Update on the energy sector and agriculture: federal revenue forgone from tax provisions

Summary

On December 7, 2021, the PBO published a report entitled “Energy sector and agriculture: federal revenue forgone from tax provisions” to identify the cost of tax provisions specific to fossil fuel development and the lost revenue from exemptions to the carbon levy for agriculture.[^1] On January 18, 2022, the PBO published additional analyses examining Export Development Canada’s “business facilitated” for the oil and gas sector and the economic contribution of the oil and gas sector in Canada.[^2] As a supplement to the aforementioned reports, this document provides an update using the most recent data (up to 2021) and addresses new questions posed by Senator Rosa Galvez and Member of Parliament Mike Morrice.

Table S-1 provides an estimate of the federal fiscal impact of the tax provisions covered in our 2021 report[^3] from 2015 to 2021 for corporations engaged in the oil, gas and coal mining sector. This cost has declined from its 2019 level but remains comparable with previous years. Consistent with our previous findings, Canadian development expenses have the largest annual revenue impact.

It is estimated the foregone revenue from the carbon levy exemption[^4] to agriculture will reach $595 million as of 2023 and $1,562 million as of 2030 (Table S-2).

Our projection is slightly higher than our prior publication. This is mainly due to historical data adjustments and a higher projection of the use of fuels used by agricultural machinery. The magnitude of the potential response by farmers is underscored by estimates that in the rest of the economy, a carbon levy of $170 per tonne is expected to achieve the bulk of the reduction to 31 per cent below 2005 levels by 2030.[^7]

At COP26, Canada signed the Statement on International Public Support for the Clean Energy Transition committing countries to not introduce new support for the international unabated fossil fuel energy sector by the end of 2022.[^8] On December 8, 2022, the Government of Canada released policy guidelines on its implementation of this commitment. With the announcement of ending new direct public support for the international unabated fossil fuel energy sector, government agencies are anticipated to move away from investment in oil and gas.

Recent data suggests that Canada’s commitment already had an impact as EDC’s support for the oil and gas sector declined in 2021 and 2022 compared to 2018 and 2019. Table S-3 indicates the level of support that EDC provided to the international oil and gas sector.

BDC’s support in the international unabated fossil fuel energy sector is effectively zero.

Background

1.1. Review of the Oil and Gas sector

Since 2014, corporations in the oil and gas sector have experienced declining profits. This was due to a sharp decline in global oil prices in late 2014, ongoing excess global supply, transportation bottlenecks and weaker energy demand during the global pandemic.

The oil and gas sector experienced a particularly difficult period in 2020 due to the price war between Saudi Arabia and Russia coupled with the COVID-19 pandemic reducing the demand for oil.[^9] Prices declined from January to April of 2020, however by February 2021 both West Texas Intermediate (WTI) and Western Canada Select (WCS) had fully recovered. Prices continued to surge in 2021 as global economies reopened.[^10]

In the first few months of 2022, the sector was impacted by economic uncertainty, geopolitical concerns, supply constraints and inflationary pressures.[^11] The uncertainty caused by the Russian invasion of Ukraine in early 2022 further increased global demand for Canadian energy.

Office of the Parliamentary Budget Officer

Statistics Canada Table 33-10-0500-01

Office of the Parliamentary Budget Officer

Statistics Canada Table 33-10-0500-01

GDP at basic prices of the oil and gas extraction industry and support activities as defined by NAICS codes 211 and 21311.

Investment in Oil and Gas

The PBO examined EDC’s investment or “business facilitated” for the oil and gas sector disaggregated by each type of transaction.

At COP26, Canada signed the Statement on International Public Support for the Clean Energy Transition ending new support for the international unabated fossil fuel energy sector by the end of 2022[^12].

On December 8, 2022, the Government of Canada further announced their implementation of this commitment through guidelines. Of these guidelines, this included “end new, direct public financing for international unabated fossil fuel investments and projects via Government of Canada departments, agencies and Crown corporations, and federal support programs.”[^13]

EDC announced it commitment to no longer provide new direct financing to international fossil fuel companies and international projects as of January 1, 2023, in line with Canada’s commitment at COP26.[^14] Table 1-2 demonstrates the decline in international support in the unabated fossil fuel energy.

