August 10, 2022

Alberta, we still have a problem

Even for a province used to riding the roller coaster, the recent upswing has been exhilarating.

Alberta may bring in as much as $24 billion in revenues from resource royalties this year, nearly $20 billion more than initially expected, and about the same above and beyond recent norms.  

This is no pocket change. It is more than the amount we will spend on education across the province for the entire year. And that makes for quite the financial turnaround: for the first time in seven years, the province will bring in more money than it spends; and it is expected to do so for at least two more years.

But what we’re seeing isn’t a fundamental shift in our fortunes. This is just the fun part of the roller coaster—the part where we throw our hair back and forget all our worries—before being jerked around again by global markets, wondering how we’ll meet our mounting health care needs or provide top-quality schooling for our children.

In this commentary, we assess what’s changed—and what hasn’t—since we first looked at this issue last year and appeal to all Albertans and leaders to, please, please plan for the future and not “piss away another boom.”

First, a step back

We first brought attention to Alberta’s concerning financial state in February 2021 in a paper titled Towards a Fiscally Sustainable Alberta.

In it, we detailed how the province’s financial situation swiftly deteriorated since 2014, going from the best in Canada to being one of the most worrying. Ironically, the crux of Alberta’s problem was what once made it the envy of others: a dependence on royalties from resources.

We found that resource royalties—a notoriously volatile source of income—both:

      1. Brought in considerably less money following the oil price collapse of 2014/15, something we said was likely to continue; and
      2. Made budgeting extremely difficult, as not only was it hard to plan in the midst of such volatility, but also because provincial governments tended to increase spending in response to high commodity prices, but resist cutting it when prices declined.

In other words, a reliance on income from resources had, over time, led to too little money coming in and too much money going out. As a result, the province found itself writing more and more IOUs to pay for the public services—health, education, and so forth—of Albertans.

    In the end, we concluded that both spending and revenues needed to be addressed—while considering how we grow the economy longer term—to support the health, well-being, and prosperity of Albertans now and for generations to come.

        A lot has changed since then

            Most notably, the market for oil has been upended: by underinvestment in sustaining energy production, war, and an eagerness around the world to make up for lost time jet-setting, road-tripping, and living life.

              As high demand collides with limited supply, the price for a barrel of crude (as measured by WTI) has soared to the triple digit norms of the early 2010s, about double what it was when our background paper was written.

                This has put considerable cash into the Government of Alberta’s pockets—an estimated $24 billion this year—far more than most would have thought possible in early 2021.

                  There are a couple of reasons for this.

                    First, math: a higher global price for oil means more revenue per barrel for energy companies which, in turn, means more money flowing into government coffers via royalties and corporate taxes.

                      Second, how resource royalties are calculated: oilsands projects are taxed at different rates depending on whether they have recouped their initial cost of investment. Once projects have reached “payout,” a new, higher royalty rate can kick in. Recent high oil prices have helped to tip more projects over this line a lot sooner than expected.  

                        Therefore, while the biggest wave of cash is expected this year, the effect of this boom is likely to carry over for years to come.

                          There is also another reason to think that this boom could carry over for some time: global leaders may be willing to support fossil fuels more and for longer than previously thought.

                            Before recent challenges, presidents, prime ministers, and other leaders seemed keen on moving swiftly away from fossil fuels to lower carbon energies. However, as individuals across the globe struggle to fill up their tanks and heat (or cool) their homes, it has served as a reminder that an energy transition will be more complicated than a flip of a switch. Affordability matters.

                              Over the last few months, the Biden administration has encouraged oil companies to increase production; Canada has given the green light to the Bay du Nord offshore oil project; while European countries have, pressed up against limited options, reverted to coal-fired power plants, all in support of affordability.

                                All this is to say that Alberta may see a longer runway for its energy resources—and higher royalties—than we would have thought a year or two ago.

                                    The more things change, the more they stay the same

                                        While this is encouraging from a revenue standpoint, resource royalties have not grown any less volatile or more reliable with time, and the longer-term outlook remains hugely uncertain.

                                          Furthermore, while decision makers may be more sensitive to the importance of affordability and the need for fossil fuels, how this shapes longer-term policy decisions—and thus Alberta’s royalty income—is unclear.

                                            Meager capital spending by oil and gas companies reflects this uncertainty: investors are calling for fiscal discipline, and businesses—coming out of years of financial strain and an evolving policy jungle—are responding by using new revenues to pay down debt and hike dividends to shareholders, in lieu of striking up new projects to boost output.

                                              Meanwhile, governments are making moves to jumpstart the energy transition. Notably, the US is expected to pass the Inflation Reduction Act of 2022 which includes a whopping $300 billion investment in “energy and climate reform” to ramp up renewable forms of energy, electric vehicle use, and energy efficiency, all of which will push down longer-term demand for oil and gas.   

                                                Taken together, this suggests two things. First, that Alberta should savour the moment and monies as this windfall could be among our last. Secondly, hoping for—or planning on—a more prolonged rebound in royalties would simply be a doubling down of the roller coaster we’ve always been on.

