Oct 7, 2014

Competitiveness vs public benefits: the LNG tax and regulatory regime

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This Fall’s legislative sitting will be an important one for shaping the future of LNG in BC. Will one or more companies make final investment decisions? And if they do will there be any public benefits?

One of the key questions is whether the BC government will cave on its proposed 7% LNG income tax rate. Industry has criticized the LNG income tax as an extra tax not applicable to other industries, but this misses the point. BC’s natural gas is a public or Crown resource, so, ultimately, this jockeying is about what is BC’s fair share of the profits. If I was to sell your car for you, because I had special infrastructure for that purpose (a used car lot), how should we split the proceeds: 50/50? 80/20? 95/5?

In order to capture public benefits from extraction of a public resource, most jurisdictions auction the rights to explore and extract resources, and receive a royalty on actual production. The proposed LNG income tax is an extension of the royalty framework, ensuring the BC government captures a share of the windfall profits associated with selling the public resource at higher prices in Asia.

To date, BC’s royalty regime has not achieved a good return for the province. Natural gas production is at record levels, up by one-third over the past five years, but royalty revenues have dropped significantly over this time due to low market prices and large credits associated with fracking and other gas infrastructure. Over the past five years, royalties from natural gas averaged a mere $0.3 billion per year, on a total BC budget of about $44 billion.

The proposed LNG income tax may already be a huge giveaway to global corporations with little public benefit in terms of revenues. In part this is because new supply is coming onto world markets, and Asian importers are seeking to strike a better deal. This points to lower prices in Asia going forward. Because of the massive capital investment in extraction, processing, pipelines and liquefaction associated with landing gas in Asia, small drops in price have a large impact on profit margins, and therefore LNG income tax revenues.

It gets worse. Because companies can fully deduct billions in capital costs before starting to pay the full 7% LNG income tax, any cost over-runs will be paid for by reduced future LNG income taxes. This is important because in the LNG industry huge cost over-runs (especially in Australia) have been the norm. Canada is not immune, either, as evidenced by cost over-runs in Alberta’s tar sands.

To get the money flowing earlier, the BC government has also proposed an initial “tier 1” tax of 1.5% for the early years when capital costs are being paid off, but this is deductible from the later “tier 2” full rate of 7%. Nonetheless, if BC caves on the 7% rate due to industry pressure, it could be decades before the province generates any revenues through the LNG income tax. And this is not counting the capacity for global corporations to engage in creative “transfer pricing” to reduce their tax liabilities.

The tax is one piece of “competitiveness” for the industry. The other is the regulatory regime, and here the BC government is tying itself in knots because of an inconvenient law it brought in late 2007 legislating greenhouse gas reduction targets. The Premier has promised to have the “cleanest LNG in the world,” which sounds nice if we forget that the very nature of LNG is to extract fossil fuels for combustion.

There has been talk of ensuring that LNG liquefaction plants have to meet a “carbon standard” of emissions per tonne of LNG exported. But if we have a standard that is tough, or if the government required the plants to be powered by renewables, it will mean extra costs for proponents. So we may get a standard that pushes them somewhat, but not a lot. It may also give them a backdoor to compliance in the form of an Alberta-style “tech fund” for emissions that exceed the standard, or allow them to purchase carbon offsets (though discredited following the Auditor General’s 2013 report on the Pacific Carbon Trust).

Furthermore, the carbon standard is unlikely to apply to upstream emissions from fracking and processing of gas. These emissions are largely exempted from the BC carbon tax, and the extent the province applies the carbon tax to the LNG industry as a whole is another question for consideration.

Bottom line: the more “competitive” BC’s tax and regulatory regime from a corporate perspective, the less British Columbians will get in public benefits. Given that the government has staked so much on LNG as its top economic priority, we may see them accept a bad deal out of desperation to show they are delivering on that promise, rather than no deal.

So far, none of this has been debated publicly, as the government negotiates behind closed doors with proponents. It’s time for some daylight and a sober assessment of costs and benefits for British Columbians.

 

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