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The Energy Sector: The err in buying diversification


October 22, 2016  


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The present economic situation in Western Canada, largely driven by the tribulations in the oil and gas production sector, is now predictable causing some provincial governments to once again claim this is the ideal time to pick the “winners” in the continual pursuit of economic diversification.

Yet government intervention through investment has a poor track record. Perhaps one of the few exceptions was the Syncrude investment to spur oilsands development. The Northwest Upgrader investment by the previous provincial Conservative government should soon start providing a return with its ‘guaranteed’ feed courtesy of the royalty skim, though for many the benefits are still up for debate. Time will tell.

With that program coming to an end, the Alberta government is once again in the investment game and trying to pick winners by taking advantage of our ‘cheap natural gas feedstock’ through its “Petrochemicals Diversification Program.” At least this time, the investment is in tax credits, which is a commonly used government incentive program. One can even claim the royalty program is itself structured along this line with different rates depending on the resource being developed. Unfortunately, tax incentives are just like car incentives.

To be competitive, we need to do it because everyone else is. This mentality is somewhat akin to the annual free agent frenzy in professional sports where teams pay outrageous amounts for players only to complain about the size of the payroll or running the business. It is time to look in the mirror. Most economists know no one wins in bidding wars over the long term. Winning companies are simply not able to make enough profit to sustain growth. In the end, these companies have to find other ways to get their money from you. Governments hope they get their money back through the taxes of the workers, and, eventually, corporate taxes once the incentive program is over.

One hard reality facing Western Canada is it is landlocked (the loss of the port in Manitoba now makes this true), which means higher transportation costs than other provinces that have sea ports – though they still have to get to the port. The only way to overcome this disadvantage is to be more productive with lower costs. In addition to the actual production costs, taxes, royalties, and tariffs need to be included. The better bet would be to remove barriers to trade and create an investment environment so businesses could develop long-term plans with confidence they will receive a reasonable return on their money.

Lots of large companies are sitting on cash hordes because of the current economic environment than putting it to work purchasing equipment. Encouraging trade and investment is what our governments should be doing rather than quick fixes that provide multiple photo opportunities. Building and developing the New West Partnership Trade Agreement will encourage natural diversification of the Western Canadian economy.

A recent report titled Supplier Diversity in Canada by the Canadian Centre for Diversity and Inclusion reinforces how diversity of supply makes for stronger organizations and diminishes the need for outside intervention. In fact, removing intervention is what makes it work even better. Rather than use tax dollars to purchase diversification, which is somewhat akin to “affirmative action,” make it easier to invest and diversify the supply chain naturally or with gentle nudges through tax regimes. This has naturally been done for decades to encourage development of our natural resource sector. It not only works. It is more efficient.

About the author: Ian Verhappen is a professional engineer, ISA Fellow, certified automation professional and a recognized authority on industrial communications and process analyzer technologies with 25-plus years’ experience in the hydrocarbon industry. Verhappen provides global consulting services specializing in industrial communications, SCADA, process analytics and heavy oil/oilsands automation. Reader feedback is always welcome. Email iverhappen@gmail.com

10-24-16