The grand bargain between Prime Minister Mark Carney and Premier Danielle Smith that could lead to the construction of a West Coast oil pipeline comes with two costs for the oil and gas industry. Alberta agrees to a higher industrial carbon tax and oilsands producers invest in carbon capture, utilization and storage facilities that could cost at least $20 billion. The industrial carbon tax and the requirement for “decarbonized oil” are now being hotly debated in Alberta.
How Carbon Policies Affect Alberta's Tax Competitiveness
The debate bears on Alberta’s tax competitiveness for new investments, not only in the oilpatch, but also in fossil-fuel-using industries such as electric power. Because the U.S. does not have a carbon tax, the question is whether Alberta’s industrial carbon tax makes the province less tax-competitive for investment compared to the U.S.
Much analysis of these issues has focused on corporate income taxes, royalties, sales taxes on capital inputs and other capital-related charges, but so far little has been done regarding the impact of energy taxes. To fill this gap, my new study published by the Fraser Institute compares the effects of taxation on the cost-competitiveness of investments in oilsands, conventional oil, natural gas and electric power production in Alberta, Texas and New Mexico.
Alberta's Tax Advantage Without Carbon Policies
Looking just at standard taxes, Alberta’s effective tax rate on marginal costs is actually lower than in Texas and New Mexico for the oilsands, gas and power, though not for conventional crude. Alberta’s tax advantage comes from its relatively low corporate income tax rate, profit-based oilsands royalty and low fuel tax rate, and also because it doesn’t add on other taxes, such as the retail sales taxes and high severance taxes used in Texas and New Mexico.
Impact of Carbon Taxation on Marginal Costs
My study looks in addition at the effects of taxation on energy producers’ marginal cost of production. Why? Economic theory predicts that competitive businesses will produce to the point where the price charged for a product equals the marginal cost of producing it. Produce more than that and you lose money: costs exceed revenues on the extra output. Produce less and profits are being left on the table: more output generates more revenue than cost. Taxes that add to the marginal cost of production therefore cause businesses to reduce output, lay off workers and forgo investment opportunities.
Carbon taxation affects company’s marginal costs in a couple of ways. Under the current rules, companies don’t pay the industrial carbon tax on all their emissions, just those in excess of a specified threshold. For these firms, the carbon tax adds to their marginal cost of production. However, instead of paying the tax, companies can either invest in technologies to reduce emissions or buy carbon credits from firms that are generating less than their threshold emissions. If the price of the credits is less than the carbon tax rate, that makes such deals win-win. The price of carbon credits is established by supply and demand and at the moment those implacable forces are producing a price per tonne that is substantially less than the carbon tax rate. Last year credits cost about two-fifths of the official carbon tax rate of $95/tonne. Until now, companies liable to pay carbon tax have had about one-third of their emissions covered by purchasing carbon credits.
According to Jack M. Mintz, the combination of a higher industrial carbon tax and the requirement for decarbonized oil effectively offsets Alberta’s tax advantage, making the province less competitive for investment compared to U.S. states like Texas and New Mexico.
