Murray Edwards And Why Tax Rates Matter to Oilfield Services

MNP LLP - Oilfield Service News April 6, 2016

By: David Yager, National Leader, Oilfield Services

"Who will stand up for Alberta's persecuted billionaire community?" the headline of popular political blog site sarcastically blared after the story broke last month about how wealthy and successful Calgary entrepreneur N. Murray Edwards had apparently relocated his residence to London for tax reasons. The article opened with the sentence, "A billionaire is moving from Calgary and we should all be worried, the newspapers tell us." Obviously, some don't think this is a problem.

The story broke in the Calgary Herald on March 24 after publicly traded Magellan Aerospace Corp., a company controlled by Edwards, disclosed in its annual year-end filings its chairman resided in London, United Kingdom, not Calgary/Banff as had previously been the case. A few days later in its Annual Information Form, oil and gas producing giant Canadian Natural Resources Limited (CNRL) released the same information about its executive chairman. The Herald wrote, "Two sources familiar with the situation who asked  not be identified said Edwards is switching his residency to the U.K. For Tax reasons."

The increasingly reclusive Edwards has yet to publicly confirm or deny his departure from Calgary. But it is illegal for listed companies like Magellan and CNRL to knowingly publish false information in their regulatory filings. Therefore, it is safe to assume Mr. Edwards has indeed physically left Calgary. Whether rising corporate and personal income taxes are the reason is only speculation. However, it is not speculation to observe wealthy and successful entrepreneurs like Murray Edwards pay very close attention to tax rates. That's why they are wealthy and successful.

Canada's battered oilfield services (OFS) sector should certainly be worried when a serial entrepreneur and wealth creator of Murray Edwards' reputation concludes for whatever reason Calgary is no longer his preferred place of residence. Besides CNRL, Edwards has been a driving force behind one of Canada's most successful oilfield service companies, drilling giant Ensign Energy Services Inc. plus other high profile investments like the Calgary Flames hockey team and Resorts of the Canadian Rockies.

In the past 20 years Calgary has become the headquarters location of every major Canadian exploration and production (E&P) company and the majority of the larger OFS companies. In turn, Calgary has attracted or developed a massive financial, technological, legal and administrative support infrastructure to allow these companies to support domestic and global operations from a city once best known for its annual rodeo. This century, Calgary has grown into one of the world's most important oil and gas centres and is now comparable to places like London and Houston. When one of Calgary's most important company builders and dealmakers decides to leave, everyone in the oilpatch should wonder why.

When people talk about how the Canadian oil and gas industry began a near-continuous 20-year growth spurt in the mid-1990s, the most obvious reference point is commodity prices. While oil didn't do that well until the 21st century, natural gas certainly did. Deregulation of gas and the opening up of U.S. export markets through the construction of new pipelines unlocked opportunities for all participants. Oil got more attention with rising prices and oilsands expansion early last decade. While there were small dips in 1989-99, 2001-02 and 2008-09, the general trajectory for Canada's oilpatch was upwards until last year.  

While too many in this industry are insufficiently modest to credit factors beyond their own genius for their success, another big growth driver was major changes to Alberta's corporate and personal tax regime in the early 1990s. Following nearly 15 years of difficult times following the National Energy Program of 1980 and the oil price collapse of 1985, Alberta was in tough shape. Deficits had skyrocketed. The economy was stagnant. There was little, if any, capital flowing into Alberta.

To improve the economy, the government of Premier Ralph Klein reduced corporate tax rates, introduced a flat personal income tax rate and slashed provincial government spending. The message to the world was Alberta was a great place to invest. Taxes for corporations and executives would be low and very competitive. Two major royalty reviews -- 1991 for conventional oil and gas in 1996 for oilsands -- ensured this key element of the fiscal regime was globally attractive. With government spending under control, investors could be confident the fiscal regime would remain competitive and stable.

The program was called "The Alberta Advantage." While it was not certain at the time it would work, what followed can only be described - and would frequently be described -- as a modern economic miracle.

The first sign this strategy would be successful occurred in 1996 when venerable Canadian Pacific Railway Limited (CP) - the ribbon of steel across Canada that helped create Calgary and arguably Canada's longest established major corporation - moved its head office to Calgary from Montreal. This decision was precipitated by the actions of two provincial governments. Alberta was selling itself as open for business, while Quebec was governed by the Parti Quebecois, which had barely lost a referendum to separate from Canada October 30, 1995.

