Provincial Perspectives Alberta

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1 INVESTMENT D E A L E R S ASSOCIATION OF CANADA Oil and Gas Sector Underpins Growth Projections for the short-term economic performance of the province are expected to moderate as the North American economy works to deal with the tragic events of September 11, Growth for the province held steady through the first six months of 2001; however, the terrorist attacks have increased the likelihood of a global recession that would negatively affect the province s economic prospects in the short-term. Growth in GDP for the province finished at 5.6 per cent for 2000, well above the national average of 4.6 per cent and tied with Newfoundland for tops among the provinces. A strong oil and gas sector, led by solid oil prices, provided the impetus for superior growth last year. The relative strength in the energy sector will lead to stable GDP growth for the province through the current year. The provincial economy is expected to expand by 4.0 per cent in 2001, down two percentage points from a year ago, but still tops among the provinces and well ahead of the growth for all of Canada, forecast to be 1.4 per cent. The downward pressure for the provincial economy will be more readily evident in 2002, when growth is expected to dip to just above 2 per cent. Following the terrorist attacks of September 11, oil and gas price volatility has risen sharply, leading to demand that is less predictable, making estimates of economic activity for the province in the short term increasingly difficult. After beginning the year in the $28.00 range, oil prices have slipped and currently reside under $ The average price for the year is expected to be very close to the $25.00 projected by the province in the most recent budget. Natural gas prices have lost ground throughout 2001, due to slumping demand and above average inventory levels. Provincial Perspectives Alberta The Future Continues to Look Bright November 2001 As a result, the province lowered the average price assumptions to 3.75 Cdn$/mcf for the year, compared to 5.03 Cdn$/mcf estimated in the 2001/02 budget. The softening in oil and gas prices will result in lower non-renewable resource revenues for the province and a reduced pace of economic growth. Alberta Selected Economic Indicators f Real GDP 1 111, , , ,274 % change Real Business Investment 1,2 23,340 23,759 25,200 26,460 % change Employment (000's) 1,515 1,553 1,588 1,623 % change Unemployment Rate (%) Manufacturing Shipments ($ millions) 32,842 36,014 42,583 44,286 % change (3.9) Housing Starts (units) 27,122 25,447 26,266 27,580 % change 14.6 (6.2) dollars million, expenditure based 2 Non-residential construction and machinery and equipment f: forecast Sources: Statistics Canada, IDA The longer term outlook for the oil and gas sector looks promising despite the recent slump in prices. For 2001, demand for oil (as shown by oil rig usage) has been steady. The number of oil producing wells is not expected to show significant growth this year compared to last. Future demand for oil and gas produced in the province is expected to be strong despite the short-term price decline and the projected lower drilling operations for the next year. The market remains confident that recent price volatility has not had a negative impact on the medium to long-term outlook on capital spending. In fact, medium to long term plans for major capital initiatives in the province (as forecast in the major projects inventory) have actually increased 21 per cent from a year ago to stand at $77.5 billion. The energy sector again accounts for the bulk of planned investment, with a full two-thirds of the planned capital spending directed to this sector. A large portion of the planned investment continues to emanate from the

2 large oil sands projects that look to take advantage of the positive long-term prospects for the energy sector. Since the terrorist attacks in September, speculation has risen regarding the development of a North American energy policy that would place increased reliance on the energy sector in Alberta. shortage. Specific areas of the economy have experienced difficulty filling positions with qualified candidates, particularly the petrochemical and the aerospace sectors. The government maintains that the provincial labour market demand for employees exceeds supply. Housing Manufacturing Transportation, Warehousing Utilities Agriculture Finance, Insurance Source: Statistics Canada Public & Private Investment Intentions ($billions) Mining, Oil and Gas Business confidence in the province remains buoyant as the province uses its tax advantage and strong fiscal position as a lure for business to invest in the province. The latest figures for public and private short term spending intentions for the province show a jump of 14 per cent over last year to nearly $40 billion. The current weakness in the general economy is reflected in lower expectations for investment spending for the upcoming year. All sectors (save the utilities sector) are anticipating reduced investment spending next year. For 2002, one half of the intended spending will flow into the oil and gas sector, consistent with the medium to long term planned spending initiatives in the province. The most recent investment intentions data was released prior to September 11, so the forecasts may be somewhat ambitious, but a significant portion of the energy sector investment is fixed and long term in nature and therefore should not be compromised. It is expected that investment will not fall dramatically when compared to last year. Growth in the manufacturing sector has tailed off so far