Develop the oil sands, or make life difficult for foreign investors

We can’t do both, writes Stephen Gordon

by Stephen Gordon

(Jason Lee/Reuters)

The proper context for thinking about the CNOOC-Nexen and the Petronas-Progress takeovers is what I described  here: the real economic story of the oil sands is the investment in physical capital—structures and equipment—that is required before production can even start.

These investment numbers are very, very large. The oft-cited estimate of $650 billion in the next decade should be taken with a grain of salt, because we don’t know the assumptions that went into it. Even so, the fact that the costs of a single oil sands installation is measured in billions of dollars suggests that estimates in the hundreds of billions of dollars are at least plausible. (To give you an idea of how big these numbers are, current Canadian GDP is around $1.8 trillion a year.)

A national accounts identity tells us that all investment expenditures must be financed out of the savings of someone, somewhere:

Investment = Private domestic savings + Public domestic savings + Foreign investors’ savings

Let’s look at each component in turn.

  • Private domestic savings: Canadian investors already own 65 per cent of the assets in the oil and gas sector, and if they wanted to drastically increase those holdings, foreign takeovers wouldn’t be an issue: Canadian investors would have snapped up Nexen and Progress. Canadian investors, though, are not obliged to restrict their holdings to assets located in Canada, and a prudent investment strategy calls for a diversified portfolio across industries and countries. For example, the Canadian Pension Plan Investment Board’s holding of foreign equities are more than three times as large as its holdings of domestic equities. It’s possible that Canadian investors’ interest in the oil sands will be renewed by the new foreign investment rules, but it’s hard to see why it would. These investors now have to accept all the usual risks of investing in the oil sands plus the additional risk of not being allowed to sell their holdings to the highest bidder.
  • Public domestic savings: Governments could use tax revenues to finance oil sands projects. That is all the attention I’m going to pay to this option, because it is a happy example of a seriously dumb idea that does not enjoy the support of any major political party.
  • Foreign investors’ savings: Canada is running a current account deficit, so we are already relying on foreigners to sustain current levels of investment. A current account deficit means that investment is greater than domestic savings, and foreign savings are making up the difference. Making it more difficult for foreign savings to finance oil sands projects is not going to increase investment in that sector.

So the lesson to be drawn from new rules on foreign takeovers is that the government seems to be willing to accept reduced oil sands investment in return for… what, exactly?

No-one seems to know—or if they know, they’re not telling. Mistrust of state-owned enterprises (SOEs) is supported by not much more than dark, inchoate hints of their potential for mischief. On the other hand, the reason why SOEs in China and other countries would want to invest in the oil sands is obvious: the expectation of a return on their investments. The result of years of deliberately suppressing the value of the yuan renminbi  has been the accumulation of over $U.S. 3 trillion in foreign reserves, and the Chinese government is no doubt interested in earning returns greater than what U.S. treasuries are delivering right now.

There are of course concerns about dealing with a country with a human rights record like China’s. But it seems odd to be raising these concerns at this point. China accounted for 10 per cent of Canadian imports in 2011 (worth $48 billion), up from 1 per cent in 1990. SOE ownership of oil companies is a curious place to draw the line.

This story could be on the right track: the government may want to use obstacles to investing in the oil sands as a bargaining chips to force China to let Canadian investors have greater access to Chinese capital markets. This is at best a gamble: there’s a not-insignificant probability that Ottawa is overplaying its hand. But if this is in fact what the Conservatives are thinking, then the message they’re giving to Canadian investors in the oil sands is that their interests are significantly less important to the government than are the interests of investors in other sectors.




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Develop the oil sands, or make life difficult for foreign investors

  1. Would Cons please note the statement ‘current Canadian GDP is around $1.8 trillion a year.’

    We are not Somalia. We are not Greece.

    We’re an advanced wealthy western nation, and we didn’t get this way by being cheap and chintzy. We have looked after our people, and helped the world.

    Certainly there is more to do, here and abroad…..but enough with this constant chanting of Scrooge’s ideology. It’s not sustainable.

  2. Nice summary of “externalities.”

  3. Develop the oil sands, or make life difficult for foreign investors

    Btw, that’s a really stupid title. I believe they call it a false dichotomy in some academic circles.

    • On the ‘home’ page it subtitles with…..’we can’t do both’.

      • There is no shortage of investment capital. In fact, today, there is too much. Why companies like Suncor have scaled back on devl’nt plans.

        Yeah, some smaller companies are getting squeezed and their investment bankers are trying to help them cash out. If Chinese SOE’s don’t take them out, someone else will, and the wealth will then transfer to the other acquiring party, or revert to the Crown if the leases are not developed, to be resold.

        • Agreed. Everyone screams when a ‘Canadian company’ goes to a ‘foreign buyer’…..but Canadians don’t buy or even keep their own companies.

          Iconic Hudsons Bay….HBC for ‘Here Before Christ’…1670….pffft.

          We sold out our car industry in 1918

          We build to sell.