The PBO also examined Business Development Bank of Canada’s (BDC) investment in the oil and gas sector. BDC is a complementary lender that focuses on SMEs and provides financing to entrepreneurs on commercial terms. Therefore, their portfolio does not generate a fiscal cost to the government as BDC is self-sustaining.

BDC’s lending to Canadian oil and gas (“O&G”) producers represents approximately 1% of their portfolio. This translates to an estimated $2.4 billion in lending from 2015 to 2022.[^16] These transactions are completed primarily through participation in syndicated transactions with Canadian banks.

With respect to the international unabated fossil fuel energy sector, BDC’s investment is effectively zero. BDC supports Canadian oil and gas producers with Canadian assets and does not finance foreign oil and gas producers.

1.2. Review of the Agriculture Sector

Between 2014 and 2017, total net farm income[^17] was stable, with a slightly positive rise year over year, on average. In 2018, there was a large decline in profits due to sharply higher total operating expenses.

However, in 2020 and 2021, net farm income saw a strong growth in receipts that more than offset higher expenses. The average value of the Farm Product Price Index grew 20.3 per cent in 2021 compared to 2020, the largest growth in nearly 50 years.[^18]

In 2021, primary agriculture[^19] contributed $31.9 billion, or 1.6 per cent, to Canada’s GDP. The Covid-19 pandemic presented new challenges to the agriculture industry; however, increased global demand, lower oil and fertilizer prices and higher prices contributed to higher profit margins.

1. Federal Tax Provisions

1.1 Income Tax Provisions

Between 2015 and 2021, the total cumulative resource-related expense pools remained at historically elevated levels (Figure 1-3). Due to declining profits (as shown in Figure 1-1), corporations had historically fewer opportunities to use expense pools to reduce their taxable income.

Office of the Parliamentary Budget Officer

Statistics Canada T2-LEAP database

Office of the Parliamentary Budget Officer

Statistics Canada T2-LEAP database

Values correspond to total CEE, CDE and COGPE expense pools at year end.

Office of the Parliamentary Budget Officer

Statistics Canada T2-LEAP database

Office of the Parliamentary Budget Officer

Statistics Canada T2-LEAP database

The value of exploration and development expenses renounced to investors via flow-through share agreements have declined significantly over the past 15 years (Figure 1-5). This is partly due to lower investment levels in the sector (Figure 1-4) as well as policy actions that restrict access to the flow-through share mechanism for fossil fuel-related activities.

Office of the Parliamentary Budget Officer

Statistics Canada T2-LEAP database

Office of the Parliamentary Budget Officer

Statistics Canada T2-LEAP database

1.2 Exempting agricultural activities from the carbon levy

Greenhouse gas emissions from agricultural activities in Canada amounted to 10.2 per cent (68.6 Mt CO2 eq) of all emissions in 2021. Emissions have continued its slow upward trend since 1990, rising from 49 Mt to 69 Mt by 2021. Agricultural activities produce GHG emissions largely from biological processes inherent in animal and crop production (Table 1-3), in contrast with most other sectors in which emissions are largely energy related. Biological emissions are exempt from carbon pricing.[^20]

The federal exemption for agriculture shields a small but significant source of emissions. Since provinces also do not price emissions from agriculture, and direct non-fuel emissions are not yet covered, almost 10 per cent of Canada’s total emissions are largely exempt.

In our previous report, we attempted to identify the fuel consumed for operating machinery and equipment on farms in regions covered by the carbon levy. This report updates our analysis to include data up until 2021.

In 2021, the top 25 per cent of farms accounted for 85.5 per cent of farm revenue. Half of all farms were either losing money or barely profitable (column 4 of Table 1-4). Compared to 2019, farms with revenues under $50,000 had negative net operating income, on average, whereas farms above $50,000 generated profits. Therefore, the bottom 30 per cent of farms increased their losses, on average, whereas the top 25 per cent of farms saw a gain of 35 per cent in net operating income, on average, in 2021 compared to 2019.

