Energy Transportation and Negative Externalities: The Argument for Sound Regulation

On the heels of my analysis of whether Newfoundland and Labrador has become a “petroprovince,” I examine another aspect of the natural resource development: safety and negative externalities, i.e. environmental costs. In particular, this blog post will focus on the rising usage of large oil tankers for transporting Canadian petroleum products overseas.

Because of Canada’s generous resource endowments, it has become one of the largest oil producing countries and exporters in the world. The proposed Keystone XL pipeline appears to be floundering, however, and the shale gas boom in the United States has withered consumer demand in that country for Canadian exports–both of which have encouraged Canadian producers to look for new markets in emerging economies.

Expanding into overseas markets necessarily requires maritime transportation in the form of transoceanic supertankers, and as demand for energy rises in emerging economies, so too will tanker traffic. Citing devastating spills such as Exxon Valdez, however, several individuals and groups have made an effort to ban or heavily restrict such traffic. Yet, there is a serious economic rationale for continuing to develop, and promote, Canada’s energy sector and the more important issue is developing and promoting it responsibly.

Oil spills have astronomical ecological and economic costs and environmentalists who have concerns about them are justified. In a study published recently by the Fraser Institute, however, the authors note that Canadian tanker traffic has increased by leaps and bounds despite accidents declining sharply, which they argue is the result of better safety practices, smarter regulations, and technological innovation. To reinforce the downward trend in accidents, the most effective regulatory regime is one that requires stringent safety protocols such as corrosion-proof lining for supertankers, in addition to rigorous and frequent inspections to ensure that firms meet these requirements, i.e. a first “line of defense.” Furthermore, establishing safe, well-monitored shipping routes would also reduce accident probability.

Incentives matter and, therefore, policymaking must be independent of private sector interests. (Energy companies have a market-based incentive to avoid losses, which encourages them to take precautions, but many firms fail to pay for their negative externalities.) In addition, regulatory agencies can structure their fine schedules to compensate entirely for the externality costs of environmental damage, which would ensure that firms bear all of the potential costs when making decisions about safety. Canada should also maintain a comprehensive and streamlined oil-spill response strategy that would help contain the damage and repair it, i.e. a second “line of defense.” Lastly, Canadian governments could invest in research and development into containment techniques for “dirty” substances such as diluted bitumen. (Note: most of these precautions exist within the Canadian regulatory structure.)

Some stringent opponents of natural resource development, however, posit that spills are never worth the risk. The nightmarish consequences of many infamous spills haunt the collective memories of coastal communities and environmentalists tend to assume the potential costs to the local economy will outweigh the potential economic benefits. Diluted bitumen, for example, has unknown effects in maritime environments and could prove to be very damaging if it spilled in a maritime setting. Ultimately, those who seriously oppose natural resource development and energy transportation argue that disasters are statistically inevitable and, therefore, not worth risking Canada’s fragile ecosystem and tourist “brand” of having a pristine coastline.

There are several problems with the above link of thinking, however, the most glaring of which is the “inevitability” argument. Indeed, oil spills are inevitable, but so too are all accidents. All economic activities carry some risk, whether they are human, environmental, or financial. Air accidents, for example, have steadily decreased in the last few decades, and although additional accidents are inevitable, it would be unwise to ban air travel. In essence, opponents of natural resource development would like a moratorium on tanker traffic. This approach, however, would stymie efforts within the energy sector to develop safer transportation mechanisms and it could encourage alternative forms of transport that are more dangerous such as rail. Most importantly, it would cripple Canada’s economic prospects and damage our living standards. These caveats show precisely why the apparently calm, well-reasoned rhetoric of the anti-tanker movement is simply a knee-jerk reaction that ignores many constructive solutions to a complex challenge.

Leo Plumer is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in economics and political science at McGill University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

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

Airfare Must Descend

Since the first commercial passenger flights at the turn of the 20th century, aviation has advanced global integration in many ways that few other technologies have. By transporting people around the world in a quick and efficient manner, modern aircraft has allowed for cultural diffusion and economic globalization.

However, Canada’s ability to forge stronger connections with other countries is somewhat threatened by its restrictive airline regulations, which not only protect domestic airlines, but also limit competition from foreign operators. These stipulations ensure high operating costs for airlines and reduce options available to consumers (compelling them to pay higher prices), pleasing neither business nor the public.

There are, for instance, two especially prohibitive and protectionist rules mandated by the federal government that facilitate inefficiency in the Canadian aviation market. First, the Canadian Transportation Agency (CTA) requires Canadian ownership of domestic carriers. Second, Canada’s “cabotage” laws decree that only Canadian airlines may transport passengers between airports within Canada. As a result, two firms dominate Canadian airspace: Air Canada and West Jet. Together, these companies control roughly 90 per cent of Canada’s aviation market.

It may seem as though these regulations would have a savings effect, since insulating Canadian carriers from foreign competition allows them monopoly access to flights within the country. However, the Canadian market is not large enough to support these firms under the current regulatory framework and new airlines could scarcely hope to achieve economies of scale, which would reduce costs and prices in the end. Yet, by facilitating competition via foreign carriers, the federal government could ensure lower fares, if not efficiency gains.

More importantly, if other countries scrapped their cabotage regulations, which restrict the ability of foreign airlines to flying between two points within a country, international competition would likely drive both prices and costs down and Canadian airlines could access new markets. Nevertheless, unilaterally abolishing these restrictions would still push down the costs and prices associated with air travel.

Increased competition from foreign carriers would additionally reduce Air Canada’s political influence. The Canadian airline’s market share affords it lobbying power without much of a counterweight. In fact, some associate Ottawa’s decision to reject Emirates Airlines from operating direct flights between Toronto and Dubai to Air Canada’s political influence.

Supposing the federal government eliminated cabotage regulations, the high cost of operating in Canada would preclude many foreign airlines from entering the Canadian market. In 2012, for instance, the Conference Board of Canada claimed that about five million Canadians opt to cross the American border by land to fly from airports in the United States. They concluded that high labour compensation, fuel costs, aircraft prices, airport fees, and navigational expenses explain why Canadian flights are, on average, 30 per cent higher in price compared to equivalent flights operated from the United States.

Higher costs in Canada have already encouraged many foreign airlines to exit. JetBlue, a low-cost American carrier, refuses to fly to and from Canadian cities, despite having a license, as high costs prevent it from making any profit without sacrificing their low-price airfare.

What is the result of Canada’s strict aviation rules?

The Frontier Centre for Public Policy found that for 5400KM flight, Canadian consumers pay $1,499.62, whereas American’s pay $934.72. (Europeans paid $525.72).

Reducing the rents charged to airports and the mess of taxes and surcharges placed on flights would assuredly reduce costs. However, in order for lower costs to translate into reduced prices, the federal government must eliminate barriers to entry. This would allow new firms to undercut the cost of existing ones, placing downward pressure on prices. Thus, by cutting costs and enabling competition, Ottawa could make flying more accessible for consumers and businesses while increasing choice for flyers.

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