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

We can’t do both, writes 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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