this year following the stellar 20 per cent gains recorded in the sector last year. Through July, manufacturing shipments were up 5.6 per cent, although growth is expected to be sluggish for the remainder of the year, ending the year with an annual growth rate near 4 per cent. The primary sector continues to account for a large chunk of the manufacturing activity in the province, however, growth in the machinery, transportation equipment, and metal fabrication sectors all showed smart gains over last year, and were important contributors to the overall growth for the sector. The securities industry has a strong presence in Alberta with 14 firms locating their head office in the province. The province is supported by over 100 branches of securities industry firms and many more sub-branches. The most recent data shows that over 4,400 registrants are licensed to trade securities in the province. Black k Ink, at t Least in the Short t Run Following the events in the U.S. in September, the provincial government was quick to reassess their fiscal situation to ensure that the province remains in the black for the current fiscal year. The government s updated forecast calls for lower non-renewable resource revenues for the current budget year due to sagging natural gas prices. The latest forecast for non-renewable resource revenues for the 2001/02 fiscal year is $6 billion, down $1.5 billion from the $7.5 billion budgeted for the year. Royalties from the sale of natural gas are projected to be off budget by $1.7 billion, partly offset by a small increase in oil royalties and land sales. The unexpected drop in revenues caused the government to react, in keeping with the Balanced Budget and Debt Retirement Act that forbids that the government finances run a deficit. The province has announced spending reductions for the current year that total $1.2 billion. The cost savings take the form of specific spending cuts and deferment of scheduled expenditures. While Alberta leads all the provinces in employment growth, the labour market continues to be tight. Through nine months of 2001, the unemployment rate has averaged at 4.5 per cent, the lowest of all the provinces and significantly better than the average rate across the country (7.2 per cent). Alberta has been flirting for the past few years with the prospects of a labour 2 Provincial Per erspecti spectives-alber es-alberta

3 To combat the revenue decline and to ensure at least a balanced budget, the province has announced the following steps: a freeze on hiring; a halt to all discretionary spending; ministries are reducing total expenses by 1 per cent; and, reserves scheduled to be used for electricity and natural gas rebates will not be used. The government expects the action taken will improve the bottom line by $500 million for the current fiscal year. The 1 per cent reduction in the base budgets of all ministries combined with the hiring freeze and the halting of discretionary spending are expected to save the government $160 million. Discontinuing the two energy assistance programs is expected to save the province a further $285 million in the current budget year. The remainder of the cutbacks (approximately $80 million) will be achieved through funding reductions and deferrals and the withdrawal of energy rebates to health authorities. Alberta Fiscal Summary ($ millions, unless otherwise noted, March year-end) 1998/ / / /02f Total Revenues 16,882 20,168 25,393 20,957 % change (5.4) (17.5) Total Expenditures 15,788 17,377 19,188 20,673 % change of which: Program Expenditures 14,409 16,421 18,188 19,848 % change Interest Expense 1, , % change 16.6 (30.7) 4.6 (17.5) Surplus or economic cushion (1) 1,026 2,717 5, Market Debt 14,106 12,490 10,342 8,580 % change (5.4) (11.5) (17.2) (17.0) % GDP (1) includes special transfer of $500 million in 2000/01 f: forcast Sources: Alberta Budgets, Statistics Canada, IDA In addition, the government has announced the deferment of infrastructure projects that will save the province a further $735 million. The deferrals consist of $282 million for health projects, $109 million for education projects, $280 million in transportation funding and $64 million in other infrastructure projects. The province also declared that taxes would not be raised and that the proactive actions taken will ensure that the books will remain balanced despite the slowing of growth. With the downward adjustment to revenue forecasts, the question begs, What happens if revenues continue to shrink? In the past, Alberta was thought to have broken the ties between the fate of the provincial economy and the price of natural resources such as oil and gas. During the past five years, budget surpluses have been realized even during times of weaker commodities prices. A firm stance on reigning in discretionary spending growth contributed to the fiscal strength of the province and that has aided in the economic health of the province. Discretionary spending, which makes up a large percentage of the total costs, has grown steadily over the past few years. The actions announced recently by the province will act as a one-time shift keeping the province in the black, but the province will need to be prepared to address the issue of discretionary spending with the same resolve required to get control of the expense side of the equation in the early 1990 s. Due to the many consecutive years of budget surpluses, and the government s continued pursuit of a debt elimination program, debt agencies rewarded the province with an upgrade in the credit rating of their domestic debt. Moody s Investor Service moved Alberta s rating up a notch to Aaa, higher than the Aa1 rating