HOW ROYALTIES ARE
RELATED TO HOMEMADE PASTA
Before digging into the detail of royalties, it helps to
understand what royalties are, and their purpose. An
important starting point is that royalties are different
than taxes, and they serve a different purpose.
Governments levy different kinds of taxes on different
things — such as land (property taxes), the purchase of
goods and services (sales taxes), and liquor and cigarettes
(sometimes called “sin taxes”). When governments set
these taxes, they generally do it based on how much
money they need to pay for things like health, education
and other public services. The taxes don’t have any-thing
to do with ownership. (Government doesn’t own the
cigarettes, but it taxes them.)
Royalties, on the other hand, are about getting value from
selling something we own. On behalf of Albertans, the
Government of Alberta uses royalties as one of two key
mechanisms to collect the value of the oil, natural gas
and oil sands resources that Albertans own. The other
mechanism is how it sells the right to explore for and
produce oil, natural gas and oil sands (known as “land
sales”.)
Imagine this. You own a very special pasta-making machine. It makes some of the best pasta the world has tasted. Your plan is
to start selling your pasta at the local market but ultimately sell it around the world and you plan to do this for 10 years.
There’s a couple of approaches you could take to do this. You could do it all yourself, assume all the risk, raise all the capital
and take all the profits (or losses). Or you could licence your pasta-making machine to many business operators who specialize
in food distribution, and negotiate a share the profits.
If you take the first approach and decide to operate on your own, you’ll receive a price for the homemade pasta you sell, which
will be based on what people are willing to pay for it. If there are lots of other people also selling homemade pasta, this price
might be lower at times. If there’s a homemade pasta shortage in the land, the price you receive might be higher than other
times.
As owner of the pasta-making machine, you’ll realize value from the homemade pasta you pro-duce and sell, which is different
than price. The value is the price you receive for the homemade pasta, minus:
• the cost of the pasta-making machine,
• the cost of the ingredients to make the pasta dough,
• the cost of your labour,
• the cost of transporting the pasta to and from the farmer’s market,
• the cost of your booth at the farmer’s market, and
• the cost of electricity to operate the pasta-making machine…
…over the entire 10 years you plan to operate.
If you take the second approach, and decide to licence the rights to a pasta company, you will still own the pasta-making
machine but the pasta company will produce and sell homemade pasta on your behalf. The pasta company will be the one
raising the capital to produce the pasta, incur-ring the day-to-day costs and risks, and receiving the price for the homemade
pasta that is pro-duced and sold on a day-to-day basis. However, as the owner of the pasta-making machine, you’ll still want to
get the value of the homemade pasta your machine has produced.
Under this approach, you’ll need to determine the value of your machine and the homemade pas-ta that is produced and sold
from it. You’ll also need to decide how you’re going to collect that value. That would likely include an upfront cash payment
from the pasta company, and then some money based on how much profit the pasta company makes or a monthly payment
based on how much you think the pasta company can afford or is willing to pay you before they’d decide to find another pastamachine owner that charges less.
When it comes to energy production, Alberta uses the second approach. The Government of Al-berta doesn’t directly explore for
and produce Alberta’s oil, natural gas and oil sands resources. Energy companies do all of that on Alberta’s behalf. They drill for
the oil and gas, they operate the wells and projects, they transport and sell the resources, and they aim to make money doing it.
But the resources they are producing and selling are owned by Albertans, and these resources have value. Albertans receive a
share of that value when the resources are produced and sold.
When the government sets royalty rates and holds land sales, the objective is to receive good value for Alberta’s resources
while, at the same time, encouraging energy companies to invest in producing and selling those resources on Alberta’s behalf.