Wednesday Night #1355

Margaret Lefebvre will introduce her colleague and good friend, George Kesteven, president of the Canadian Association of Income Funds (CAIF) – an organization with dwindling membership in the face of the Conservatives’ taxation policy with regard to income trusts.
Director of Investor Relations for PrimeWest Energy Trust since 2001, George is in a unique position to discuss the issues related to trust acquisition by sovereign wealth funds as his company has disappeared into a new entity, TAQA North, otherwise the Abu Dhabi National Energy Company [“On January 16, 2008 PrimeWest Energy and TAQA successfully completed their plan of arrangement. As a result of the acquisition all traded securities of PrimeWest have been de-listed from the Toronto and New York Stock Exchanges.”]
(Note also today’s news that Qatar is buying shares in Credit Suisse Group and plans to spend as much as $15 billion on European and U.S. bank stocks over the next year)
On Thursday Margaret and George will present a brief to the Competition Policy Review Panel, which was established to provide recommendations on how Canada should adapt and move forward in a new environment of global competition. It will be remembered that last October the Panel tabled its consultation paper outlining “what the Panel believes are the two principal issues for Canada’s economic performance: How best to create the domestic conditions to foster the development of Canadian-based global businesses; and how to best position Canada to be a world-leading destination for talent, capital and innovation”.
As the old saying has it: From their lips to God’s ear.
We anticipate that George and Margaret will have some insightful (UGH!) and possibly provocative views to share with us.
As George is not only a Calgarian, but one with deep roots in Alberta, we do not plan to limit his comments to issues of income trusts and competition policy, but look forward to his take on the Alberta election – we confess that we have been far more focused on elections in remoter parts of the world – not to mention the race to our south , so we are sure to learn something from him.
The Castonguay Report on financing Quebec’s medical system is public and there will no doubt be commentary from our medical practitioners, even though the conclusions are not likely to startle since we know that Claude Castonguay has long been an advocate of greater privatization, user fees and private insurance in the system and Minister of Health Couillard is on the same side.
Pakistan’s vote will have been counted and no doubt by Wednesday there will be accusations and counter-accusations flooding the airwaves and ether.
Finally, as became abundantly clear in last week’s exceptionally informative and lucid seminar on The Balkans, the aftermath of the Kosovar declaration of independence is likely to be felt for many weeks to come and will have important repercussions on relations between the U.S. and E.U. on one side and Russia & Serbia on the other. For your information and reading pleasure, we maintain a watching brief on this issue.

The Report

Introducing George Kesteven, Margaret noted that since the “Hallowe’en Massacre” of October 31, 2006, when Finance Minister Flaherty announced new taxation policy for income trusts , George has worked tirelessly, giving over 150 interviews and appearing before any parliamentary committees looking into any aspect of Income Trusts.

Income Trusts
Ever since the issue of taxation arose (originally with Minister of Finance Goodale in 2005), CAIF has been arguing that unintended – and negative – consequences would follow any change in taxation policy. Those consequences are now becoming apparent. Tax leakage is a major concern: forty-four trusts have been sold or merged; 70% of those sold have been sold to foreign entities. PrimeWest’s sale to TAQA is an example; PrimeWest’s unit holders paid $110 million in taxes annually – TAQA will pay no Canadian income taxes. Moreover, no reciprocity exists: non-citizens of the UAE cannot invest in TAQA. As sovereign wealth funds and foreign private equity acquire these assets and structure the acquisition in such a way as to create a tax shield, concerns that the former tax regime’s imposition of 15% withholding tax on U.S. and certain other foreign investors was too modest appear less and less credible.
The Canadian investor has always paid tax on investments in the trusts; the trusts were not operating tax-free, they simply pushed the tax down to the individual level. Now the government will have ‘lost’ between $370 and $430 million in tax revenues annually.
CAIF’s message to the Wilson panel and others is in essence that the Government’s move in 2006 cut off access to capital for small and medium size business, drove their valuation down, making them attractive acquisitions for foreign investors while at the same time making it less and less possible for the Canadian investor to own equity in his own country. The domestic Canadian retail investor is now at a disadvantage in comparison to the foreign investor.
In any discussion of the Alberta oil & gas industry, it must be remembered that 80% is natural gas and only 20% is (rapidly depleting) oil. In the Alberta basin exploration has been replaced by harvest mode (recovering the 40% of remaining reserves that are most costly to recover) and for this there is a requirement for a much lower cost of capital. The tar sands development is accelerating to meet the insatiable demands of the U.S.
Historically, gas should trade at about 1/6^th of the value of oil; currently it is trading at about half of that.
While most Wednesday Nighters agree with the argument that the oil & gas industry needs foreign investment [Canada isn’t big enough to invest what is required. Furthermore, it would be disproportionate in terms of portfolio management and asset allocation for Canadians to put all their money into the one sector.], the case for the recent spate of business trusts, like the telecommunications giants, is less convincing.
I don’t think we need foreign investors for the tar sands – let’s nationalize them and develop them as a state corporation – just as the Arabs do it
I have no desire to see us owned by foreign interests that can then dictate our foreign policy

The economy
Lou Dobbs’ interview with U.S. Comptroller General David M. Walker following Walker’s resignation as comptroller general set the tone. Mr. Walker believes that the U.S. is on the brink of ever worsening economic challenges caused by the $53 trillion hole that the U.S. is in; $9 trillion is debt we already have; $44 trillion is in unfunded promises for social security, Medicaid and Medicare. There must be fundamental reforms including entitlement programs and the tax system.
What will happen when the truths that David Walker has been preaching are finally recognized and how to deal with them? Will globalization recede? Can the West continue to encourage China’s explosive economic development in the face of the spread of environmental degradation emanating from that country? Will western economies turn to a mix of private and state enterprise to fund social programmes? How can we protect the young and the elderly from the worst of the inevitable collapse of the economy?
I don’t think anything can save it – we are running a bubble based on spending what we don’t have