          • If you legitimately argue that FDI is good for improving industry productivity (and I’m not going to bother providing a link to such blogs on WCI), how can you then claim that unproductive/inefficient FDI is also good?

          • I realize that you’re trying to keep this thread alive, so I’ll bite

            I didn’t say a word about ‘unproductive/inefficient FDI’ being good

            But there is nothing wrong with foreign investments. Nothing wrong with Canadians building and investing in their own companies either. We just don’t.

            We’d rather sell out, and go to the lake.

          • No, you didn’t. But SG and AC have. On twitter. Coyne in a NP column. To counter the claim that SOE’s are inefficient and overpay. They have argued that this is good for Canadians, because it’s the Chinese that suffer (ignoring in large part the reduced royalties and taxes paid in Canada as well as adding to inflation). I have a problem with inconsistency of argument. Just thought you’d have an opinion.
            This is just a continuum of what happened in the oil patch with Income Trusts. Junior companies would start-up with small private capital. Then they’d grow production exponentially (easy to do when you start small) and eventually sell out to Income trusts (who had the preferential tax treatment – the jr’s and IT mgrs and Investment bankers profited $$$ )when it became increasingly difficult to double production again. Then start a jr again.
            Nothing wrong with continuing to grow organically….

          • Ahh well. I ignore Twitter for the most part. And I’ve ignored Coyne since he did an article thinking it was a good deal to trade grain for cars .

            The right appears to know the price of everything, and the value of nothing……moreover they are criminally short-sighted.

            This is the problem with the freemarket/capitalist/whatever system that we have. Eventually it just comes down to algorithms and cash….and the Caymans.

            No actual economy at all. No progress either.

          • I should just ignore them – as everyone else increasingly appears to be doing. Emperor/clothes.

          • A continuing love affair with outdated Rand philosophy I think….[like Greenspan and Friedman had] and no understanding whatever of the knowledge economy.

            I hope they sign up for night-school before it’s too late.

          • To better understand what is driving the CNOOC/Nexen deal (and potential future ones) listen to Brett Wilson, (founding partner of FirstEnergy Capital Corp) BNN Market Sense, July 24th. Note his observation on who he sees on the flights to China.

            It’s the finance guys driving this, not the search for investment capital for future oil sands development. http://watch.bnn.ca/#clip727072

  4. “A national accounts identity tells us that all investment
    expenditures must be financed out of the savings of someone, somewhere:

    Investment = Private domestic savings + Public domestic savings + Foreign investors’ savings”

    This is precisely my problem with relying almost solely on the market to sort out national priorities [ as opposed to implement them...i know SG's no fan of central planning] and i suppose this is as much a political question a an economic one – nevertheless:

    Doesn’t this amount to opportunity cost?[ no economist me. I think that's the term] as regards diversifying away from carbon intensive renewables? There being only so much available capital and skilled labour to go round. If all of the available savings/investment resource are going into making one particular unhealthy [ in non economic terms] omelete, just where are the resources, and when are the resources going to be found to get off this particular energy resource?

    We are frequently told nothing just happens. Waiting for the market to satisfy its fix for the “easy” choice is something that we may no longer have the luxury of indulging. Because that’s what it boils down to. Investors and business in general is notoriously unwilling to get out the trolley tracks and pursue other options that don’t have the immediacy of the payoff of the oil/tar sands. It’s tradition…it’s hard to change…painful even…involves sacrifices that are difficult to quantify. Let’s just stick to our knittting; everyone knows science’ll save us.

    I’d feel a whole lot more sanguine about this if i felt there was some great compromise, some great trade off in the works here. Get the stuff out to the degree we must, using best available practices; attach a stiff windfall tax of some kind.[ the model doesn’t have to be statist. The carbon tax that AB or BC is using, but specifically targeted at green technology is fine by me – but is all so slow and often looks like window dressing, lip service; in the face of the environmental changes that appear to be heading down the pike. A bit like throwing up a little dike, one tedious brick at a time when you suspect a tidal wave may be headed your way someday soon.

    It’s all so human and all so futile. But keep on fiddling Mr G…my kid will need a job some day. The climate she can just adapt to. And…and i must have a place to safely stash my retirement income. I think i’ll go spend it in the Seychelles…if they’re still there when i need em.

  5. “Canadian investors already own 65 per cent of the assets in the oil and gas sector”.

    Curious where that stat comes from, as it seems to contradict other reports I have read on the matter, which tend to say that oil sands ownership/profits are overwhelmingly un-Canadaian, e.g. http://www.canada.com/business/Majority+oilsands+ownership+profits+foreign+says+analysis/6599547/story.html et al. (not that I take this particular story as Gospel truth — it seems quite clear the analysis was made by an interest group that opposes the oil sands — just that it has always been my understanding that Canadians did not have enough capital to develop the oil sands from the get-go, and that even the big “Canadian” oil sands players are more or less all subsidiairies of larger US oil companies with relativelysmall Canadian market floats and/or “Canadian” shells owned by US/foreign majority shareholders…)

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