                                                  Yet, so far, we seem to be buckling up for that same ride.

                                                    Despite calls for action, there has been no major change to the province’s revenue model. In the 2021 Mid-year Fiscal Update, the province mentioned the possibility of creating a panel on government revenues. However, little, if anything, has been said about this since.

                                                      Complicating matters are calls to spend, spend, spend the surplus.

                                                        Though spending is expected to be in line with other provinces soon—a major milestone—whether this will last is yet to be seen. Once again, there is mounting pressure to spend the newfound revenue, whether to alleviate the hardships brought by inflation, address crime in Alberta’s major cities, or support the province’s efforts in reducing global emissions. If history is any indication, this boom could yet result in a more permanent increase in dollars flowing to various public projects, services, and offices.

                                                          In other words, the key challenges outlined in our initial background paper persist: 1) royalties will ultimately decline over time as the world moves to lower-emitting forms of energy, and 2) the size and volatility of this revenue source will continue to challenge our ability to budget wisely.

                                                              Albertans’ health and education needs continue to grow

                                                                  First, Alberta’s population is ageing and demand for health care is growing. Individuals over 65 represented 14% of Alberta’s population as of 2020 but are expected to make up about 20% of the population by 2046. By 2029, this age group will outnumber children aged 0 – 14.

                                                                    This might not sound like a huge shift, but the impact on the budget will be sizeable. As more Albertans reach retirement, fewer dollars will come in via taxes on income and, at the same time, more dollars will be doled out to cover medical expenses.

                                                                      This latter part is especially true for individuals over 70 and as individuals reach the later years of their life: according to a recent study by the Fraser Institute, health care spending for those aged 70 – 74 is about 20% higher than the average Canadian; from 75 – 79, it’s about 50% higher; and from 80 – 84, spending is double. To put some numbers to it, while the average 40-year-old requires about $2,600 in care (less than the average), the typical 80-year-old requires about $16,000.

                                                                        As well, demand for education and skills training is growing.

                                                                          While the province will see a growing share of older individuals, it will also see a bubble of young adults entering post-secondary. From 2025 to 2031, the young adult cohort (aged 18 – 24) in the province is expected to grow considerably. This will strain Alberta’s post-secondary institutions, resources, and staff. 

                                                                            Beyond this, education and training, whether through traditional institutions or proven alternatives, will be increasingly important as the need for individuals who can think critically and creatively and effectively manage and collaborate with people grows. Education used to be about access to better jobs and opportunities; over time, it’s becoming a requirement to access any opportunities at all.  

                                                                              But, to pull from the MacKinnon report: “Alberta’s track record shows we are not competitive in developing the workforce Alberta will need in the future, especially with the growing emphasis on technology and innovation.”

                                                                                Government funding and planning will be needed so Albertans can not only participate in but thrive in a world run on knowledge, critical thinking, and creativity. 

                                                                                  All this to say that health and education needs in Alberta are growing. It would be extraordinarily difficult to meet those needs without ending the government’s current practice of holding total spending relatively flat while population growth and inflation chip away at real spending per person.

                                                                                      A call for change

                                                                                          It’s tempting to pretend that royalty windfalls have made our problems go away. But they haven’t.  

                                                                                            Questions of what to do with the surplus should therefore be answered within the broader context of solving the province’s longer-term problem: how to sustainably provide the services Albertans want and need, while ensuring the province is a great place to live—now and for generations to come.

                                                                                              Flipping the script will take courage, engagement, and a plan. It has literally never been “the right time” to do this. Successive governments have found that either their hands are tied in bad years, or that urgent spending priorities must be addressed when times are good.

                                                                                                But now is the time to be brave. This newfound money can go a long way to making a longer-term adjustment easier and less scary—whether by setting some aside for the rainy days sure to come; by lowering the amount we spend financing public debt; or by amplifying long-term investments for prosperity.

                                                                                                  Ultimately, the choice is ours. We can hope energy markets deliver what we need over the long term—but hope is not a strategy—or we can use this windfall as a steppingstone to build a more stable foundation for prosperity for decades to come.

                                                                                                      Future work

                                                                                                          The province must ultimately create a better revenue model—one that supports the prosperity of future generations.  

                                                                                                            As the MacKinnon Report noted back in 2019: “…to successfully manage the province’s finances, steps need to be taken to increase stable sources of revenue and decrease the reliance on the volatile non-renewable resource revenues.” The same is true today.

                                                                                                              Decisions on how to do this will take time, thoughtful analysis, and broad engagement of Albertans. So, while with an election on the horizon, this might not be the year to enact change, it is most definitely the time to have an adult conversation and get to work.

                                                                                                                For our part, our future work in this area will set out to:

                                                                                                                    • Review the major components of provincial government revenues and how they could be optimized;
                                                                                                                    • Consider and evaluate a range of ideas on how to improve the revenue model with a focus on enhancing competitiveness; and
                                                                                                                    • Propose options for the best use of what could be the last resource windfall.

                                                                                                                  Alicia Planincic, Economist & Manager of Policy

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