Cablegate: Soaring Oil Prices Raise Alberta Surplus and Ottawa

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 CALGARY 000600

SIPDIS

STATE FOR WHA/CAN, EB/ESC/ISC, EB/EPPD

USDOE FOR IA (DEVITO, PUMPHREY, DEUTSCH)

E.O. 12958: N/A
TAGS: ECON ENRG EPET ETRD PGOV ZR CA
SUBJECT: SOARING OIL PRICES RAISE ALBERTA SURPLUS AND OTTAWA
EYEBROWS

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SUMMARY
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1. While commuters from New York to Tokyo watched in horror as
oil and gas prices shot up this year, residents of Calgary,
Alberta celebrated, and for good reason. For every US$1 increase
in the price of a barrel of oil, an estimated C$100 million is
pumped into provincial coffers. Recent spikes in the value of
these commodities have fueled a booming Alberta economy, already
the strongest in Canada. However, just as no lottery winner is
long appreciated by his neighbors, surrounding provinces have
experienced no shortage of surplus envy. The provincial
government is therefore faced with the unusual problem of too
much money, and too many options. This report will survey some
of the possible solutions being investigated for this unbudgeted
cash, as well as the effect Alberta's newfound wealth has had on
intergovernmental and international relations in Canada. End
Summary.

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Sources of Alberta's Wealth
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2. As recently as 2004, the Finance Ministry of Alberta
predicted that oil prices would fall from the "unsustainable
high" of US$31 a barrel to "US$26 per barrel in 2004-05 and
US$25 for the following two years." Currently, the price of oil
is well over US$65 a barrel, and most economists expect this
trend to continue. This unpredicted surge has result in an
unbudgeted provincial surplus estimated at anywhere from C$6
billion to C$12 billion. Resource royalties are the largest
source of income for the Alberta government, which is expected
to take in at least C$14 billion from oil and gas companies in
2005. One important factor behind the unbudgeted surplus is that
rising oil prices cut down the average time before an oilsands
project reaches payout status. Three-fifths of the projects are
now in this higher tax bracket, causing royalty revenue from
synthetic crude oil and bitumen to come in seven times higher
than budgeted.

3. While international attention has recently focused on the
increasing development of Alberta's huge oil reserves, 75% of
the province's energy revenues actually come from natural gas.
In 2003, Alberta's pipeline infrastructure of 332,000 km
delivered 5 trillion cubic feet (tcf) to international and
domestic markets. That same year, the province exported 2.6 tcf
to the United States, meeting about 12% of American demand. The
price of natural gas is historically tied to the price of oil,
and at US$14 per thousand cubic feet, is seven times the average
price of the 1990's. Alberta is also seeing an increase in its
role as a natural gas hub, with gas from the proposed Mackenzie
Valley and Alaska gas pipelines set to run through the province
on route to markets in the U.S.

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Oilsands Seen as the Future
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4. However, with the vast majority of known natural gas fields
already mature, and exploration finding few new sources,
Alberta's vast oilsands are seen as the future of the province's
resource economy. The 2003 Oil and Gas Journal reported Canada's
oil reserves at 180 bbls (second only to Saudi Arabia), an
increase from earlier estimates of 4.9 bbls. This increase was
due to the recognition of Alberta's oilsands, where oil
production had previously been considered uneconomical. A
combination of high oil prices and improved refinement
techniques have made this resource competitive, as Saudi Arabia
and other suppliers of traditional crude oil struggle to
increase their own production. Alberta's oilsands production of
one million bpd is expected to triple over the next 15 years.

5. Not all of Alberta's prosperity can be attributed to winning
the resource jackpot, however. The "Alberta Advantage" of low
taxes, advanced infrastructure, and a well-educated workforce
has drawn in many industries from less pro-business provinces.
The value of Alberta's industrial goods increased at an
annualized rate of 30% in the first half of 2005, a factor in
the 15% surge in total exports. Construction is another booming
part of the economy, with the issuing of new permits growing so
fast the national statistics are being inflated. Alberta is by
far the wealthiest province in Canada, and with a 4% GDP growth
rate this year, the gap is growing. At more than C$45,000,
Alberta's per capita GDP is 140% of the national average.

