Does Subjectivity Improve Foreign Investment in Canada?

The level of attention and investment geared toward natural resource development in Western Canada has increased over the last several years, particularly from foreign state-owned enterprises (SOE). Concerns regarding SOE acquisitions in Canada include the perceived loss of sovereignty, in addition to uneasiness about allowing governments with questionable human rights records to profit from exploiting resources in a democratic country.

In Canada, acquisitions involving foreign buyers, including SOEs, are subject to a so-called “net benefit test,” which is defined in the Investment Canada Act. The public does not understand this process very well and it has drawn severe criticism for its subjectivity. For example, Petronas, a Malaysian resources firm, acquired shale assets in 2012 from Progress Energy in British Columbia, while CNOOC, a Chinese SOE, received permission to undertake similar investments in Canadian firm Nexen shortly thereafter. Both deals were subject to lengthy bureaucratic scrutiny.

What should the net benefit test look like and should Canadians be concerned?

It is well know that uncertainty about subjective regulatory hurdles can deter investment, potentially steering it elsewhere. In this way, the “net benefit test” could discourage foreign capital inflows. With this in mind, many have called for transparent, black-and-white criteria for investment approvals, if not scrapping the net benefit test altogether.

On the other hand, concerns surrounding SOEs seem to be driving the federal government’s insistence on subjective, case-by-case evaluations. The fear, presumably, is that an SOE tied to an oppressive government, such as China, could meet the criteria and be able to set up shop in Canada. By allowing leeway in the approval process, the federal government presumes to be able to choose whether investments are “good” or “bad.”

However, defining SOEs is a complex process. For instance, Ottawa could consider publicly traded companies that receive subsidies from a foreign government to be a private entity or it could determine that it is an SOE.

Lastly, there are political aspects that contribute to the federal government’s desire to evaluate each application subjectively. Canada is currently in the process of negotiating a sweeping free trade agreement with a group of Pacific Asian countries and it could hurt these negotiations to have rejected the CNOOC-Nexen acquisition in 2013.

In summary, the foreign investment “net benefit test” remains a topic of debate. While the regulatory subjectivity appears to deter investment, it may also provide the federal government with room to maneuver on political and human rights grounds.

Michael Craig is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute

Dealing with Oil Money: learning from Newfoundland and Labrador

With both a new premier and finance minister, the Government of Newfoundland and Labrador (NL) has begun to prepare its 2014-2015 budget in earnest with consultations that run throughout the month of February. NL’s newly appointed Minister of Finance Charlene Johnson will present the budget to the province’s House of Assembly in the coming months.

Last year, NL’s provincial government projected expenses roughly $500 million greater than revenue, which contrasts starkly to the province’s seven-year period of surpluses between 2005 and 2012. This year, the provincial deficit will likely be smaller due to cost-saving measures taken last year under the Dunderdale administration.

In part, NL’s fiscal troubles are due to declining oil royalties. The provincial budget is largely dependent on offshore royalties, which constitute over $2 billion in revenue of the province’s total of $6.392 billion, as estimated in the 2013-2014 budget. However, annual offshore oil production in NL peaked in 2007 (although new discoveries could boost figures in the future). Due to declining production, in addition to the emergence of new technologies, such as hydraulic fracturing, the province altered its price projections for a barrel of oil from $124 to $105. Royalties from future projects are also unreliable because volatile oil prices determine whether developments are profitable and, ultimately, reign in government revenue. With the upcoming Hebron project, for instance, the expectation is that production will plummet after 2020.

These developments demonstrate that buttressing long-term fiscal arrangements on temporary and volatile resource revenue is imprudent. In many cases, governments benefit politically from spending more or taxing less. However, lapses in revenue can compel them to pursue these benefits even spending increases or tax cuts are unsustainable.

If governments did not spend this revenue on programmes, though, where would it go? A number of alternatives exist.

The first alternative, based on Thomas Paine’s idea of a “citizen’s dividend,” involves equally distributing among a country’s population the rents received from private industry using public resources. Although Paine built the notion of a citizen’s dividend using common ownership as a foundation, the citizen’s divided can be justified on fiscal grounds. Giving royalties to citizens, rather than funnelling it back into government programs, would prevent disproportionate increases in the size of the public sector. Such decreases are problematic, as political incentives preclude the ability to lay-off workers in the future.

The second alternative reflects the Alberta Heritage Savings Trust Fund, which received initially 30 per cent of resource royalties within the province. In NL’s case, and in many other jurisdictions, debt reduction would take the place of a savings fund. Saving allows governments to pay less in interest payments or even earn money from lending. A model similar to Alberta’s, which stipulates mandatory savings, would undermine government attempts to boost spending in order to win short-term political gains.

Choosing either of the two options would conceivably help NL’s provincial government end its fiscal dependence on resource royalties. The current system encourages the government to borrow political capital from future governments by boosting spending when resource money is available. This incentive structure has adverse effects on certain individuals. For instance, laying off public sector employees hired on the assumption that their new position was stable due to budget cuts. Creating rules that govern the use of royalties would mitigate these unfortunate developments.

Michael Sullivan is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute

Regulation or Moratorium? New Brunswick’s Fracking Future

Shale gas development is a contentious issue in Atlantic Canada. Public concerns over fracking encouraged Newfoundland and Labrador’s (NL) Progressive Conservative government to impose a moratorium and, similarly, the newly elected Nova Scotia (NS) Liberals promised continue the province’s ban on fracking.

In New Brunswick (NB), where seismic testing is determining the possible opportunities for shale gas development, this issue has become an even hotter debate topic.

NB’s Progressive Conservative government asserted that seismic testing will continue and the opposition Liberals–with support from local Aboriginal leaders and other opposition groups–have recently renewed their call for a fracking moratorium.

While there are serious concerns that must be addressed, however, a fracking moratorium is not a sound policy route: there is a risk of shutting down the debate on what could be a major boost for Atlantic Canada’s economy.

The principal public concern surrounding fracking is the contamination of drinking water. Some observers suggest that the fracking process could contaminate drinking water and damage water tables from which people draw their wells. Water contamination is a serious concern for individuals for obvious reasons and, as such, due consideration must be given. There are others, though, who argue that this is not necessarily the case (although, this is, in and of itself, another debate).

However, a moratorium is not an appropriate policy route to deal with these concerns for two reasons.

The first reason is that banning fracking would discourage companies from exploring for possible shale gas opportunities. NB’s shale gas reserves are still largely unknown and not exploring what the province has available would be an irresponsible policy.

The second reason is that a moratorium prohibits constructive discussion on the issue. In other words, banning fracking gives more legitimacy to the anti-shale gas side, which could result in the destruction of legitimate arguments from the pro-shale gas side.

Regulation, rather than moratorium, is a much better policy tool for government to use in dealing with the fracking industry.

Adrian Park, from the University of New Brunswick, recently published an article that notes jurisdictions in the United States that have experienced horror stories associated with fracking are by and large those with weak regulations. Park’s article also points out that those jurisdictions that have developed the resource alongside strong regulation, such as North Dakota and British Columbia, have experienced far fewer publicised horror stories.

British Columbia, for example, requires oil and gas companies to ensure there are no adverse effects on the quality or quantity of water where development is happening. The province also has the Surface Rights Board (SRB), which requires natural resource companies to compensate landowners for damages resulting from resource extraction.

Ultimately, other governments must follow-suit, especially in Atlantic Canada where the economic possibilities from shale gas development are largely unknown. North Dakota and British Columbia are success stories in the fracking industry because they chose a policy route that allowed the industry to develop in a safe manner: they choose to regulate and have the discussion rather than close the debate.

Randy Kaye is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute