“FUEL AND FIRE” DEVELOPMENT VERSUS ECONOMIC AND ENVIRONMENTAL BALANCE: WHAT THE ALBERTA OIL SANDS CAN LEARN FROM THE NORWAY GOVERNANCE MODEL By ANU CARENA HARDER Integrated Studies Project submitted to Dr. Angela Specht in partial fulfillment of the requirements for the degree of Master of Arts – Integrated Studies Athabasca, Alberta October, 2009 2 TABLE OF CONTENTS ABSTRACT…………………………………………………………………………p 3 SECTION 1: BACKGROUND Introduction……………………………………..………………………………….p 4 Oil Market Overview…………………………….…………………………………p 6 SECTION 2: ALBERTA’S “FIRE AND FUEL” DEVELOPMENT Firing up Development: The Privatization of the Alberta Oil Sands…………..p 9 Adding Fuel to the Fire: Ratification of the North American Free Trade Agreement……….……………………………………………………………….p 11 SECTION 3: ISSUES IN GOVERNANCE OF OIL WEALTH Dutch Disease Economic Model …………… .................................................p 15 Antidote to Dutch Disease—The Creation of the Sovereign Wealth Fund…p 18 SECTION 4: GOVERNANCE PARADIGMS Alberta Heritage Savings Trust Fund……….…….………………………...p 19 Norway Government Pension Fund………………………………………...p 21 Comparative Analysis of Governance: “Fuel and Fire” vs. Economic and Environmental Balance……………………………………………………...........................p 22 SECTION 5: CONCLUSION Conclusions……………………………………………………………..…….p 28 Afterword……………………………………………………………………..p 29 3 Abstract The Alberta Oil Sands Reserve is one of the world’s largest hydrocarbon deposits ever discovered, second only to Saudi Arabia. Due to the impact on the environment, the mining of this unconventional oil resource has been mired in controversy. With the onset of the 2008 global fiscal crisis and plummeting world oil prices, many economists and environmentalists alike began predicting a moratorium of further oil sands development. This paper explores the economic and political underpinnings that secure oil sands’ continued development and a comparative case study of oil wealth management contrasting Alberta with another oil economy, Norway. The Conservative Alberta government has historically favoured privatization of this public resource, resulting in a growing firestorm of Oil Sands development. Adding fuel to the fire of development is the proportionality clause of the North American Free Trade Agreement, ratified in 1993 and presently honoured by the Harper and Obama and administrations. If not managed, these two combustible forces have the potential of leaving hapless Canadian citizens with one of the world’s greatest economic and environmental disasters. There is a beacon of hope. Sovereign Wealth Funds have become a popular and effective fiscal management tool to shelter domestic economies from recessionary decline, as well as provide returns for future generations, when the non-renewable resource is depleted. Alberta’s sovereign wealth fund has been in operation for 33 years and is worth $14.4 Billion. Meanwhile, Norway’s fund is worth a staggering $374 Billion and is less than 13 years old. As much as it is admired, the success of the “Norway Model” has eluded other economies around the world .1 A comparative case study is undertaken, analyzing similarities and differences in these two distinct political-economic systems. It is concluded that Norway’s strict fiscal discipline and transparent management of its oil wealth has not only secured its economic future, but also led it to follow an environmentally sustainable policy. Both these management practices can inform the Alberta case, maximizing its long term economic as well as environmental health. 1 Taylor, A. (2006) Klein Fails to Provide Nest Egg. Edmonton Journal. March 25. 4 SECTION 1: BACKGROUND Introduction Located 250 miles northeast of Edmonton, Alberta, the oil sands have had a colourful and often controversial history. Peter Pond, and his successor, Alexander Mackenzie, discovered the layers of tar sands—later to be named the McMurray Formation—cut into the steep Athabasca River banks in 1776. Both men had been on expeditions for the North West Company, the rival to the Hudson’s Bay Company during the height of the competitive Canadian fur trade industry. Mackenzie had even traded a precious flask of whiskey with aboriginal tribes of the area the Indians to purchase some of this “molasses-like tar substance” to repair his canoe. Presently, the Alberta Oil Sands contain 175-200 billion barrels of recoverable oil— one of the largest hydrocarbon deposits ever discovered. Its size is second only to Saudi Arabia. Presently it is producing approximately 1.2 million barrels per day and is forecast to be producing 3 million barrels a day by 2020. 2 The Canadian government has stated that this resource alone has the power to transform Canada into an energy superpower. 