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The Enviable Task of Spending Alberta's Surplus
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6. Forecasts of Alberta's 2005 surplus have risen steadily this
year, as oil and natural gas prices passed US$50 in July, then
hit a record high of US$70.85 in the aftermath of hurricane
Katrina. The budgetary infusion this surge has created for
Alberta's government has prompted many around the province to
submit their own wish lists. Recent proposals have ranged from
spending the money on environmental upgrades in the oilpatch to
virtually eliminating corporate and income taxes. In an example
of why the Liberal Party will likely never form a majority
government in the conservative province, prominent Liberal
legislator David Swann has suggested that Alberta spread the
wealth: "Alberta needs to step up and share," said Swann. "The
feds will do what they need to do in the interests of Canada -
they don't need to apologize for that." More feasible Liberal
measures include eliminating education and health fees. Alberta
Premier Ralph Klein, a conservative Tory, has presented a fusion
of several approaches to solve the "problem" of the C$6 billion
surplus.

7. Perhaps most prominent in the premier's new budget is the
C$400 "giveaway" he has promised each Albertan, at an estimated
cost of C$1.4 billion. While this distribution of oil money may
seem familiar to observers of the Alaska Permanent Fund,
provincial leaders have been careful to avoid structural
similarities. Klein has emphasized that the surplus will not
necessarily grow into the entitlement enjoyed by Alaskans,
explaining that it is a "one-time investment because we have
one-time riches". Surprisingly enough, Albertans have been split
over the giveaway, with 48% saying the government should keep
the money and use it to address provincial problems, such as
rising tuition costs and expensive health care. Dr. Roger
Gibbins, President of the Calgary-based Canada West Foundation
(CWF), has warned that the giveaway is short-sighted public
policy: "We are talking about the responsible stewardship of
public funds coming from non-renewable natural resources and in
this context the prosperity dividend makes no sense". CWF, a
well-known think tank, recently published a report advising that
half the surplus be placed in savings accounts and the other
half be used for current government programs. The payout has
also angered Alberta's municipal governments, with the mayor of
Calgary recently publishing a pamphlet accusing Klein of
"shortchanging city governments". Klein has also promised broad
tax cuts targeted at the long-term growth potential of Alberta's
more stable industries, such as high technology and finance.
Business and taxpayer groups are petitioning the provincial
government to eliminate the gas tax, but at C$.09/litre, Premier
Klein argues that any further cuts would only anger neighboring
provinces forced to charge much higher rates. One popular
proposal supported by the Liberals and NDP would eliminate
provincial health premiums, costing the treasury about C$900
million.

8. Any plan for using the surplus will include a substantial
enlargement of the Alberta Heritage Fund, which acts as an
investment service for government money. Past Heritage Fund
projects have included the ongoing Foundation for Medical
Research, as well as infrastructure upgrades and scholarship
programs. Throughout its 29-year history, the fund has generated
C$30 billion in investment income for the province. Much of the
anger directed at Klein in recent weeks has come from groups
frustrated by his "lack of long term vision," and tenuous
support for the Heritage Fund. The Calgary Chamber of Commerce
called such programs as the C$400 payout as "ill-conceived,
short-sighted and compromising to Alberta's prosperity." Such
feelings are common in Albertans who remember the disastrous
National Energy Program of the early 1980s, when federal raids
on resource revenue turned the last oil boom into a recession,
and put up to 15% of Albertans out of work. It remains to be
seen whether the premier will heed calls for a long-term
commitment to the Heritage Fund.

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Alberta Reacts to Eastern Canadian Calls to "Share the Wealth"
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9. In the same month that Albertans are celebrating the latest
oil boom with a spending spree, other provinces continue in a
persistent economic slump. Even Ontario, traditionally one of
the wealthiest provinces in Canada, recently published a study
warning Ottawa that it is danger of becoming a "have not"
province. A number of different provinces have called for a
reevaluation of the equalization formula, which ensures
standardization of services across Canada by redistributing
funds from wealthy provinces (Alberta, Ontario) to the
less-fortunate (everyone else). Currently, the formula averages
the per capita income of the middle five provinces to determine
appropriate levels of distribution. However, many in Quebec and
Ontario are now petitioning Ottawa to include Alberta, by far
the richest province, into this equation. If the Council of the
Federation succumbs to this pressure, Alberta would become the
sole "have" province, causing the equalization burden for 30
million Canadians to fall on three million Albertans.

10. Not surprisingly, this idea has not been popular with
Albertans, who already send C$3,500 per capita more to Ottawa
than they receive in services every year. Klein has repeatedly
warned other provinces to "keep their hands off" Alberta's
resource revenues, which the provincial government owns under
the authority of the Canadian Constitution. The increasing
antagonism between Alberta and eastern provinces has fueled
isolationist attitudes in the already conservative province,
with 41% of Albertans supporting independence talks. It is
highly unlikely that a local separatist movement will ever reach
the levels of popular support enjoyed by the Bloc Quibecois, but
these numbers have alerted the central government to the ongoing
alienation felt by the western provinces. As the Lethbridge,
Alberta Citizen Society Research Lab member Dr. Faron Ellis has
warned, "Canadians across the country should be aware that if
these are the bedrock levels of frustration without a crisis,
the next crisis (will have) westerners at least debating the
concept."