assigned to domestic federal government debt, the only province to attain a ranking higher than the federal government. Standard and Poor s also has Alberta s domestic debt rated at AAA, a step above the federal government rating of AA+. The Dominion Bond Rating Service (DBRS) upgraded the province of Alberta to AAA on August 30, 2001, matching the ratings of the other two agencies. The government boasts a very competitive tax structure with Albertans benefiting from the lowest overall taxes in Canada. At the beginning of 2001, Alberta unhooked itself from the progressive tax rate regime initiated by the federal government and introduced a flat tax on income, the first province to do so. Implementing a flat tax provides the province with increased flexibility to implement tax credits and alter tax policy to the benefit of the province and Albertans. Taking into consideration the recent changes in personal tax rates, Albertans can continue to stake claim to the lowest top marginal income tax rate, at 39 per cent, over 3 percentage points below B.C., the nearest provincial competitor. The province has also made strides in reducing the tax burden for businesses operating in the province. After the implementation of the latest reduction in general business tax rates, Alberta can claim the lowest rate of all provinces at 13.5 per cent. The government has also structured their manufacturing and processing and small business rates to be very competitive to other provinces and to states in the U.S. Provincial Per erspecti spectives-alber es-alberta 3

4 Capital Market et Activity Falls Off Dramatically In keeping with the national trend in underwriting activity, financings in Alberta dropped off dramatically through the first half of New equity raised in the province for six months of 2001 was a dismal $435 million, a 71 per cent drop versus the $1.5 billion of capital raised over the same period a year ago. On a national basis, new issuance fell 55 per cent over the same period to $5.5 billion. Alberta saw its portion of the equity underwriting market slide from 12.2 per cent for the first six months of 2000 to 7.9 per cent through the first half of The decline was widespread as nearly all sectors reported lower new issue numbers compared to the same period a year ago. In fact, the largest deal completed in the province so far this year was a Canadian Western Bank secondary issue for $29 million, a clear indicator of a weak underwriting environment. The oil and gas sector accounted for nearly 48 per cent of all equity underwriting activity during the first half of 2001, compared with 60 per cent in 2000, a 12 percentage point decline. The fall-off in dollar value of funds raised year-over-year is even more dramatic. $183 million was generated by the Alberta oil and gas sector in the first half of 2001, nearly 80 per cent lower than the $887 million of equity raised in the same period the previous year. As expected, Alberta continues to account for much of the oil and gas sector underwriting activity in Canada, although the percentage is down from last year. For the first half of the year, Alberta tallied 78 per cent of all oil and gas financings in Canada, down from 95 per cent over the same period last year. IPO activity has suffered as well with issuance through the first six months of the year standing at $39.2 billion, down 62 per cent from last year. In particular, oil and gas IPOs, which accounted for over $60 million in IPO issuance in the first half of 2000, fell to a mere $8.7 million in the January June 2001 period. Volatility in the markets, a drop off in oil and gas prices (particularly natural gas prices), and a shift in focus towards consolidation in the oil patch all contributed to the lower financing numbers. period in Across Canada, $21 billion in corporate debt was raised in the first half of the year, a decline of 16 per cent from the same period a year ago. The vast majority of the Albertan debt financings were concentrated in either the oil and gas or the utilities sectors. In total, 94 per cent of the debt raised in 2001 came from these two sectors, versus 60 per cent a year ago. 10,000 8,000 6,000 4,000 2,000 0 Cross Border M&A Activity In Alberta (in $millions) Q1 Foreign Firms Aquiring Alberta Companies Q2 Q3 Q4 Q1 Q Alberta Companies Aquiring Foreign Firms Similarly, new corporate debt issues in the province were also down markedly through the first six months of Corporate debt underwriting in the province totaled $1.6 billion for the first half of this year, down 36 per cent from the $2.4 billion raised over the same with large upside potential. M&A activity involving 4 Provincial Per erspecti spectives-alber es-alberta Q3 Venture capital raised in the province also trended downward in the current year. Alberta companies have maintained their share of 3 per cent of the venture capital available in Canada, but the total venture capital pie has contracted somewhat from Venture capital in the province fell off the pace of last year raising $75 million through half of this year compared to $189 million for all of The total Canadian venture capital industry invested $6.3 billion for 2000, easily establishing a new record. Through the first half of 2001, the $2.5 billion invested in venture capital projects is off the pace set last year by about 20 per cent. Merger and acquisition activity in the province has been very robust so far in 2001 with $21 billion worth of transactions announced through the first nine months of the year, more than double the $10.2 billion in M&A transactions announced over the same period a year ago. Consolidation in the oil patch is largely responsible for the activity as foreign firms acquiring Albertan companies accounted for over $18 billion of the total amount of transactions through three quarters of The relative strength of the US$ compared to the Canadian dollar is the dominant factor in the M&A numbers. The currency advantage combined with the long-term strength of the oil and gas industry creates buying opportunities for U.S. firms

