Canadian Exploration Expense

Alberta Premier Rachel Notley and Prime Minister Justin Trudeau shaking hands. 

Alberta Premier Rachel Notley should spend political capital with PM Justin Trudeau to reverse Canadian Exploration Expense change

Big Oil is everyone’s favourite punching bag, but when they’re right, they’re right. And this time they’re right about changes in the federal budget to the Canadian Exploration Expense that will make it more difficult Alberta for exploration and production companies to attract capital, all for no discernible benefit.

Canadian Exploration Expense

Economist Jack Mintz.

The Canadian Exploration Expense enabled E&P firms to the write off exploration costs for wells drilled in the year the expenses were paid. But federal finance minister Bill Morneau changed the rule in last week’s budget and now the expense can only be written down at a rate of 30 per cent a year on a declining basis.

Economist Jack Mintz says the change will add about a full percentage point to the tax rate on new oil patch investments in Alberta, Saskatchewan, British Columbia, and the Maritimes. The current effective tax rate on conventional oil and gas production in Alberta, for instance, is roughly 27 per cent, and amortizing drilling expenses would bump the rate to “a little over 27% as a result of that one change,” he said in an interview.

“Even though successful exploration is only 10% of total capital investments in oil and gas, it does have a pretty meaningful impact in that sense.”

Big Oil, which has been pretty happy thus far with the Trudeau Liberals and their support for increased market access via pipelines, was critical of the federal budget change.

Canadian Exploration Expense

Tim McMillan, CAPP president.

“I am disappointed and I think it sends a bad signal and further puts us at a disadvantage in terms of the capital we are trying to attract from global markets, compared to the US, which is our biggest competitor for that capital,” said Tim McMillan, president and CEO of the Canadian Association of Petroleum Producers, as reported by the Calgary Herald.

To make matter worse, the new Trump Administration and House Republicans are mulling over a major business tax reform package that will move in the opposite direction to the Trudeau budget, allowing all companies to expense capital expenditures, effectively ending the practice of amortizing capital assets over a period of time.

Mintz points out that other countries – like Russia, Australia, and Chile – allow companies to expense exploration costs. If the United States moves in that direction, which appears a good bet at the moment, then American shale producers (a major competitor for capital) will be able to expense all exploration and development.

“We’ve expensed research under the income tax system. You can make a similar argument that we should do the same thing for exploration,” he says.

“Why have a differential treatment on expenditures on discovery – never quite figured that out. My view is that we should treat these things neutrally.”

McMillan makes the point that drilling a well now costs millions of dollars. Even a small increase in that expense can seriously affect exploration economics, which has the potential to dampen activity just as oil and gas prices are rising and industry is rousing from the slumber of the last two years, hiring again in Alberta and starting to put the service companies back to work.

“The government is very concerned with the middle class. Our industry hires the middle class,” said McMillan to the Herald, referring to the 425,000 Canadians working in the oil patch.

Canadian Exploration Expense

Brian Jean, Wildrose Party leader.

Wildrose leader Brian Jean is calling on Notley to take up the industry’s call to reinstate the Canadian Exploration Expense.

“Our government should be demanding an immediate reversal of these changes so we can protect jobs across our oil and gas sector,” he said in a press release.

Jean has a point.

 Amortizing instead of expensing will have a negative effect on Alberta oil and gas investment and job creation. The financial benefit to the Canadian government will be minimal, and presumable offset by lower tax revenue.

And if, as several pundits have suggested, Trudeau made the change as a sop to Canadian eco-activists after approving two pipelines late last year, environmentalists don’t seem grateful to have been thrown this particular bone.

A fair conclusion is that no one benefits from this federal move and the Alberta oil patch will be hit with higher costs at a time the Alberta government has said it is trying to help industry lower costs.

This sounds like a job for Notley the lobbyist. Especially since the Alberta government has added to the oil patch tax burden by bumping up the provincial corporate tax and implementing a province-wide carbon tax, says Mintz.

Notley should punch in Trudeau’s number on her speed dial and persuade him to walk back the tax change.

She would be doing a good thing for the Alberta economy and the optics in Calgary – home of most swing ridings in the 2019 election – of helping the oil and gas industry wouldn’t hurt her, either.

Canadian Exploration Expense