Houston, we have a problem
Maybe you can run a global oil company from Canada instead of Texas, says Alberta Energy Co.'s Gwyn Morgan. But Ottawa is making it tough
Gwyn Morgan
National Post
Can a global oil and gas company headquartered in Calgary be competitive with a global oil and gas company headquartered in Houston?
I will set out for you the "winning conditions" required to succeed, and how these conditions look from a Calgary or Houston headquarters. The "winning conditions" involve the ability to recruit and retain "best of class" knowledge workers, the ability to obtain competitive access to capital and fair, consistent and competitive government policies.
Canada's quality of life factors do, in my biased opinion, give Calgary an advantage over Houston. Our Canadian professionals' capabilities are generally on par with those in Houston, even if we must hire some of our core professionals from other countries; we have relatively few global oil and gas companies, relative to Houston, and finding Canadian workers with international experience is difficult.
But we have one key problem: Much higher personal tax rates discourage those experienced international people from coming. And when our Canadian workers go abroad, it's very difficult to get them to come home due to the double cold shock of moving to after-tax financial realities and to Canadian dollars from U.S. dollar-based wages.
As far as access to capital goes, U.S. investors are becoming more willing to consider the merits and potential of the strongest Canadian-based oil and gas companies, against their universe of home-based opportunities. Therefore, Canadian companies with strong reputations do attract international investors, albeit with somewhat more difficulty than our Houston-based counterparts. For example, Alberta Energy Co.'s foreign ownership has moved from just 5% in 1994 to around 40% today.
Canada's domestic financial markets are simply too small to support global champions. This stark reality is underlined by the fact that Canada places ninth in terms of Western industrialized capital markets, after Italy, the Netherlands, Switzerland, France, Germany, Japan, Britain and the United States. In fact, Canada makes up only 1.4% of global capital markets while the United States makes up a whopping 57%.
Why are Canadian capital markets so small? The money individual Canadians have available to invest, after paying their taxes and meeting their immediate cost-of-living needs, goes into such vehicles as RRSPs and mutual funds. The balance of the Canadian capital comes mainly from corporate and government pension plans. The fact that these capital sources are minuscule in world terms should send a message to governments at all levels. The total tax load of Canadians is simply draining the ability of our economy to provide the investment capital necessary to fuel a strong, free market economy.
So, the reality is that to achieve the second "winning condition" of access to capital, we need to ensure that the majority of our growth capital comes from foreign investors.
To retain our Canadian investors and attract those international investors, we need the third "winning condition": fair, consistent and competitive government policies. I'll bet the vast majority of people think the recent federal budget announced plans to reduce federal corporate taxes from 28% to 21% over a five-year period. Well, not for our industry! Tucked away in the fine print, was the qualifier that "resource allowance recipients" would not be eligible for the reduction.
One moment of explanation about the "resource allowance": Our industry mainly drills and produces on lands whose mineral rights are held by provincial governments. As the constitutional mineral rights owner, these governments have the right to a "royalty share" of production, which averages around 25%. Therefore, the producer is left with about 75% of production to pay for his costs and, if prices are in an up cycle, make a profit. The province either leaves the production in the hands of the producers to market and forward their share in cash, or takes their production and markets it.
In the 1970s, the federal government unilaterally required producers to pay federal tax on 100% of production, including the provincial government's share, effectively increasing producer corporate tax rates from 48% to more than 60%. The feds felt provincial royalty rates were too high and were cutting into the federal income taxes. The Western provincial leaders reacted with a vehemence that is etched in our memories. And our industry was caught in the middle. In a settlement, the federal government allowed us to deduct a "resource allowance" of approximately the same amount.
Mr. Martin's latest discriminatory budget exclusion of our industry from tax reduction threatens to ignite this historic war once again.
I could be generous and follow the biblical advice, "forgive them for they know not what they do." The Western provinces and our industry pray that Ottawa will soon repent its sins and reverse this policy before real damage is done to our industry in the eyes of international capital markets.
The budget exclusion has yet another bizarre implication: It reduces our incentive to invest in Canada and increases our incentive to invest internationally. In fact, in the March 17 edition of Energy Tax News, PricewaterhouseCoopers indicates that today, the tax rate on domestic production is 43.5% (ignoring that "temporary" surtax they throw in), whereas the tax rate on foreign production is 38%. In five years, the tax rate on foreign production is scheduled to decrease to 31%. So, we would get the benefit of the phased-in federal tax reductions for our foreign production, but not for domestic. Here is an example of government policy that drives investment outside the country.
Now to summarize the balance sheet of "winning conditions" and decide whether AEC is better off pursuing its "global champion" strategy from Calgary or Houston. I'll try to be objective, even though as a Canadian who loves his country, I have a strong bias as to what I want the answer to be.
On the first winning condition, because it's pretty tough to compete with wages in U.S. dollars taxed at U.S. rates, Houston wins by a significant margin.
On the second condition, access to capital, we can be competitive, even though a Houston base provides direct access to 57% of the world's investment capital, while our Calgary base provides direct access to only 1.4%. The announced tax rate reduction on our foreign income will help narrow the significant Calgary-Houston gap, five years out, providing we can obtain some technical changes to allow us to get the lower tax rates when operating through international subsidiaries. We can outperform our Houston-based competitors operationally and get the attention of global investors if we have no higher RT&T (red tape and taxes) than a Houston-based company.
But when we look at winning condition No. 3, I conclude that our federal government's performance regarding fair, consistent and competitive policies gives a big nod to Houston.
Overall, Houston gets a clear win as a place to build a global oil and gas champion.
But, like many Canadians, I don't give up easily. We have a huge opportunity by moving from a state of denial over the things that are holding us back, to embracing the simple changes needed to unleash our full potential. If we can change, if we can embrace the possibilities for Canada in the new millennium, we will unleash the full potential of this country.
Gwyn Morgan is president and chief executive officer of Alberta Energy Co. Ltd. This is an excerpt of a speech he gave at this week's CEO Summit 2000 conference in Toronto |
