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When it comes to carbon pricing, you have to take the good with the oil sands.

Carbon pricing is hard, and not just because you need to know a lot of terminology or because it’s a political minefield. Supporting carbon pricing means that you hand control of who wins, who loses, and where emissions come from in the economy to the market.  True carbon pricing also likely means, sin of sins, that environmentalists might have to give the oil sands a pass.

I expect that last sentence threw many of you for a loop, but I hope that it did not dissuade you from reading further. Imagine, a carbon price in Canada which is charged on every ton of emissions, the proceeds from which are re-distributed on a proportional basis through corporate and individual income tax reductions.  Let’s set that carbon price at $30/ton and have it rise at 5% per year so that it would approach $ 50/ton by 2020 payable on all industrial emissions as well as downstream sources. As emissions decline and the tax rate rises, revenues would likely remain relatively stable at about $30 billion per year, or about 10% of the consolidated federal and provincial revenue collected through income taxes, so let’s say that for argument’s sake the collection results in a 10% reduction in payable taxes across the board.  Now, I have offended both pro-industry and pro-environment people.  Equal opportunity.

This is about as simple a policy as you can get (and not the one for which I would advocate) but it serves the purpose. Now, you may feel that I have just written the death warrant for the oil sands – the evil, job-killing carbon tax. This simply isn’t true, and there are a few good reasons why. First is the structure of the royalty regime for oil sands. Second is the implication of revenue recycling and the tax leverage of high value products. Finally, and most importantly, it’s simply a fact that oil sands production generates a great deal of value per ton of carbon emissions. They may be a new, large and growing source of emissions, but they are also among the highest value uses of carbon, at least among industrial activities, in the country.

Consider that a barrel of oil from the oil sands, upgraded to synthetic crude, at an existing plant (Suncor, Syncrude, CNRL) costs about $32/bbl in operating costs, plus the costs of capital in the plant. At current prices, tax rates, and royalties, the net backs to producers are in the $40-$50/bbl range. Now, we have all heard about how much carbon is emitted from oil sands production. I expect some readers will be surprised to find that a good approximation is about 0.1t/bbl, with (generally) mining operations coming in below that figure and in situ above. So, what does this all mean? It means that each ton of carbon emitted in the course of oil sands production is tied to about $900 worth of sales (at $90/bbl), and $400-500 worth of profit. If you think that an investment with that kind of value proposition is going to dry up in the face of a $30-$50 (or even much higher) per ton carbon tax, think again.

Let’s look for a comparison in coal-fired power. Coal power generates about 1t/MWh of electricity. That MWh sells for somewhere between 35 and 40 dollars in most jurisdictions in Canada today, and the costs of generating that electricity are somewhere in the $20-30/MWh range before taxes, virtually non-existent royalties, etc. depending on how you cost the capital of the facility. So, the value added generated by a ton of carbon emissions is somewhere in the $20-30/ton range. Now, that’s a value proposition that is in serious trouble under a carbon tax.  Hard to disagree with Greenpeace on this one – coal is a much worse climate offender.

There is, of course, more to the story. Since oil sands generate significantly higher net backs from each ton of carbon emissions, they also have significantly higher leverage to any income tax reduction that comes from recycling the carbon tax revenues. At the current corporate tax rate of 16.5%, Canadian income tax payable per barrel would be about $6.00 after attributable costs are deducted, so the potential per-barrel savings from from carbon tax revenue recycling could be somewhere in the neighborhood of $0.50-0.60/bbl, or $5-6/ton of carbon.  If you do this same calculation for coal-fired power, where the net back per ton of carbon is roughly $10, the potential tax savings through revenue recycling are only about $1.60 per ton.

Next, recall that royalties are rent (or net revenue) calculations in Alberta and that Alberta will “recognize any new environmental fees or levies as an eligible cost of doing business, and therefore (these fees are) deductible in determining royalties on oil sands projects.” – Alberta’s New Royalty Framework, p12 So, as a producer, the $3-5/bbl that you pay in carbon tax expenditures are a royalty deduction, which could be worth as much as $1/bbl for a plant which is post-payout.  Coming back again to coal-fired power, coal royalties are virtually non-existent so the costs of electricity generation don’t change much due to royalty savings.

So, let’s put that all into perspective.  Costs of any aggressive carbon pricing to an oil sands operation will be significant (even $5/bbl on a 600,000 bpd operation like Suncor would be over $1 billion per year) but the value proposition is significant as well.  I am a firm believer in carbon pricing, and that’s because I don’t think the world or our country can afford to keep doing things which generate little value while emitting carbon. But, if you believe in carbon pricing, you also have to accept that it is not a market failure when the activities you do not like keep going in the face of a carbon charge.

