Will The New U.S. Tax Reforms Affect The Oil Sector In Canada?

Is Canada about to lose the competitive advantage it currently enjoys in attracting investment to its oil sector? With a U.S. tax reform package on the horizon, the answer could be yes.

If the Republicans succeed in passing a version of their tax-reform proposals— Alberta will slide quickly from one of the most tax favorable destinations for oil investments to somewhere in the middle of the pack, and Saskatchewan will become one of the highest-taxed oil-producing jurisdictions. Also, should rising oil prices trigger higher royalty rates in both provinces, they will become even less competitive. 

Under the current tax policies affecting the upstream oil industry, Canadian oil extraction enjoys a considerably lighter tax burden versus the United States, with a marginal effective tax and royalty rate approximately eight-percentage-points lower. Alberta in particular currently offers the lowest METRR for conventional oil in the three Western provinces and four of the five U.S. states examined. But this comparative advantage is under threat given the tax-reform proposals advanced by the Republican party currently in power.

The School of Public Policy at U of Calgary, authors Daria Crisan and Jack Mintz explain tax reform implications, “The election campaign leading to the U.S. election in November 2016, President Trump has announced his intention of slashing the corporate income tax rate from 35 to 15 per cent, while potentially expanding the tax base. If his plan comes to fruition, the METRR in the U.S. would fall by almost five percentage points, from 36.1 to 31.2 per cent, still above the average Canadian METRR, but much closer than it is now.

Under the House Republicans’ “Blueprint,” the corporate income tax rate would be reduced to a more conservative 20 per cent, but combined with the proposal for immediate deductibility of capital expenses while eliminating the interest deductibility, the impact on the capital-intensive oil industry would be substantial. The average METRR in U.S. would fall to 28.6 per cent, less than one percentage point above the Canadian METRR of 28.0 per cent.

More importantly, under both tax reform plans, the competitiveness of the two largest Canadian oil-producing provinces, Alberta and Saskatchewan, would significantly diminish. From one of the least taxed at current market prices, Alberta’s conventional oil would fall behind to somewhere in the middle of the pack, while Saskatchewan oil would go from the middle of the pack to become more taxed than in any of the five U.S. states considered.

The current results are derived using a benchmark oil price of US$50 per barrel. Any increase in the price of oil would further erode the competitiveness of Alberta and Saskatchewan through the automatic adjustment of the royalty rates. It is unclear at the moment what will be the final shape and form of the corporate tax reform in the U.S., but Republican politicians are under intense pressure to

It is unclear at the moment what will be the final shape and form of the corporate tax reform in the U.S., but Republican politicians are under intense pressure to fulfill one of their most significant campaign promises. At the same time, a recent change introduced by the Canadian federal government that treats successful exploratory wells as development spending rather than exploration spending has already raised the METRR in Canada by close to half of one percentage point. Add in the lower regulatory burden on the oil industry in the U.S. and the absence there of any firm intentions to tax carbon, and the Canadian oil industry has significant reason to follow very closely the changes about to happen south of the border.”

THE SCHOOL OF PUBLIC POLICY REPORT

The School of Public Policy with authors Daria Crisan and Jack Mintz released a report that measures the impact of potential U.S. tax reforms on Canadian competitiveness for the oil industry.  It also ranks Alberta and Saskatchewan against other jurisdictions on tax rates on investment for 2017.

According to Mintz, “Canada may be about to lose the competitive advantage it currently enjoys in attracting investment to its oil sector, namely, its low corporate tax and royalty rates compared to the U.S. While we will start to know better the details of a U.S. tax reform package in the next month or so, two reform plans provide a basis to analyze potential impacts: the tax-reform “Blueprint” put forward last year by the Republican-controlled House of Representatives, and President Donald Trump’s own reform proposals. Either one or even a hybrid version of the two would make tax and royalty effective tax rates on new investment in the U.S. oil industry significantly more attractive to investors.”

Alberta, for example, which currently offers the lowest marginal effective tax and royalty rate (METRR) on conventional oil investments of all the Canadian provinces based on a $50 per barrel West Texas Intermediate price, also offers a lower METRR than nearly all comparable U.S. states measured (except Pennsylvania). But if the Republicans succeed in passing a version of their tax-reform proposals — and as a major campaign promise, they are facing great pressure to do so — Alberta will slide quickly from one of the most tax favourable destinations for oil investments to somewhere in the middle of the pack, and Saskatchewan will become one of the highest-taxed oil-producing jurisdictions. Yesterday’s increase of BC’s corporate tax is another blow to Canadian tax competitiveness. 

It is unclear at the moment what will be the final shape and form of the corporate tax reform in the U.S., but Alberta and Saskatchewan policy makers need to understand this looming threat and develop plans to respond to it if they hope to keep attracting investment to their provinces. 

The report can be found online at www.policyschool.ca/publications/

For more information please contact:
Morten Paulsen   403.220.2540     morten.paulsen2@ucalgary.ca

SOURCE & AUTHORS
University of Calgary – The School of Public Policy with authors Daria Crisan and Jack Mintz