Estimating the Credibility of the Co-operative Commonwealth
Federation's Threat to Nationalize Oil Resources in Saskatchewan
J. C. Herbert Emery
∗
Jennifer L. Winter
†
May 20, 2008
Abstract
Preliminary. Several scholars and politicians argue that the ideology and policies of the Cooperative
Commonwealth Federation (CCF) governments in Saskatchewan from 1944 to 1964, including an alleged
expropriation threat, retarded the development of Saskatchewan's oil and gas resources. Since 1950, a
signicant portion of Western Canada's wealth has been generated by the oil industry, and in Canada,
the provinces control the mineral rights. Provincial government policy could have a signicant eect on
the level of private investment in the resource sector, and consequently, the wealth of the province. The
purpose of this paper is to develop a model to value land with an exhaustible resource under uncertainty.
The uncertainty comes from the positive probability of expropriation by the government, with zero compensation. The value of a unit of land is assumed to be strictly a function of expected prots resulting
from the extraction of the resource. The main result is that the change in the value of a unit of land
is a function of prots, the discounted value of the land, and the change in the reserve stock. The net
discounting term consists of the discount rate and the probability of expropriation. This paper adds to
the existing literature as the model results in the derivation of a simple equation that allows estimation
of the perceived probability of expropriation. The model is used to evaluate the eect of the CCF on
the natural resource industry in Saskatchewan. Our results are inconclusive regarding a perceived threat
of expropriation, but do indicate a positive risk premium from 1955 to 1964 associated with the CCF
government.
∗ Department
of
Economics,
University
of
Calgary,
2500
University
Drive
NW,
Calgary,
Alberta,
T2N
1N4,
hemery@ucalgary.ca
† Department of Economics,
University of Calgary,
2500 University Drive NW, Calgary,
ter@ucalgary.ca
1
Alberta,
T2N 1N4,
jlwin-
1 Introduction
Governments and their policies have the potential to signicantly aect economic development. These policies
can include preferential tax treatment, openness to foreign investment, and the security of property rights.
Without secure property rights, industries that require large amounts of capital relative to labour will be
underdeveloped. With insecure property rights, there is the possibility of expropriation, which means that
rms face the risk that they will not earn a return on their investment, or that the investment itself will be
seized. This risk leads to lower levels of investment, and lower development, which has a detrimental eect on
growth. In industries that use large amounts of labour relative to capital, insecure property rights can lead
1 The risk that land or resources could be expropriated
to over-development and over-extraction of resources.
will cause rms to extract faster, to earn prots while they still can. This could lead to irresponsible and
unsustainable exploitation.
Political stability is an important determinant of secure property rights. It is often the case in developing
countries that insecure governments are unable to enforce property rights eectively, or will themselves
expropriate foreign investments. However, political stability is not the only determinant of secure property
rights. Often, it is the political ideology of the government in question that will determine whether or not
the government will choose to expropriate property or resources. There are several examples of this in recent
world events. In Russia in 2004, Yukos was charged with tax evasion, which resulted in the forced sale of
its assets. In addition, Yukos was subsequently purchased by the state-owned Rosneft. In early 2007, the
Venezuelan government seized control of foreign-owned oil elds. In both cases, it is obvious that there is a
threat of expropriation from the respective governments, but it is dicult to identify the probability of this
threat, or the eects it has on the economy. Foreign investment has been shown to be very important for
growth in developing countries, and the threat of expropriation reduces investment. Jones (1984) found that
adverse government action by the Venezuelan government in the form of expropriation was positively linked
to corporate income and relative deprivation and was negatively linked to changes in the economic growth
rate.
Several scholars and politicians argue that the ideology and policies of the Co-operative Commonwealth
Federation (CCF) governments in Saskatchewan from 1944 to 1964, including an alleged expropriation threat,
retarded the development of Saskatchewan's oil and gas resources.
2
Since 1950, a signicant portion of
Western Canada's wealth has been generated by the oil industry, and in Canada, the provinces control
3
the mineral rights.
Provincial government policy could have a signicant eect on the level of private
investment in the resource sector, and consequently, the wealth of the province.
The economic literature
demonstrates that the threat of nationalization and/or expropriation of assets without compensation can
lead to underinvestment in the country where the threat is present, as well as sub-optimal extraction of
resources.