Unfortunately, we see all too often that carbon pricing proposals turn this value from a badge of honor to a regulatory curse.  For example, in the TD-Pembina-Suzuki modeling, to meet the “ENGO” target, an additional regulatory assumption…CCS is regulated for most emissions from new…oil sands facilities and upgraders starting in 2016.” In carbon pricing terms, this puts a much higher shadow price on carbon from oil sands facilities than is imposed on other activities. The atmosphere does not discriminate based on the sector from which a carbon molecule was emitted, and neither should a carbon pricing policy.

When it comes to carbon pricing, you have to take the good with the oil sands.

23 responses to “When it comes to carbon pricing, you have to take the good with the oil sands.”

  1. Alastair

    Interesting post.

    I hope you will write another post some time on whether (and why) you prefer a carbon tax or cap-and-trade system.

  2. Kyle

    I always found it funny that environmentalists attack the oilsands when even within Alberta, unless things have changed really recently coal power production produces more emissions than the oilsands.

    Where was greenpeace chaining themselves to Genessee 3 and pulling stunts at Edmonton City Council meetings and TransAlta AGMs?

    It is almost like the oilsands are just a symbol to them, a rallying point, and reality need not apply.

    1. Alastair

      Hi Kyle,

      “It is almost like the oilsands are just a symbol to them, a rallying point, and reality need not apply.” I think you’re right here, though we may differ on why.

      I think that while many activists do believe that the oilsands are as bad as Greenpeace presents them, others, even committed and heavily involved Greenpeace members, do not and are well aware of the realities.

      Greenpeace has the goal of raising public awareness, and through the public’s response, forcing government and industry and individuals to change their ways. I think Greenpeace leaves it up to organizations like Pembina to point out the best way to make those changes, and concerns itself with motivating people.

      If the goal is to advance societal change and public awareness, then environmentalists need a a symbol to rally around, and the realities of where best to reduce emissions are left to others.

      You’re right though, many environmentalists care more about the ducks than CO2 emissions, or just don’t get the realities.

    2. Joel Wood

      “It is almost like the oilsands are just a symbol to them, a rallying point, and reality need not apply.”

      One reason being that it is easy to hold up a place that looks like Mordor as being bad. Many Canadians (outside BC and Quebec) and people around the world would just shrug their shoulders about pictures of a coal electricity plant since they are familiar with them and might even have them in their town. But if you have never been to the oil sands the pictures are breathtaking and shocking at the same time and “gut’s” reaction is negative and, to paraphrase Dan Gardner, “head” will then try to rationalize “gut’s” feelings . I would guess that people who have had positive experiences with the oil sands and people who work there would be much less likely to have a negative gut reaction.

  3. Jess

    Thank you for a refreshingly simple overview of an appropriate cost of carbon.
    The end of coal is far more important for the world than the end of tar sands.

    Note: we should expect that the objections to tar sands will continue due to the appalling environmental contamination risk. I used to live downstream of MacMurray and can assure you that the credibility of the current environmental monitoring is approximately zero. As they say in the North: if Calgary or Edmonton were downstream of the tar sands you can be sure there’d be a lot more action to clean things up.
    That said, there is remarkably little complaint about the environmental impact of coal mining, the hazardous waste, air emissions which include radioactive dust (not much per tonne burnt, but millions of tonnes are burnt annually in Alberta alone), etc.

  4. James Thompson

    Thanks for an intruiging perspective on carbon pricing and its potential impacts on oil sands investment. Considering your value propositions I am wondering about how you have come to your conclusions.

    I believe that the capital and operating expenses you have chosen are low and that your netback is high especially when considering recent or planned developments. Depending on which price point you use for the bitumen I would suggest that the netbacks based on a $90WTI price is closer to $20/bbl. Based on my assumptions this puts the profit at $200/ton, and that is undiscounted which is not unsignificant from an investment perspective. Either way a $50/ton undiscounted hit on a $200/ton profit is no small cost, and I am not so sure it won’t discourage investment (although given the global appetite for energy and at the carbon prices considered I would guess this would just work its way into the end price without a significant shock).

    Why did you choose to compare oilsands to coal (given the historical granting of coal mineral interests I am not sure it is a fair comparison)? Why not oil sands to natural gas (e.g. shale gas is a much more relevant comparison – I believe – given its infancy and royalty regime)?


  5. Alastair Sweeny

    Why are carbon emissions even an issue? The entire output of oilsands production is less than one coal fired power station in Taiwan.

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  7. Ujjayant Chakravorty

    Nice piece..the numbers are quite qs is, if you impose a carbon tax, then as you say, the coal industry will be impacted where will the power in the province come from?

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