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June 13, 2013

Clark's LNG Super-Tax

Reports from private consultants hired to support claims regarding future LNG revenues suggest Premier Clark's government is set to impose a super-profits tax on B.C.'s LNG industry.

Premier Clark's dream of paying off the provincial debt thanks to LNG depends on adopting a tax equivalent to Australia's Petroleum Resource Rent Tax (PRRT) of 40% on taxable profit. Australia's PRRT has been in effect since 1987 for off-shore production, but was only applied to on-land production as of July 2012. At the same time a controversial profits tax (Mineral Resource Rent Tax) was introduced on coal and iron ore. Australia's fiscal year ends June 30th and preliminary financial reports combine MRRT and PRRT revenue. It is suspected that virtually nothing has been raised from the MRRT, but the PRRT is raking in big dollars for the government. The Labor government is expected to lose power in September with a coalition government led by the Liberals winning. The Liberals recently flip-flopped on the resource tax issue, saying they'd get rid of the MRRT but keep the PRRT which is expected to rake in billions in the years ahead. Watch for Liberals in BC to follow the Australian lead.

In her May election campaign, Premier Clark promised to pay off the provincial debt. The Liberal platform spoke of a roadmap to a debt free BC for government, BC Ferries, BC Hydro and the Port Mann Bridge. It said: "Today's BC Liberals will keep our budget balanced and pay off our provincial debt, while continuing to make strategic investments. Balanced Budget 2013 means capital expenditures of $10.4 billion over the next three years." A case can be made that BC requires well over $3 billion per year in capital spending in order to keep up with requirements to build, replace and repair infrastructure. In order to pay down the debt, current capital spending must be funded out of current surpluses and enough must remain for debt repayment.

Part of the Liberal platform was titled "Our plan for a Debt-Free B.C." The platform referred to a study government commissioned by consultants Ernst & Young and Grant Thornton on LNG opportunities for B.C. The platform said: "Up to $100 billion will flow to the BC Prosperity Fund over the next 30 years if five LNG plants are in operation. Industry is asking for permission to build them at a total cost, including pipelines, of $98 billion." It is not clear if the government is counting multiple "LNG trains" as multiple plants even if they are at the same location. In the language of LNG a LNG train is the production plant.

Pacific Northwest LNG is expected to complete the first phase of its facility near Prince Rupert in 2018. It will then produce 12 million tonnes per annum (MTPA) of LNG. A second phase could add a further 6 MTPA when market conditions warrant. Canada LNG is expected to complete the first phase of its facility in Kitimat in 2019/2020. It will also then produce 12 MTPA. Subsequent phases could double that production should market conditions warrant. The combined production from the two facilities will require approximately 2.2 trillion cubic feet (Tcf) of pipeline quality natural gas per year. B.C. currently produces 1.1 Tcf, so if nothing else changes, natural gas production will be in excess of 3 Tcf by 2020. It needs to be determined whether the availability of water will limit the ability of the industry to reach that level of production, let alone the dreams of production several times greater.

In fiscal year 2012-13 BC received $144 million in natural gas royalties. Higher prices are expected to result in the 2013-14 royalties increasing to $282 million. It doesn't take a rocket scientist to multiply by three and conclude that increasing production from 1.1 Tcf to 3 Tcf would not begin to cover the cost of annual capital projects, let alone pay off the provincial debt. Government revenue from natural gas can increase through higher prices or through higher production, but no reasonable combination of increases in price and volume produce enough revenue to fund annual capital requirements, let alone pay off government, BC Ferries, BC Hydro and the Port Mann Bridge debt. Hence the super-profits tax, a.k.a. resource rent tax!

The consultant reports are both surprisingly short, including title page and other filler, ten pages for Ernest & Young, eleven pages for Grant Thornton. Most of both reports is devoted to qualifying their opinion, essentially saying they are using the government's model to crunch numbers the government gave them. While the Liberal platform projected revenue for thirty years, both consultants projected revenue for just twenty years (starting in 2017). Both reports refer to Australia.

The Grant Thornton report says:
"We reviewed the model prepared by the Province's advisors for completeness in terms of interaction between the Australian royalty regime, Australian Petroleum Resource Rent Tax legislation, and Australian income tax legislation, as Australia is an important competitor jurisdiction in the Asia Pacific market."
"We were provided a possible BC LNG revenue framework by the Province as outlined in the Base Case Assumptions which was used to adjusted Australian-based model where appropriate."
The Grant Thornton report found:
"As summarized above, the total estimated Provincial revenue for the Base Case over the construction and 20 year operation period assuming 82 MTA capacity ranges from $130 to $180 Billion."
"The Province requested an estimate of revenue based on 120 MTA capacity (High Capacity) for 5 plants and the result was $160 to $277 Billion."
The Ernst & Young report says:
"The province and its advisors have undertaken a detailed review of taxation frameworks for LNG projects on a global basis. As a result of this review the Province has determined that an appropriate comparator is the regime in place in Australia."
Ernst & Young found that on capacity of 82 MTA by 2018, provincial revenue might range between $79 billion and $162 billion in 2012$ over the 20 year operating period. It also found that on capacity of 120 MTA by 2020, government revenue might range between $112 billion and $224 billion over 20 years of production.

The low volume assumption of 82 MTA in the two reports is over three times higher than the likely combined capacity of Pacific Northwest LNG and Canada LNG in 2020; the high end assumption of 120 MTA is five times their combined phase one capacities.

There are ample reasons to question the government's claims about enough revenue from LNG to yield a debt free BC; it is likely that the Pacific Northwest LNG and Canada LNG proposals will be under construction in three or four years. You can follow the Pacific Northwest LNG environmental approval application on the Canadian Environmental Assessment Agency site. The Canada LNG environmental application can be followed on BC's Environmental Assessment Office’s site. Many of the documents filed in those applications are more detailed and more reliable than reports from other sources.

It is reasonable to think both companies would want to know the details of B.C.'s "LNG revenue framework" before they commit to spending billions on construction. It would also be fair for the Clark government to share those details with British Columbians. With so much bet on LNG, will the Clark government negotiate the tax structure, trading off certain construction against uncertain thirty year returns? British Columbians may have to wait until after the 2017 election before any of that information is public.