign wealth fund sits at nearly $1 trillion, or $177,000 for every Norwegian citizen. Alberta’s per-capita figure? A shade over $4,300.

As Bruce Campbell, the executive director of the Canadian Centre for Policy Alternatives, noted in a 2013 report titled “The Petro-Path Not Taken: Comparing Norway with Canada and Alberta’s Management of Petroleum Wealth”, Norway takes in more than 80 per cent of the net revenues from petroleum production through a combination of state ownership, corporate taxes, special taxes and its carbon tax. Norway, of course, has the advantage – or disadvantage, depending on where you sit – of state ownership of its oil industry and a population that’s willing to pay taxes to fund its day-to-day commitments, which allows it to sock away its oil and gas royalties and revenues. Effective income tax rates there can be as high as 48 per cent, while the country also has an eye-watering 25 per cent value-added tax. Norway also doesn’t have the same challenges or lack of fiscal capacity as Alberta, which as a province must deal with a stingy federal government and cash-hungry municipalities. As such, a comparison of the two countries – one that’s commonly made to demonstrate how poorly Alberta has done – is unrealistic.

What isn’t unrealistic is a comparison between Alberta and Alaska, and here too we don’t fare well. In Alaska, a 1976 constitutional amendment requires the state to deposit at least 25 per cent of non-renewable resource revenues into a fund. At the time of publication, it was worth US$50.5 billion.

In economic theory, this failure to save is considered an intergenerational transfer of wealth. As a 2013 Fraser Institute report on the Heritage Fund said, “Such revenues are not income in an accounting sense, but instead are a transformation of one type of capital asset (oil deposits in the ground, for example) into another type of asset – cash in the Treasury’s bank account. Therefore, to treat these revenues as analogous to sales tax receipts, and to spend them on projects that provide a flow of present services, would be to engage in unwise capital consumption, a drawing down of principal. Intuitively, the present generation would be selfishly eating away at a finite stock pile of wealth, rather than acting as custodians of ­nature’s gifts on behalf of all future generations.” Or, as the University of Calgary’s Jack Mintz says, “Every time you’re pulling oil from the ground, which is an asset owned by the government, you’re borrowing from the future.”

In Alberta, a place where people have a habit of writing off the mistakes of the last oil boom as a cost of preparing for the next one, such concerns about saving for the future might seem distant. But while there are still billions of barrels of oil and trillions of cubic feet of gas left in the ground, we shouldn’t wait too much longer to start stashing some of the potential revenues associated with them away. As Michael Holden, a senior economist with the Canada West Foundation, noted in a 2013 paper called “Hedging Our Bets”, the oil and gas business is not an annuity that can be counted on forever.

“The concern today is that political, social or economic forces could dramatically affect the future of Alberta’s oil industry,” he wrote.

“Any one of several possible developments could undercut the viability of oil and gas extraction in the province and cause the flow of resource royalties to the Alberta government to dry up.” And there’s no better time to start saving than right now, Holden says, given that there’s always going to be a reason not to. “After decades of false starts and failed attempts, there is a dawning realization that there will never be a right time to begin saving for the future. There will always be a persuasive reason to put off savings and deal with more immediate needs, whether it be flood-related reconstruction, eliminating the deficit, coping with economic downturns, addressing long hospital wait times or fixing leaky school roofs.”

Of course, the real challenge isn’t selling academics or researchers on the merits of putting more money into the Heritage Fund. It’s convincing the public, and by extension the people that represent them politically, to make the sacrifices needed to do so. And as Mount Royal University political science professor Keith Brownsey says, there will have to be sacrifices. “If we did put 50 per cent of the non-renewable resource revenues into the Heritage Fund, it would be a dramatic change. We’d have to institute some massive reforms to keep the level of services that we have today.” That could come in the form of a sales tax, increased oil and gas royalties or an elimination of the province’s flat tax, he says, but it would have to come.

On this point, Mintz agrees. “I do think they [the government] need to do more to save, and I think they need to start thinking about increase in revenues – other revenues. That includes some excise tax increases, and maybe even a health-care premium or some form of user fee-based funding.” Those new taxes, he says, could be sold to the public by promising to use the funds that would get diverted to the Heritage Fund to chip away at the province’s future health-care tab. “There’s a significant amount of implied debt that’s associated with that,” he says, “and the idea of Alberta putting money aside in something like the Heritage Fund to help cover future age-related expenditures makes a lot of sense. It’s going to be 40 to 50 per cent of government expenditures anyways, and we could do a lot to pre-fund these future health-care liabilities that the government’s going to be facing.”

Indeed, as the final report of former Premier Ed Stelmach’s Council for Economic Strategy noted, Alberta may be effectively squandering its greatest advantage by using its non-renewable resource revenues to underwrite the province’s favourable tax code. “The true Alberta advantage is not the ability to create a low-tax environment by underwriting a significant proportion of government services with funds received from the sale of energy assets,” says the report, which was tabled in 2011. “Rather, the advantage lies in our opportunity to use the proceeds from our natural resource wealth – in combination with our highly educated and skilled people – to intentionally invest in shaping an economy that is much less dependent on natural resources. The practice of spending this converted capital as if it were ordinary income deprives Albertans of the opportunity to intentionally shape our future.”

The Premier’s Council for Economic Strategy recommended a five to 10-year transition period over which the province should move to a position where 100 per cent of operational spending was financed by current revenues, with all oil and gas royalties flowing into savings. But Brownsey doesn’t think that’s likely to happen any time soon. “We’re too addicted to the money,” he says. “It’s a sad, sad situation, and it makes for absolutely terrible policy, but governments use the non-renewable resource revenues to prop up the budget. That’s what we’ve seen this time.”

But, he says, it’s not inconceivable that a political party could find the courage to run on the issue – or that they could win. “I think a party could get elected doing it,” he says. And there is an opportunity coming up. In 2015, the royalty regimes governing a number of the big oil sands projects will change as they finish claiming deductions for capital expenditures. This will result in a windfall to the Albertan government. The only remaining question will be whether or not government will break with tradition and stop squandering the province’s natural endowment.

What could have been

Between 1981 and 2010, the Alberta government contributed $9.1 billion to the Heritage Fund. Here’s what they could have socked away under different scenarios – and remember, this is just contributions. The value of the fund could conceivably be far greater depending on how much of the fund’s net income was withdrawn and spent by the government each year.


The Klein Years

08_Money_story2The provincial government may not have contributed much to the Heritage Fund during Ralph Klein’s reign, but it didn’t squander as much of its non-renewable resource wealth as it might seem. That’s because the government paid down debt during that period, eliminating a liability on its balance sheet and improving the province’s fiscal capacity. Indeed, the decision to pay down debt may have satisfied former premier Peter Lougheed’s desire to see the province save 30 per cent of its non-renewable resource revenues. “You can look at debt reduction as another form of financial savings,” Mintz says. “When I did the commission for the Alberta government, we showed that between 1994 and 2007, Alberta actually did save around 30 per cent of its non-renewable resource revenues, either through debt reduction or putting some money into the Heritage Fund.”

The problem, Mintz says, is that we’re racking up debt again. “It’s almost like the Getty years all over again. There have been five years of deficits, and if you look at what’s happened to net financial assets held by the Alberta government, it’s almost at zero – in fact, it might be at zero. Back in 2007, there was $38 billion.”


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