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Premier Klein Prepares for "Goodwill" Tour of Eastern Canada
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11. Current antipathy towards Alberta has been growing
throughout the 1990's, as neighboring provinces have watched a
demographic shift as many of the youngest and brightest across
the Confederation move to booming metropolises such as Calgary
and Edmonton. This trend will likely continue, as high wages and
severe labor shortages across Alberta draw in job seekers. To
allay fears of this growing prosperity, Premier Klein will
embark on a goodwill tour of eastern Canada later this year. The
central theme of his trip will be to remind easterners that
Alberta already does more than its part, contributing C$10
billion every year to other provinces through equalization.
Furthermore, a recent study by the Calgary-based Canadian Energy
Research Institute (CERI) found that, with 41% of tax revenue
generated by Alberta's energy industry, Ottawa was the biggest
winner from high energy prices. The study also projected that
over the next 15 years, more than six million person years of
employment will be created by the booming oilsands; half of it
will be in other provinces, especially in the manufacturing
sector of Ontario's economy. Unfortunately for Edmonton, these
reminders may not be enough to assuage jealousy in eastern
cities struggling with record budget shortfalls.

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Alberta Has a Friend in Imperial Oil CEO
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12. This antipathy was touched on by Imperial Oil's Chief
Executive Officer Tim Hearn in a speech to the Calgary Chamber
of Commerce on October 6. Hearn, who moved Imperial's head
office from Toronto to Calgary this summer, predicts that
Alberta's current energy-driven prosperity is more than just an
oil boom. With global consumption of all forms of energy
forecasted to rise by 50% over the next quarter century, it is
likely that current high oil prices represent not a spike, but a
new price plateau. According to Hearn, Alberta's 1.7 trillion
barrels of bitumen represent the last large, undeveloped,
non-renewable energy resource in G-7 nations. As developing
nations strive to break age-old cycles of poverty, the
inevitable increase in energy demand will provide lasting
prosperity to Alberta, and to all Canadians.

13. Echoing many of the sentiments Premier Klein has voiced in
recent months, Hearn pointed to the Calgary-based Canadian
Energy Research Institute (CERI) study to argue that
unrestrained prosperity in Alberta is good for the entire
Confederation. CERI estimates put the amount of economic
spin-off from the oilsands development at C$1 trillion between
2000-2020, with a large portion occurring outside Alberta. For
every two jobs created in Alberta, there is an additional job
elsewhere in Canada. Additionally, Hearn reminded Canadians that
oil prices are highly cyclical, and today's "boom" could easily
be tomorrow's recession, as Albertans, Imperial Oil employees in
particular, know so well.

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A Tax Grab by Ottawa on the Way?
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14. While the Canadian Constitution states that Alberta's
resources are the property of the provincial government, a
number of methods through which the federal government could
increase its take have been proposed. Prominent among them is an
increase in the carbon tax, which already costs Canadian
companies an estimated C$9 billion dollars a year, the bulk of
it from Alberta. This would also be a popular move with
environmental lobbying groups, which have been angered by
Alberta's rejection of the Kyoto Protocol. A more questionable
move legally, nationalization of the oil industry is favored by
almost half of Canadians. However, it is highly unlikely that
this radical buyout and the resultant "made-in-Canada" pricing
will take place, as it would virtually bankrupt Ottawa.
Furthermore, current exploration and development efforts cannot
be sustained without massive infusions of private monies.

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Comment
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15. Fluctuating resource prices make projections of Alberta's
economic future difficult. However, continued development of the
oilsands makes it certain that the province will increasingly
play an important role in the North American energy market.
Ottawa is beginning to see the exports of its richest province
as a bargaining tool, with 61% of Canadians favoring limits on
oil exports to punish the United States for perceived
infractions of NAFTA statutes in the ongoing softwood lumber
dispute. While Canadian Ambassador to the United States Frank
McKenna rules out closing down Alberta pipelines, he advises
that booming oil exports could be an "important card" in future
trade disputes. A healthy Alberta energy industry continues to
be vital to the well being of the American economy, as oil and
gas prices continue their seemingly unstoppable rise to new
heights.

16. This cable was drafted by our fall intern David Dill.

AHMED

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