3 However, there are issues of concern. Due to the complex process of extracting oil from the oil sands, to produce one barrel of oil requires mining 2 tonnes of oil sands using 5 barrels of fresh water and 750-1000 cubic feet of natural gas (that is enough to heat a house for a week). 4 This has caused uproar, especially among environmental groups. The resulting discourse and writings in this area from all sectors has been voluminous and controversial. This paper, is not about the environment. However, the environment has specific economic implications that will be discussed. There are two components of fiscal policy in the oil sands. There are the revenues, in the 2 Government of Alberta. (2009). “The Oil Sands”. Government of Alberta Website. Retrieved February 3, 2009. Retrieved February 3, 2009http://www.energy.alberta.ca/OurBusiness/oilsands.asp. 3 Richardson, L. (2007). The Oil Sands: Toward Sustainable Development. Report of the Standing Committee on Natural Resources. Communication Canada: Ottawa. March. 39th Parliament, 1st Session. 4 Ibid., p 54 5 form of royalties and leaseholds that the Alberta government, on behalf of its citizens, collects from the oil sand developers. The present royalty framework was designed to encourage development of the private sector. One per cent royalty agreements, as well as one hundred percent deduction of all capital expenditures, in place of Revenue Canada regulations allowing for only depreciation, were achieved with strong lobby efforts by private oil companies. Kevin Taft, Liberals Shadow Minister of Energy, exclaimed that the return of two pop bottles yielded more than the forty-eight cents paid by oil companies for each barrel of oil they extracted from the Oil Sands. 5 In fairness, the 2006 Royalty Review in Alberta did mandate that oil revenues needed to be increased. Royalty increases are to be phased in commencing in 2009. 6 This paper focuses on the second component of the government of Alberta’s fiscal strategy that the government employs to ensure that the revenues that it collects are most effectively managed in order to protect its citizens when this non-renewable resource runs out. The concept of “Dutch Disease”, the inflationary cycle that follows the swings from booms to busts to boom again is introduced. As threatening as Dutch Disease’s potential can be resource economies can survive and even thrive. The key is sound fiscal governance. 7 The fiscal governance tool that is investigated in this paper is the creation and management of the sovereign wealth fund. Sovereign wealth funds are special entities created by countries running large trade surpluses to manage their accumulating wealth. More specifically, in the case of Norway and Alberta, they were created to 5 Taft, K. (2008) “Two Pop Bottles pays more than Oilsands Giant Paid in Royalties. Canadian Press. May 12. 6 Originally, the Alberta government had charged a low royalty, equal to 1 per cent of gross revenue after all costs were factored in to encourage development. Their critics charged that they were “greasing the wheels for an investment that corporations would have made anyway.” As the Oil Sands development emerged as a dominant factor in the 1990’s, the low royalties were still in place. The 2007 federal Canadian budget phased out the accelerated capital cost allowance that was given to oil sand producers. Provincially, a panel of 6 members were appointed to review the Alberta Royalty Policy. The Alberta Royalty Review returned with recommendations of increases to the royalty structure that would be phased in starting 2009. 7 Powell, B. (2008). Curing the Dutch Disease: How Resource-Rich Nations can Unravel the Paradox of Plenty. Time. March. Vol 171. No 12. p41 6 manage their respective oil generated wealth. This report is presented as follows: Section 1 provides an economic, political, social and technological overview of oil in context of the energy industry and then more specifically, the development of the Alberta Oil Sands. It shows how the oil derived from the oil sands, although more labour-intensive and environmentally hazardous than conventional oil, is traded in the world oil commodity market. Section 2 describes the unique history and development of the Alberta Oil Sands development, fired up by privatization policies of the Alberta government and fuelled by the 1993 North American Free Trade Agreement (NAFTA). The proportionality clause of NAFTA has made a globally traded product such as oil essentially a continental resource product. Although mired in controversy, further development of the oil sands is not only likely, but imminent. Section 3 explains macroeconomic principles that correlate a resource boom with a long-term negative impact on the economy. Avoidance of this phenomenon, dubbed “Dutch Disease”,