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Should Canada slap a new tax on oil & gas industry profits?

Experts say a windfall tax on the profits of Canadian oil and gas companies would hurt investment in the sector. (GETTY)
Experts say a windfall tax on the profits of Canadian oil and gas companies would hurt investment in the sector. (GETTY) (Ladanifer via Getty Images)

With no clear end in sight to rising energy costs, could a U.K.-style windfall tax on the profits of Canada's oil and gas producers be in the cards as Ottawa looks to ease the strain on household budgets?

If inflation continues to run hot and prices at the pumps remain high, Ian Lee, an associate professor at Carleton University's Sprott School of Business, says the idea could make its way across the pond in time for the government's Fall Economic Update.

"It would allow the government to stand up in the House of Commons and say they're doing something about the problem," Lee said in an interview. "I don't think it makes economic sense, but with the political optics of it, I wouldn't be shocked if they did."

Last week, U.K. Finance Minister Rishi Sunak announced a temporary 25 per cent windfall tax on what he described as "extraordinary profits" booked by companies in the nation's oil and gas sector. Sunak says the additional tax includes an "investment allowance" to encourage companies to re-invest their profits. The measure was announced alongside a $18.9 billion package to support those struggling to pay rising energy bills.

The tax represents an about-face for Boris Johnson's government, which previously dismissed the idea as harmful to investment in energy. The move by Downing Street follows efforts by European governments, including Germany, France, Italy and Spain, to soften the blow for consumers by cutting taxes and issuing fuel rebates.

Meanwhile, many of the oil and gas companies that benefited from surging commodity prices in the wake of Russia's invasion of Ukraine have signalled plans to pay down debt and boost shareholder payouts, rather than pour excess funds into boosting oil production or adopting climate-mitigation technologies.

Oil continued to rally on Tuesday, following news that European Union leaders reached an agreement on a partial embargo of Russian oil. Patrick De Haan, head of petroleum analysis at GasBuddy, referred to the news in a tweet on Monday, writing "this is your warning - today is the calm before the storm" for gas prices.

A 2-year view of average retail gasoline prices in Canada.
A 2-year view of average retail gasoline prices in Canada.

Lee agrees with the U.K. government's first assessment, saying Ottawa's "unlimited taxation power" should not be used to pick winner and loser industries within the economy. Doing so, he says, would send the wrong message to investors looking to deploy capital in Canada. If a U.K.-style windfall tax were to be proposed, Lee recommends the government couple it with a temporary cut to the excise or sales taxes consumers pay on fuel.

"Governments in the past have declared temporary tax holidays in recessions, so there is a precedent for it," he said, referring mainly to provincial governments.

"We know that the cost of living is a real concern for Canadians," Adrienne Vaupshas, press secretary for Deputy Prime Minister and Finance Minister Chrystia Freeland, wrote in an email to Yahoo Finance Canada in response to questions about measures to address rising energy costs. "That is why affordability was at the heart of the budget released last month."

Government cash tills also benefit from an influx of oil revenueRoger McKnight, chief petroleum analyst at En-Pro International

While borrowing from the U.K. playbook may sound like a tempting idea to combat rising costs, energy industry experts warn that comparing the two nations is extremely challenging, given the role of provincial governments in Canada's energy industry, and the royalties linked to the price of oil that companies pay.

"[The] U.K. vs here is not comparing apples-to-apples on many dimensions," said Peter Tertzakian, ARC Energy Research Institute's deputy director, in an email. "Windfall royalties are baked into our royalty formulas through the sliding scale structure. The higher the oil and gas price, the higher the royalty rate."

The U.K. government abolished royalties from its oil and gas fiscal regime in 2003.

Tertzakian was a member of Alberta's 2015 royalty review panel. It issued a report ranking the U.K. eighth on a list of 15 oil and gas-producing jurisdictions most analogous to Alberta.

Kevin Krausert, a former oil field services executive and CEO of Avatar Innovations, says a windfall tax in Canada would be "counter-productive and work against both outcomes the public wants – lowering the price of energy and emissions."

"What policymakers need to do is incentivize energy producers to invest in energy transition technologies with these windfall profits," he added. "This is the only way to lower energy costs in the short term and lower emissions in the medium."

Werner Antweiler, director of the Sauder School of Business Prediction Markets at the University of British Columbia, called the idea "a popular sentiment," but one that's ultimately "ill advised." He warns a windfall tax would disrupt investment in an industry known for extreme boom and bust cycles.

"Windfall taxes would do nothing to reduce the high price of crude oil and refined petroleum products. In Western/democratic countries [it] would also distort the within-industry capital allocation, because it would punish investment in Western countries while leaving investments in OPEC countries (many of which are not democratic) in a more advantageous position," he wrote in an email. "Do we really want to boost OPEC's power?"

Photo taken on May 18, 2022 shows a price board at a gas station in Toronto, Canada. (Photo by Zou Zheng/Xinhua via Getty Images)
Photo taken on May 18, 2022 shows a price board at a gas station in Toronto, Canada. (Photo by Zou Zheng/Xinhua via Getty Images) (Xinhua News Agency via Getty Images)

Roger McKnight, chief petroleum analyst at En-Pro International, says a better way to pacify frustrated consumers would be to cap the price at which the federal and provincial governments charge HST at the fuel pumps.

"As this is a percentage, not a fixed amount, and is charged at the end of the pricing train, the higher the end price goes, the more cash goes out of the consumer's wallet and into various government bank accounts," he said. "My observation would be that perhaps the oil industry isn't the only one profiting from high petroleum-related pricing. Government cash tills also benefit from an influx of oil revenue."

Dan McTeague, president of Canadians for Affordable Energy, says "moves by governments to choke off production, regulation, [lack of] take-away infrastructure and ESG mandates have played no small role in undercutting supply that is falling short in addressing burgeoning global demand."

Lee, of Carleton University's Sprott School of Business, agrees.

"We are making a mistake. Not in trying to decarbonize, but in beginning to shut down existing energy supplies before we build alternative energy infrastructure," he said.

"We put the cart ahead of the horse."

Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.

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