4
As these outcomes could also arise from less extreme policies like higher tax rates, or other
economic fundamentals of the resource economy, a more dicult challenge is quantifying the credibility of
the threat so as to determine whether or not the threat is the cause of the poor economic outcomes. The
purpose of this paper is to develop a model of land value when the land contains a natural resource stock,
and there is a threat of government expropriation. A key feature of the model is that it allows identication
of the expropriation threat. An estimating equation is developed from the model, which is used to estimate
the perceived probability on the part of private interests in the sector that the Co-operative Commonwealth
Federation government would have expropriated Saskatchewan's oil resources in the 1940s and 1950s.
We assume that any credible expropriation threat would have been priced into the value of government
land lease sales, for land leased for the purposes of oil and gas exploration and production. We believe that
this is a reasonable measure quantifying an expropriation risk as the amount rms pay for land should reect
1 Bohn and Deacon (2000)
2 Richards and Pratt (1979).
MacKinnon (2003, 19) suggests that many business people and right-of-centre politicians feel
that the socialists in Regina rather than oil in Alberta have had more to do with Saskatchewan's perceived under-performance.
MacKinnon cites Colin Thatcher, former Saskatchewan MLA, The CCF-NDP has been a curse on the province of Saskatchewan
and have unquestionably retarded our economic development, for which our grandchildren will pay.
3 While
both Saskatchewan and Alberta produce oil and natural gas, the greater importance of energy resources for Alberta is
clear. Alberta is the 9th largest producer of oil in the world and the 3rd largest natural gas producer. Within Canada, Alberta
produces 55% of Canada's conventional crude oil. Saskatchewan is Canada's second largest producer of oil in Canada, producing
20% of Canada's conventional crude oil.
4 Long
(1975); Geiger (1989); Melese and Michel (1991); Konrad, Olsen and Schöb (1994); Bohn and Deacon (2000); Jacoby,
Li and Rozelle (2002).
2
the net present value of expected prots from oil reserves it may contain. Land leases were sold competitively
at auction in Saskatchewan and Alberta so an expropriation risk could be priced into their value. The results
of this model are inconclusive regarding a perceived risk of expropriation occurring in Saskatchewan during
the threat period.
However, subsequent analysis shows a positive risk premium during the tenure of the
CCF. Through auxiliary regressions, we nd that the CCF had a positive eect on exploration eort and oil
production in Saskatchewan. This suggests that the main eect of the CCF's early policies was to reduce
the value of the xed factor, land. Overall, it would appear that the CCF caused no harm to the long run
development of the province's oil and gas resources with its policies in its rst term of government.
The
layout of the paper is as follows. Section 2 discusses the history of the Saskatchewan resource industry and
the CCF party, 3 outlines the relevant literature, Section 4 develops the model, Section 5 presents how the
model can be extended to empirical work. Section 6 describes the data used in the analysis, Section 7 analyses
the results of the model,and Section 8 concludes. The Appendix contains tables of summary statistics and
regression results.
2 The CCF's Expropriation Threat
In February 1905, the federal government introduced legislation that created two provinces out of the Northwest Territories. A north/south border was positioned that created two provinces roughly equal in size by
5 The economies of the two
area (275,000 square miles each) and population (about 250,000 each in 1905).
provinces remained largely agricultural and the incomes and populations of the two provinces were roughly
equal until after the Depression. The provinces' shared experiences of economic devastation, drought and
out-migration during the Great Depression impressed upon their governments the need to diversify their
economies away from agriculture. The approaches toward economic diversication would prove to be very
dierent between the provinces, particularly with respect to public policy toward the emerging oil and gas
industry. The populist Social Credit government in Alberta, elected in 1935, would respond by ensuring
that the tools of capitalism would better serve Albertans by favouring policies that encouraged external
private capital to locate in the province. In Saskatchewan, the Cooperative Commonwealth Federation party
was elected to power in 1944 and embarked on an economic program initially favouring nationalization and
public ownership of natural resources and key industries. The resources of the province were to be developed
to benet the citizens of Saskatchewan, rather than external capitalists.
Prior to the discovery of the large oil pool at Leduc in 1947, relatively little crude oil was produced in
6 Natural gas was produced in small quantity in Alberta but
Alberta and virtually none in Saskatchewan.
no substantial quantity of gas would be produced in Saskatchewan until the mid 1950s. Playing a role in
shaping public policy was the market power of private energy producers. The provincial governments lacked
the necessary public capital to develop the resources on their own. Further, the risks inherent in oil and gas
exploration proved unpalatable for provinces emerging from the debt problems of the 1930s, particularly as
it was not obvious that there was an external market for oil.