Another major move that further legitimized The Alberta Advantage was the 2004 decision by Imperial Oil Limited (IOL) to move its corporate head office to Calgary from Toronto. Montreal and Toronto have long considered themselves Canada's urban cultural epicenters while Calgary has long been regarded by both cities as a redneck cultural backwater. But when the executives of CP and IOL learned they would earn the same salary but pay lower personal income taxes and no provincial sales tax, most held their noses and accepted they ought to at least give Alberta a try. Most came to like Calgary and Alberta very much and are still here.  

Alberta's oil boom continued to the point that some started taking it for granted. In 2007 the Alberta government concluded it could substantially raise oil and gas royalties without affecting business decisions or investment. The ill-fated New Royalty Framework was all but entirely reversed by mid-2010 spurring another round of growth and investment. At the same time it tried to raise royalties, the province abandoned fiscal probity and the province hasn't balanced the budget since. Ultimately, all these things matter to keep the prosperity train on the right track.

Which brings us back to Murray Edwards and 2016. The new NDP government won the provincial election in May of 2015 led by premier Rachael Notley who said many times, “When times get tough, those who are profitable should be paying a little bit more.” The corporate tax rate was increased by 20% on July 1, 2015. People in upper income brackets also faced higher taxes. The 10% flat personal provincial tax rate that worked so well for so long was ridiculed and is now 50% higher at 15% for those
earning $300,000 per year or more, a target group of The Alberta Advantage in the 1990s.

Campaigning on a similar strategy of supposedly helping lower and middle income earners by raising taxes on the more successful, the new Liberal administration in Ottawa has jacked its rate on higher incomes from 29% to 33%. This means Alberta’s marginal tax rate for top earners has jumped from 39% to 48%, a 23% increase. While defenders of Alberta’s tax hikes continually cite how the new rates are still lower than in other provinces, those in favor of higher taxes are not asking if the new rates are still
low enough to justify moving the entire head office and executive team and uprooting families from all across the country. This is expensive and disruptive. You need every tool in the toolbox to make these decisions attractive and minimize risk.

This has been tried before in other jurisdictions and ultimately the costs have been greater than the perceived benefits. One of the better-known countries to raise taxes and spending but ultimately reverse them out of economic necessity is Sweden. Back in the 1970s, that country had cranked its marginal tax rate to 70% or more, causing well-known individuals like tennis star Bjorn Borg and filmmaker Ingrid Bergman and pop band ABBA to flee the country as tax refugees. As result, Sweden collected significantly less tax revenue than central planning had forecast. According to a 2012 article in Forbes magazine, in the hundred years from 1850 to 1950 Sweden’s productivity growth was the highest in the world. Forbes wrote, “By 1995, Sweden had fallen to sixteenth place – the most dramatic relative decline of any affluent country in history”. Sweden began to reverse its high tax course in 1980 and since has recovered significantly.

What does this mean for OFS? Again, while we can only speculate why Mr. Edwards relocated to London, it is much easier for one rich executive to move than the head office of the company. But at some point, when the fiscal regime which attracted major corporations and capital to Alberta is removed, head offices will leave and capital inflows will stop.

Having and keeping E&P company head offices in a Calgary is incredibly important to OFS. As the Petroleum Services Association of Canada has demonstrated on multiple occasions, the OFS supply chain is much broader than drilling rigs, trucks and construction equipment in the field. It also includes products and services primarily used only in the E&P head office such as software, technology, data
processing and business support and professional services.

The combination of the downturn and the myriad of new taxes and programs being introduced by the NDP caused an unprecedented written plea on March 15, 2016 by 15 major business associations in Alberta for the government to immediately meet to discuss the precipitous decline in the economy. This included the Canadian Association of Geophysical Contractors, the Canadian Association of Oilwell
Drilling Contractors and the Petroleum Services Association of Canada. Other groups included road builders, homebuilders, manufacturers, retailers and restaurants.

While the letter admitted Edmonton wasn’t responsible for the oil price collapse the groups wrote, “… We have also seen the rapid deployment of a series of ambitious government policies that have further undermined business confidence and competitiveness. Rising corporate personal taxes, a costly carbon
tax and historic increase to the provinces minimum wage are impacting Alberta’s economy when it most needs a boost.” The government was not amused and how much it is listening will be apparent when the Alberta budget is released April 14.

If Murray Edwards moving to London was the only piece of bad news besides collapsed commodity prices, this event would be immaterial. But it is not. What is occurring is a steady and systematic reversal of the major fiscal and economic policy changes in the early 1990s which helped create the oilpatch as we know it as recently as a year ago. Be very cautious.