Market Insight – Q2 2015 Alberta: NDP’s effect on Canada’s oil-rich economy

NDP victory: knee-jerk reaction from the market

There is no ignoring the immediate impact that the New Democratic Party (NDP)’s landmark victory has had in Alberta, Canada. On the news of the NDP win, Suncor shares dipped 4.3%, Canada Oil Sands slipped 5.4% and overall, the energy sub-index dropped roughly 2% in a knee-jerk reaction in the May 6 trading session. NDP’s win, after a campaign that revolved around hot button issues like oil royalties, corporate taxes, minimum wage and government spending, undoubtedly scared the market.

Riding a wave of popular support, the NDP has a mandate to shake up the well-established oil & gas sector. Over the next few months, they will realise that they may have to tamper that populist enthusiasm and revert to the norm”, which we believe will yield reasonably positive developments for the province when the dust settles.

We here present our perspective on the market based on supporting research from BMI Research, Mergermarket, KPMG and TD Economics.

The campaign: promises from the NDP

  • Resource Owners’ Rights Commission: Review the appropriateness of royalty rates. Royalty rates are set according to oil prices (for example at $60 per barrel, the royalty rate on a producer’s gross revenue and net revenue is 1.62% and 26.15% respectively). Alberta took in $8.7bn in royalties last year. The commission will also conduct research into measures that would promote greater processing / upgrading of the region’s energy resources.
  • Income taxes: Raise the corporate income tax rate from 10% to 12%, in line with other provinces; no change to the small business tax rate and also still no provincial sales tax (See Table 1).
  • Budget Proposal: Spend a bit more and take in more revenues over the next five years than what the Progressive Conservative (PC)’s had set out (See Tables 2& 3).
  • Minimum wage: Raise the minimum wage from $10.20 per hour to $15 per hour by 2018.

Canada oil industry: optimism from senior corporate executives and investment bankers

In early January 2015, oil prices had dropped by more than 50% since June 2014. This was the first time since May 2009 that the global Brent benchmark had fallen below the threshold of $50 per barrel.

In a survey conducted in December 2014 on the drop in oil prices and its effect on the industry, 80% of seasoned oil & gas professionals said that the decrease in crude oil prices would be a long-term phenomenon; but, interestingly enough, only 12% believed that these lower oil prices would negatively impact the investments in Canadian energy projects already underway (Figures 1& 2).

Economic activity in Alberta is expected to remain slow for the remainder of 2015 at 0.5% real GDP. Until there is a moderate increase in oil prices, which most forecasts we see expect in early 2016, it is unlikely that Alberta’s real GDP will soon return to the long term trend of 2 – 3%.

Bottom line: what is the takeaway?

Ultimately, it is too soon to forecast the direct impact, what the actual mix of NDP’s policies will look like, and the speed at which any changes will take effect. However, it is unlikely that the NDP would do anything drastic that would cripple Alberta’s economy with massive hatchet slashes against big oil. The reviews of corporate tax and royalty rates could impact investment decisions, but the NDP reassured investors that a possible outcome of their review may be that the system currently in place is competitive, fair and should remain as is.

With oil prices expected to hold at current prices over the medium term and with the anticipated accommodation of the presently popular NDP government, companies across the province should have a reasonable foundation to rebuild, of course if they have made it through the significant downswing in oil prices over the last year.

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