7 Finally, as domestic sources of capital were
not well developed, external private capital that produced the oil had credible exit threats.
In Alberta the Social Credit government, newly-formed and newly-elected in 1935, sought to diversify the
economy by building upon the nascent oil industry that had been established as a result of the small, and by
then declining, production of oil in Turner Valley. To do so, it sent assurances to the nancial sector and the
oil industry that the province would provide every incentive to risk capital and it established a regulatory
regime that emphasized private property rights and a generous royalty regime (Hanson 1958, Richards and
Pratt 1979). In 1949 it passed the Mines and Mineral Act in which royalty rates on petroleum and natural gas
were established. An important element of the Act was to commit the provincial government to a relatively
8
low maximum royalty rate equal to just 16.67% of gross production.
5 Only
after a prolonged battle with the federal government did these provinces gain control over their natural resources in
1930. See Boothe and Edwards (2003, 93-97).
6 In
1947, one million cubic metres of oil were produced in Alberta, mainly from the Turner Valley area. This was less than 6%
of the amount produced in 1955. In 1947 only 83,000 cubic metres of oil was produced in Saskatchewan.
Statistical Handbook,
Canadian Association of Petroleum Producers.
7 Hanson
(1958), Richards and Pratt (1979), Johnson (2004). Britnell (1953) expressed scepticism that the provinces would
nd an export market for their high cost oil.
8 Doern
and Toner (1985). Interestingly, it was not until 1971 after the election of a new government following the end of the
36-year reign of the Social Credit party that this low maximum royalty rate was raised. Great eort was made to maintain the
3
In Saskatchewan, the CCF's approach to developing the province's natural resources departed dramatically
from that of the Social Credit party in her sister province to the west. While the CCF would not win an
election in Saskatchewan until 1944, in the 1934 and 1938 provincial elections CCF candidates campaigned
on a platform of social ownership of all major industries.
9 At the July 1933 Co-operative Commonwealth
Federation National Convention, the party unveiled its Regina Manifesto which stated that the party sought
10 Among other
to replace the current capitalist system with a social order based upon economic equality.
things, the CCF called for natural resources to be developed for the public benet, and not for the private
prot of a small group of owners [or] nancial manipulators. However, the Manifesto made clear that a policy
of outright conscation would not be pursued (Zakuta 1964, 162). By 1944, the CCF's Natural Resources
and Industrial Development Committee had identied the natural resource sector as the central candidate
11 The committee recommended that the government acquire those mineral rights that
for social ownership.
were privately owned, prevent further alienation of natural resources, and plan for the eventual and complete
socialization of all natural resources. The 1944 CCF election platform (the
Program for Saskatchewan ) stated
that the party would proceed to public development and ownership of the natural resources. However, the
Program
made no mention of the Committee's recommendation that privately owned resources should be
restored to the province. The Committee also made mention of collecting royalties and taxes from privately
owned enterprises, so it is not clear whether full socialization would ever occur.
In the 1944 Saskatchewan election campaign, Douglas and his colleagues were called on to defend and
clarify the CCF's policy on socialization of industry and resources. From their responses, it appears that
the main focus of the party in the 1944 election was the development, rather than socialization, of resources.
The Saskatchewan CCF Committee on Socialization of Industry and Natural Resources stated that industry
should not be socialized for the sake of socialization, but only under certain dened circumstances (Johnson
2004, 30). Douglas argued that social ownership should be expanded upon when needed to prevent monopoly
12 Premier Douglas believed that royalties and land rental regulations would
and exploitation of the public.
be sucient to capture a fair share of resource revenues.
From 1944 to 1948 the newly-elected CCF sought to promote Saskatchewan's economic diversication
through nationalization and promotion of secondary manufacturing and natural resources. The 1944 Natural
Resources Act gave the Minister of Natural Resources power to acquire any lands or works by purchase,
lease or expropriation as necessary to develop and utilize the resources of the province.