5 Canadian companies acquiring Albertan companies was down by 45 per cent through the first nine months of 2001 ($4.3 billion in 2000 versus $2.3 billion in 2001). Canadian firms have not been able to participate significantly in the consolidation of the Alberta oil patch primarily due to the additional costs of funding acquisitions using Canadian dollars. Polic olicy y Issues of Rele elevance in the Province New w Exempt Market et Rules In September 2001, the Alberta Securities Commission (ASC) in conjunction with the B.C. Securities Commission released a set of proposed rules to reduce some of the barriers faced by investors in the province. The proposal is aimed at facilitating funding for small businesses by providing new and expanded exemptions from disclosure requirements. The proposed changes will simplify the process and reduce the costs for companies tapping investors for funds. In total there are four main exemptions included in the proposal. The Offering Memorandum Exemption allows companies to use a simple disclosure document in lieu of a full prospectus provided the investor acknowledges the risks of investing. The exemption allows for an unlimited amount of funds to be raised but includes investor protection provisions similar to a prospectus. The Accredited Investor Exemption provides issuers with the means to raise funds from financial institutions, pension funds, investment dealers, established companies, and wealthy individuals without any form of disclosure document. Wealthy individuals are defined as those with financial assets greater than $1 million or pre-tax net income of at least $300,000 in each of the past two years. The accredited investor exemption does not have a minimum purchase requirement and replaces the previous $97,000 minimum purchase requirement for sophisticated investors. The Family, Friends and Business Associates Exemption removes limits on raising funds from friends, family and senior officers and directors of the issuer without a disclosure document. Lastly, the Private Issuer Exemption enhances the ability of privately held companies to issue equity without having to become a public company. businesses without going to the time or cash expense of a formal public offering. The IDA s Alberta District Council, Capital Markets Committee is reviewing the proposal. At first glance, the Committee believes that the proposal will benefit the markets from a capital formation perspective. The Committee is focusing the review on the delicate balance between increasing opportunities for capital formation and investor protection. The proposal can only be beneficial if there are appropriate public safeguards in place. The proposal would provide more opportunities to nonregistered individuals who are not governed by securities commission and self-regulatory organization (SRO) rules requiring suitability and due diligence reviews. The Committee will conclude their review and provide comments to the ASC by November 30, Cost of Regula gulation The costs of regulating the Canadian capital markets, borne by issuers, investors and intermediaries, have increased significantly over the past five years. These costs include the direct cost of regulation imposed by provincial securities commissions and the IDA and the substantial indirect costs of dealing in thirteen securities regulatory jurisdictions to distribute securities nationwide and operate in different regions of the country. Costs have also increased from the duplication and overlap in dealing with different federal and provincial regulators, as institutions offer a range of financial services in a rapidly converging financial marketplace. The Alberta Securities Commission brought an amended fee structure into place April 1, 1997, two years after conversion into a crown corporation. This step reduced fee levels by 20 per cent. In the subsequent four years, fees have not increased. The ASC has not generated a significant surplus in fees as has been experienced in other jurisdictions. Chris Woolcoc oolcock, Financial Analyst Industry y Rela elations and Repr presenta esentation tion (416) cwoolcock@ida.ca The combined effect of the proposed exemptions will be to provide greater flexibility to issuers, particularly small businesses with respect to raising capital for their Provincial Per erspecti spectives-alber es-alberta 5

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8 INVESTMENT D E A L E R S ASSOCIATION OF CANADA CALGARY Suite Fourth Ave. S.W. Calgary, Alberta T2P 0J1 Tel.: (403) Fax: (403) HALIFAX TD Centre, Suite Barrington St. Halifax, Nova Scotia B3J 3K9 Tel.: (902) Fax: (902) MONTRÉAL Bureau Place Ville Marie Montréal, Québec H3B 4R4 Tel.: (514) Fax: (514) TORONTO Suite King St. W. Toronto, Ontario M5H 3T9 Tel.: (416) Fax: (416) Ce rapport est aussi disponible en français sur demande. The Investment Dealers Association of Canada is the national self-regulatory organization (SRO) and representative of the securities industry. The Association s role is to foster fair, efficient and competitive capital markets by encouraging participation in the savings and investment process and by ensuring the integrity of the marketplace. VANCOUVER Suite 1325 P.O. Box West Georgia St. Vancouver, BC V6B 4N9 Tel.: (604) Fax: (604) Printed on recycled paper