The newly-released Castonguay Report on healthcare seems to be part of a cycle – every five years the government decides we cannot go on this way, another report is commissioned, tabled and ignored. In fact, Minister Couillard has declared that he will not accept the report’s recommendations [«Notre rapport est à peine publié que le ministre de la Santé rejette nos propositions sur les sources de revenus que nous proposons. Vous pouvez imaginer notre déception et notre surprise. On me dit qu’aujourd’hui (mercredi), il atténue un peu ses propos. Je trouve ça encourageant; j’espère qu’il va continuer», a commenté M. Castonguay.] This out of hand rejection of any privatization of healthcare appears to be unique to this country. Government should ensure that all Canadians receive a minimum standard of healthcare, but why should healthcare alone be provided only by government? For some, there is a basic premise that all Canadians must be treated equally, but it is pointed out by others that this doesn’t happen in other areas e.g. rights. Two-tiered care in Québec already exists. The fundamental issue is that no matter the system, we cannot undertake to provide all of the care that all of the people. Those who espouse the socialist view admit that by guaranteeing that all would receive equal services, they would sacrifice certain standards (wait times would be longer, etc.), while paying higher much taxes and having less disposable income. Others believe that availability of services would disappear, as they have in Holland for patients over a certain age. Finally, we must take into consideration the social costs that result from failure to provide adequate healthcare to all (violence, school drop-outs, loss of family income, bankruptcies, etc.). There is a parallel in Alberta where homelessness is a problem; once all hidden costs of support (police, ambulance, deteriorating neighbourhoods) are tallied, it becomes clear that the provision of affordable housing would reduce the overall cost to society.
Let’s have a society where there is no real way of succeeding big and no real way of failing big

The resignation of Fidel Castro will not likely bring about much immediate change. Some believe that Cuba is in a relatively good position today with leftist friends and allies in Lain America, notably Chavez in Venezuela. It may be that history will judge Castro kindly for the advances made in social programs, healthcare and education, possibly as the best leader of a Communist régime. Others point out that those countries that have existed under a communist régime for short periods of time tend to recover well and quickly (Eastern Europe) while those where whole generations have never known any other government are not as likely to do so. The debate over socialism, communism and the various forms of democracy inevitably led to the words of Kimon Valaskakis that a visiting alien might well conclude that hereditary monarchy was the most popular form of government on Earth.
At least hereditary monarchies and electoral democracies know what to do when a leader dies and that is why Castro is trying to find a way to ensure ‘succession planning’

The news that Minister of Finance Flaherty attacked the Ontario Premier for not doing enough to ensure that Ontario survives an economic downturn (Globe & Mail RoB) was greeted with disapproval. It is unheard of that a federal minister attack a provincial premier in this manner, but not inconsistent behaviour for this minister.

Market outlook (see also)
We (North America) have started a corrective phase since last summer, culminating on January 23^rd when there was a very sharp sell off which clearly defines the end of a period. The next morning’s headline in the Globe & Mail RoB indicating that the world is coming to an end only served to reinforce the idea that we have bottomed out. It will probably take another month before all the negativism is washed out of the market and we see the beginning of another up-leg sometime in the second half of March. Financial stocks will ‘meander’; remember that the banks took a year 1998-1999 to recover after the sell off. Warning: it is going to be a very, very selective market. Gold, energy and materials are recommended. In the 1990s, the volatility of emerging markets was about twice that of domestic markets, but that’s no longer true. Emerging markets will average about 6% growth this year.
In one view, globalization is happening and the global economy is in pretty good shape. Given the demographic and environmental problems of China, and its history of falling apart (and coming together again), another view is less optimistic. Russia which has already proven its ability to ‘bounce back’ between the two World Wars, may soon be a force to reckon with, given a highly educated workforce, plentiful natural resources and excellent scientists.

Is the U.S. in a recession? There are a multitude of definitions (just try googling “define Recession”). The financial dictionary gives the following: A significant decline in activity spread across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income, and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country’s GDP. Are the numbers being fudged? If the U.S. were in a recession there would be an immediate impact on the demand for refined (oil) products with serious impact for Alberta and Canada.

The new B.C. Carbon Tax
On July 1, 2008, the province will begin phasing in the carbon tax, which will hit gasoline, diesel, natural gas, coal, propane, and home heating fuel. The starting rate will be based on $10 per tonne of carbon emissions, and rise $5 a year to $30 per tonne by 2012.
It is too early to tell what the long-term effects will be. It is of course designed to cut consumption and therefore emissions by 20% by 2020. There may be a problem with structuring, as has been suggested by the Federation of Independent Businesses. We’ll have to revisit this subject .

U.S. elections
McCain would beat Clinton; Obama could probably beat McCain
Who might Obama select as a running mate? There are two female governors whose names have been mentioned; some say Richardson, who would attract the Hispanic vote and has extensive international experience from his days as Secretary of Energy.

Rex Murphy concluded the evening with his usual brilliant commentary, this time on Obama’s candidacy, and suggesting
Our politicians should look south, look at the phenomenon of Obama and if they are determined to inflict another essentially repetitive election on us this spring – throw away their rote scripts, talking points, wedge issues, and prefabricated attacks, all the tired tactics and tired practices of the tired old game, and try something new.
Speak their minds, abandon the trumped-up warfare, and – heresy of heresies – think a little less of winning, and a little more of making their politics as large the country they profess to serve.