13 The 1944 Mineral
Taxation Act imposed a tax on undeveloped freehold mineral rights to encourage holders of the rights, which
14 Failure to pay
had been granted by the federal government, to allow the rights to revert to the province.
the mineral tax resulted in forfeiture of the mineral rights to the Saskatchewan government. A resolution
adopted by the CCF party at its' 1946 convention called upon the Government of Saskatchewan to place
oil and natural gas under social ownership, control and operation.
Similar resolutions were approved in
sanctity of the original contract agreed to by the Social Credit government of 1949 and the industry by changing the maximum
royalty rate only on remaining oil reserves. This had the eect of raising the royalty rate to 23% of gross production. Dramatic
increases in oil prices would soon cause the government to abandon this agreement and tie royalties to the price of oil (Doern
and Toner, 1985).
9 In
1938, the CCF ran second in terms of popular vote and won 10 seats despite elding candidates in only 30 of 52 ridings.
In the 1944 election, the CCF would sweep to power winning 50 of 55 seats.
10 See
pages 1 and 2 of the Regina Manifesto reprinted in Zakuta (1964, 160-169). Richards and Pratt (1979, 101). The
Depression had instilled in the CCF leaders the idea that capitalism had failed. Production was for prot and not for human
need, and these two objectives could not be reconciled. Further, the CCF leaders believed that private corporations refused to
produce to meet public need unless the returns were unreasonably high. The CCF's solution to this was a new economic order,
a planned economy that placed three key industries under public ownership or direction, the prots of which should go back
to the people. These industries were the banking and nance corporations; other industries and services essential to economic
planning; and the natural resources industry (Johnson 2004, 29).
11 According
to Johnson (2004, 43-44), the CCF's Natural Resources and Industrial Development Committee advocated that
the development of resources should take place under public instead of private control.
12 Douglas
argued that Canadians already had experienced social ownership in the form of the national railway, provincial
telephone and electrical services, etc. (Johnson 2004, 30-31).
13 Richards
and Pratt (1979, 110).
Joe Phelps, the Minister of Natural Resources, began plans for the development of
government-owned factories, including a pulp mill, a woollen mill, a brick yard, a show factory and a tannery (Johnson 2004,
68).
14 Richards
and Pratt (1979, 110).
Approximately 10% of Saskatchewan's mineral rights were owned by private rms or
individuals. The stated reason for the Mineral Taxation Act 1944 was to compensate the people of the province for the depletion
of these alienated minerals.
(Government of Saskatchewan, Department of Natural Resources and Industrial Development,
Annual Report 1949, 37.)
4
1947 and 1948. By October 1947, mineral rights in undeveloped areas had been seized by the Saskatchewan
Department of Natural Resources.
A notorious episode in Saskatchewan history occurred in 1944 shortly after the CCF had won the election.
Imperial Oil, Canada's major oil company, approached the CCF government with a proposal for a long-term
contract that would give the company exclusive exploration rights over a large section of the province should
it nd commercial volumes of oil. While the government's own advisors suggested that turning down the
oer would delay exploration and possible industrial development for many years and that the risks inherent
in oil and gas exploration were inappropriate for a provincial government to take on, it nonetheless refused
15
the oer and as a result, Imperial Oil allegedly boycotted the province.
Despite the aggressive policies and positions of the CCF in its rst term of government, debate over public
versus private development of resources continued within the CCF, and by its second term in oce, the party
was backing away from its earlier direction of public ownership as capital market forces and moderates
16
within the CCF had moved Saskatchewan into the same passive rentier role as Alberta.
Following its
formation in 1946 for the purposes of economic planning and policy evaluation, the Economic Advisory
and Planning Board (EAPB) recommended in late 1947 and again in early 1948 that Saskatchewan rely
on private development of the province's mineral resources (Johnson 2004, 123 and 131). On September 1,
1948, all forfeiture proceedings under the 1944 Mineral Taxation Act were stopped pending on the resolution
of the court proceedings surrounding the Canadian Pacic Railway's action to have the Act declared
vires.17
ultra
As a result of this, the Saskatchewan Government passed an Order in Council allowing the return of
forfeited mineral rights upon payment of the mineral taxes, with a deadline of October 31, 1950 for revestment
applications. As of March 31, 1950 82% of the forfeited mineral rights had been revested, with the remainder
18 Revestment of the mineral rights was completed by December 31, 1951, with 96.3% of
being unclaimed.
the mineral rights restored to their original owners and the remainder retained by the Crown. After the 1948
19
election, and following the Leduc and Redwater oil discoveries in Alberta.