Fuel-use in agriculture

GHG Emissions from fuel-use in agriculture largely come from motor gasoline and diesel fuel for machinery and equipment (Table 1-5). Compared to 2019, consumption declined in each fuel type except for natural gas which saw a 3 per cent increase (1,109 GL in 2019, 1,143 GL in 2021).

To determine which parts of Canada’s agricultural sector would be most impacted by ending the exemption, we compare the fuel expenditure per dollar of revenue generated for each sub-sector (Table 1-6). Crop production is more fossil-fuel intensive than animal production, with some crops having 5 per cent of revenue go to paying for fuel.

The Carbon Levy

The federal carbon backstop reached $65 per ton of CO2 equivalent in 2023 and will continue to increase by $15 annually until 2030 when it reaches $170 per ton. For perspective, applying the carbon price to all projected fossil fuels used in agriculture would hypothetically generate revenues of $0.9 billion in 2023, which would continue to rise significantly until 2030.

However, determining the financial impact of rising carbon prices requires taking into consideration the specific fossil fuel uses of various types of farming operations and the potential substitution to other forms of energy over time. More insight can be gained by looking at farm purchases of diesel and gasoline to gauge which farms would contribute the bulk of levy revenues (Table 1-7). This accounts for some of the heterogeneity across farms and distinguishes small operations from the large industrial ones that increasingly dominate the sector.

This calculation is useful to show the value of the exemption for farm operations. It also underscores that the impact depends on the scale of the farm. In the next section we explore the foregone revenue to government from the levy exemption.

2. Revenue Impacts

We estimate the federal revenue impact of tax provisions relating to fossil fuel development and for exemptions from the federal carbon levy.

2.1 Income Tax Provisions

PBO estimates the fiscal cost of income tax provisions relating to fossil fuel development using administrative (T2) corporate income tax data.[^21] We use T2 corporate tax data up to the 2021 tax year, the most recent available complete set of filings.[^22]

We identify and aggregate resource‑related expenditures by taxable oil, gas and coal mining corporations that were deducted from net income.[^23] We add these expenditures back into taxable income and simulated our T2 corporate tax model to estimate the change in federal corporate tax revenue.

Table 2‑1 provides an estimate of the fiscal cost of resource‑related deductions by corporations in the oil, gas and coal mining sector from 2015 to 2021.

For flow‑through shares, we identify corporations in the oil, gas and coal mining sector that renounced exploration and development expenses via flow‑through share agreements.[^24] Table 2‑2 provides an estimate of the revenue impact of renounced exploration and development expenses via flow though share agreements by corporations in the oil, gas and coal mining sector from 2015 to 2021.

Potential changes to the tax treatment of resource‑related expenses could result in the reclassification of such expenses[^25] and interactions with provincial royalty regimes. These factors could cause the fiscal cost of policy changes to differ from the revenue impacts provided in this report.

Table 2‑3 provides the revenue impact of the accelerated CCA treatment for certain property acquired for use in facilities in Canada that liquefy natural gas. The accelerated CCA treatment changed the annual depreciation schedule of LNG capital assets such that the revenue impact is front‑loaded but eventually becomes zero over the medium‑term.[^26]

2.2 Value of exempting agricultural activities from the federal carbon levy

Section 1.2 presented results regarding the distribution of the carbon levy exemption (for diesel fuel and gasoline). Those fuels represent 80 per cent of fuel-based emissions from regions where farms are exempted from the federal levy.

Foregone revenue to the federal government due to the exemption was estimated to be $366 million in 2021 and could rise to $1.6 billion in 2030 in the absence of substitution effects (Table 2-4).  While the average per farm is significant, it is skewed due a relatively small number of larger farms for which the exemption represents higher amounts.

It is necessary to note that the calculation of the foregone revenue omits behavioural responses by farmers. Having no behavioural response implies that the estimate is an upper bound of foregone revenue. Additionally, the above estimate does not account for potential changes to removing the exemption due to international competition (e.g., Dobson, 2021).[^27]