After the 1948 election, and following the Leduc and Redwater oil discoveries in Alberta, the CCF was
sensitive to criticism about the relatively slow pace of oil exploration in Saskatchewan. In an attempt to bring
the oil majors like Imperial Oil back to the province, Premier Douglas sent letters to major and independent
oil companies in which he stated that the province has no intention of either expropriating or socializing the
oil industry (Richards and Pratt 1979, 135-136). By the early 1950s the CCF had formally abandoned the
nationalization option and by the mid 1950s the oil polices of the CCF had largely converged with those of
the Social Credit government in Alberta.
There seem to have been several reasons for the CCF's change in policy direction. First, the government
was losing popularity through its rst term. In the 1948 election, the CCF party went from forty-seven seats to
thirty-one; one of the seats lost was that of Joe Phelps, the Minister of Natural Resources and an enthusiastic
proponent of nationalization. The position of Minister of Natural Resources went to J. H. Brockelbank, whose
ideology was less radical than his predecessor's.
15 However, several
16 Johnson (2004).
20 By this time too the failure of the publicly owned rms
companies, including Husky Oil, continued to invest. (Richards and Pratt 1979, 134).
The moderation of the CCF in Canada from 1933 to the 1950s had been described as the becalming of
a protest movement (Zakuta 1964, Whitehorn 1992). The party's ocial stand on the role of social ownership versus private
enterprise moved from a prohibition of capitalism in 1933 to the aiding and encouraging of private business to fulll its legitimate
function in 1948. The distinction between the CCF and the old parties diminished further through the 1950s (Zakuta 1964,
74, 87-88).
17 Saskatchewan
Department of Natural Resources Annual Report (1950, 29).
The Court of the King's Bench decided in
favour of the government of Saskatchewan on June 15, 1950, resulting in an appeal from Canadian Pacic Railway being led
(Saskatchewan Department of Natural Resources Annual Report 1951, 23). The Saskatchewan Court of Appeals found the tax
on mineral rights to be
intra vires, and the tax on mineral rights where there was production to be ultra vires on June 11, 1951.
The Canadian Pacic Railway subsequently appealed once more, and the judgement of the Supreme Court of Canada (June 30,
1952) was that the Act was valid in all respects. (Saskatchewan Department of Natural Resources Annual Report 1951, 22). The
CPR served notice that the Supreme Court's decision would be appealed to the Privy Council, but six months later dropped
the appeal. Ten days after the CPR's appeal was dropped, the government of Saskatchewan announced that there would be no
forfeitures during 1953. (Saskatchewan Department of Natural Resources Annual Report 1953, 35).
18 Saskatchewan Department of Natural Resources Annual Report (1951, 22).
19 Saskatchewan Department of Natural Resources Annual Report (1952, 24).
20 It is also the case that CCF moderates did not have enthusiasm for these
early attempts at nationalizing industry and
resource development. Richards and Pratt (1979) and Johnson (2004, 92) attribute these ambitious policy directions as primarily
driven by Joe Phelps, the Minister of Natural Resources in the CCF's rst term of government from 1944-1948. Johnson (2004,
62) describes Phelps as fanatically loyal to the CCF platform and ideology and he stood in contrast to principled yet practical
cabinet ministers like Tommy Douglas, Clarence Fines and J.H. Brockelbank.
5
established by the CCF government in 1945 and 1946, rms that competed with existing private rms, had
21 Second, the CCF government faced a threat from the oil companies in the province that
become apparent.
they would move out if the government went through with an agreement over the leasing of Crown reserves
that the industry saw as putting the government in the oil business. Financial necessity also encouraged the
CCF government to converge towards Alberta's policies and approaches to resource development. American
investors sent a clear message to the Treasurer, Clarence Fines, that Saskatchewan government bonds would
not be in demand if the CCF did not improve the province's credit position (Richards and Pratt, 1979).
Richards and Pratt (1979) argue that the slower growth of the oil and gas sector was the result of the
22 This conclusion seems to stem from the fallout from the CCF's
threat of nationalization from the CCF.
rejection of Imperial Oil's oer in 1944.
In a 1950 memorandum to Premier Douglas reporting on the
discussions with Imperial Oil about the company's lack of activity in Saskatchewan and the prospects for the
company becoming more active in the province, senior government ocials reported that Imperial identied
four reasons for not operating in Saskatchewan since 1945; rst, they felt there was diculty obtaining land;
second, there were more interesting geological structures in Alberta; third, there was a necessity to place
all available funds in Alberta to protect the discoveries that they had made; and fourth, they had a fear of
expropriation in Saskatchewan.
23 Further support for this view came from the coincidence of the moderation
in the CCF approach to resource development after 1948 and increasing exploration eort in Saskatchewan.
24
The province had its rst major oil discovery in 1952.
Despite the fact that any moves towards nationalizing Saskatchewan's oil resources were in the CCF's
rst term in government, it is uncertain whether the government's threat of expropriation was considered
credible by investors, and if it was, whether the expropriation risk had a lasting eect on the development of
the province's oil resources. The CCF rhetoric and actions like the Natural Resources Act 1944 and Mineral
Taxation Act 1944 signalled intent and capacity to expropriate, though it was not clear if the government
would pay compensation.
Further, the CPR's court action against the CCF government's 1944 Mineral
Taxation Act shows that industry could call on higher levels of government and the courts to enforce their
property rights.
3 Relevant Literature
Long (1975) modeled the probability of a natural resource stock being nationalized as a function of time.
Long identied three sources of uncertainty for a rm: (i) whether it will be nationalized, (ii) the time at
which nationalization occurs, and (iii) the amount of compensation at the time of nationalization.
Long
modeled compensation to the rm as a random variable, and so the rm's objective was to maximize the
expected value of the sum of discounted returns. The model predicts that when there is uncertainty about
extraction, the resource will be exhausted more quickly, and extraction begins at a higher rate. Long assumed
optimal production occurs in each period, which may have an eect on the predictions of the model. The
results of the paper suggest that with uncertainty over expropriation, resource extraction will occur faster as
rms attempt to exhaust the resource before expropriation occurs. The predictions made about the eect of
nationalization threat are stronger than some of the future empirical results.
21 In
the two years following its election in 1944, the CCF government established a brick manufacturing plant, a shoe factory,
a tannery, a sh processing and marketing board, a timber board, a fur marketing service, a box factory, a provincial bus
company, and a sodium sulphate mine (Richards and Pratt 1979, 112).
22 Alex Cameron,
a Liberal (opposition) member of the Saskatchewan Legislature in 1950 alleged that The major oil companies
have been stung by government bureaucracy, loaded with excessive taxation and having to carry these leeches (CCF patronage
land controllers) on their backs, have thrown in the sponge. (Tyre 1962, 201). Cameron said that exploration for oil and gas
had ground to a virtual halt in Saskatchewan and no new gas wells had been brought into production since 1946.
23 D.H.F. Black, Government of the Province of Saskatchewan Department Memo to T.C. Douglas, October 11, 1950.
24 Johnson (2004, 156). The relatively slower development of the oil and gas resources of Saskatchewan in the 1940s and
early
1950s would have also reected the fact that the vast majority of proven reserves of conventional oil were in Alberta. With
Alberta's geological formations having been proved to hold commercial quantities of oil, with new oil services rms established
in Alberta to service the newly discovered elds, and with new pipelines being established to transport oil from eld to market,
it is not surprising that exploration in Saskatchewan may have held less appeal for oil companies.
Hanson (1958) describes
how the development of the Redwater oil discovery in Alberta drew resources away from the further development of the Leduc
oil eld. This in part reected the shortage of equipment for drilling in the late 1940s and early 1950s which also means that
that it would not be surprising that resources would not go to Saskatchewan until these big Alberta elds were developed.
Hanson (1958, 99) describes how drilling in Alberta slowed down after 1951 as exploration and development eorts moved into
Saskatchewan where some successes had been occurring
6
Jones (1984) used discriminant analysis in an attempt to predict government actions in Venezuela that
adversely aected the local oil production operations of American companies. The objective of the model
was to determine the extent to which explanatory variables could correctly classify the respective years
where government actions were adverse to the protability of the US companies, and the years in which
adverse actions did not occur. The probability calculated by Jones was the posterior probability of adverse
government action, and ranged from 55% to 96%.
The high estimated probabilities are likely a result of
expropriation actually occurring in the time period of interest.
Geiger (1989) modeled the relationship between external capital ows and expropriations in Latin American countries where governments engaged in signicant expropriation. He estimated the eect of the dierent
types of expropriation on several types of external capital ows.
He found that uncompensated expropri-
ation signicantly reduced external capital ows, but an expropriation in one Latin American country did
not result in reduced external capital ow into neighbouring countries. Again, the strong results are likely
because the threat of expropriation was realized in the Latin American countries for the time period used
in the estimation. He found that expropriation had a negative eect on the value and level of foreign direct
investment, but the results were not statistically signicant.
Mahajan (1990) used the theory of option valuation to price the expropriation risk of a rm's foreign
project and incorporates the risk into the rm's asset selection decision, which he assumed is based on Net
Present Value.
Mahajan predicted that a project's risk-adjusted NPV equals its unadjusted NPV minus
the expropriation option value.
Melese and Michel (1991) modeled the eects of expected tax reform on
a monopolist in an extractive industry.
They found that tax reforms have two eects; through perceived
future changes in the probability of tax reform and through perceived future changes to a rm's expected
protability under a new tax structure. Three important results come out of this paper. The rst is that if
the conditional probability of an unfavourable (benecial) tax change increases in some period t a monopolist
will produce a greater (smaller) amount in the periods preceding period t. The second result is that if the
constant conditional probability of an unfavourable (benecial) tax reform is increased each period, then
initial production will increase (fall). The nal result is the lower (higher) expected marginal prots are after
a tax change, the larger (smaller) the initial level of production. These results follow from the monopolist's
attempt to shift the expected burden (or gain) from an expected change in tax policy in an intertemporally
optimal manner.
Picht and Stüven (1991) modeled and empirically tested hypotheses concerning government behaviour
regarding expropriation in response to foreign capital inows. Picht and Stüven tested whether governments
aim to maximize their country's welfare (public interest hypothesis) or whether governments aim to maximize
their own welfare: in the form of increasing re-election probability or popular support. The authors note that
the costs and benets of expropriation may also be determined by the availability of substitutes for foreign
investment such as domestic capital markets and foreign credit.
The econometric model calculated the
probability of expropriation as a function of economic performance variables. The authors use a sample of 31
less developed countries for the period 1960 to 1977 and nd that average likelihood of expropriation ranged
from 51% to 69%. They nd that self-interested governments are more likely to expropriate when they are
governing during periods of poor economic performance, indicating that politically motivated expropriation
is driven by economic performance.
Konrad, Olsen and Schöb (1994) modeled the consumption, investment and extraction decision of a
dictator in a small country threatened by dierent regimes of incompletely dened property rights.
The
authors predicted that dictators with insecure property rights will save less and consume more today than
they would otherwise. This translates into faster extraction and consumption of the resource. Clark (1997)
modeled the eects of political risk on the outcome of a foreign direct investment project as the value of
an insurance policy that reimburses all losses from the political event(s) in question. Clark argues that the
cost of political risk can be measured by estimating the value of an insurance policy that would cover any
losses arising from political risk. The model predicts that the cost of political risk increases with the average
arrival rate of political events, the rate of growth of the intensity of political risk, the rate of growth of the
investment, and the level of political risk, and that the cost will decrease with the interest rate. The cost of
political risk could be considered the change in value of a resource the mine as a result of political events,
which is a very similar structure to the previous models discussed.
Bohn and Deacon (2000) modeled the eect of insecure ownership on investment and natural resource use.
The authors developed three models to determine the eect of ownership risk on investments in produced
7
capital, petroleum and forests. An ownership-risk index was estimated as a function of economic and political
factors related to expropriation risk. They found that the ownership-risk index is a highly signicant and
quantitatively important determinant of petroleum exploration, petroleum production, and changes in forest
stocks. They conclude that the relationship between natural resource use and economic growth is likely to
be resource-specic and depend critically on the capital intensity of resource extraction. Graham A. Davis
(2001) empirically estimated the credibility of the African National Congress' (ANC) threat to nationalize
South African mineral assets in the 1990s.
Davis treated the paper as a case study of the credibility of
expropriation threats and argued that it can be used as a benchmark when including political risk in applied
models of investment timing, resource extraction and land and natural resource valuation. While the ANC
threat triggered a reaction in the South African business community, Davis nds that the expropriation
threat following the ANC's election to power in 1994 was not taken to be highly credible by investors, as
the estimated expropriation probability was 1.4%.
Davis found that the value of the mines decreased by
approximately 4.8% and found no eects of expropriation on extraction levels.
Jacoby, Li and Rozelle (2002) model investment in fertilizers by farmers in rural China that face expropriation risk through uncertain land tenure. They incorporate the risk faced by farmers into an empirical model
of investment behaviour in soil quality. The conclusion of the authors is that heightened expropriation risk
reduces soil quality investment in rural China. They found that farmers living in villages where expropriation
risk is higher use organic fertilizer less intensively. This is not the case with chemical fertilizers, which are
known to have no long-lasting eects on soil quality.
Jacoby et al found probabilities that increased over
time. The median land plot had an 11% probability of expropriation occurring, given how long it had already
been held. They also found that about 20 percent of the plots had a probability of expropriation within ten
years of 95% or greater. The increasing probabilities are likely because the threat in China is ongoing.
Clark (2003) modeled a rm's cost of expropriation risk, by including the positions and incentives of
the government and the rm. Instead of treating the probability of expropriation as a random event, Clark
modeled the government's choice problem as maximizing the value of the option to expropriate, and the rm
as managing the expropriation risk. The cost of expropriation risk is treated as the value of an insurance
policy that pays o all losses from expropriation. The government's decision to expropriate is treated as a
call option. Clark found that expropriation will occur when the value of the right to expropriate is equal
to the net value to be obtained through expropriation. Once an investment has occurred, the option value
can be monitored to forecast the likelihood of expropriation. Clark argued that the model can be used to
determine optimal corporate strategy for managing investment projects. The option value can be considered
equivalent to the expropriation probability calculated by Davis, as was implied by Clark.
4 Model
In order to explore for, develop and produce natural resources, rms must rst purchase the land the resources
are upon or beneath. The willingness to pay of a rm in a competitive market for a given amount of land
should be the discounted value of expected future prots from the extraction of the resource. Reece (1978,
1979) examines this in the context of optimal bidding for oshore oil leases in the United States.
This
willingness to pay can be further complicated by uncertainty over expected prots. Uncertainty can come
in the form of future price uncertainty, uncertainty over the magnitude of future costs, or from the threat
of expropriation. First a model without uncertainty is introduced to develop a model of land value for land
with a natural resource stock.
This model is based on the explanation of optimal control theory and the
maximum principle by Dorfman (1969), but adapted to include discounting. Then the model is expanded by
adding an expropriation threat which involves a positive probability of a government expropriating the land
(and hence the resources) owned by the rm without compensation.
4.1
The Value of Land with an Exhaustible Natural Resource Stock
In a perfectly competitive market, the price a rm is willing to pay for land at an initial point
t= 0
is
the discounted present value of total prots that can be obtained from extraction of the resource. Denote
V (R, q, t)
t
as the value of land at time , where
R is the stock of reserves and q
is production of the resource.
Suppose that a rm purchases a unit of land to be developed for the extraction of a non-renewable resource.
8
In the initial purchasing period, the value of the land to the rm is
∫
T
V0 (R0 , ~q) =
e−ρt π (R, q, t) dt
(1)
0
R0 > 0 is the initial stock of reserves at t =0, ~q is the vector of production decisions over the interval
[0, T ], T is the time at which exhaustion (economic or physical) takes place, and π (·) is net prots. Prots are
Here,
a function of reserves, production, and exogenous prices and costs. Prices and costs are exogenous because
of the assumption of perfect competition. The resource stock evolves according to
Ṙ =
dR
= f (R, q, t)
dt
(2)
We abstract from the idea of exploration and assume that the rm has only the initial resource stock
R0 .
Note that production decisions taken at any point in time inuence the rate at which prots are earned and
inuence the rate at which the resource stock is changing, and therefore the resource stock at subsequent
instances of time. We also assume that the size of the resource stock is known with certainty. Generalized
t
to period , the value of the land to the rm is
∫
T
V (Rt , ~q, t) =
e−ρτ π (R, q, τ ) dτ
(3)
t
t
Let d
of
qt
over
be a short time interval beginning at time
(t,t +dt)
t;
so short that the rm would not change its choice
even if it could. Following the methodology in Dorfman the value of land becomes the
t
sum of two parts. The rst is prots over the interval d , which are determined by
discounted prots from period
t +dt
to period
T.
∫
T
Rt
and
qt .
The second is
e−ρτ π (R (τ ) , q, τ ) dτ
Vt (Rt , ~q, t) = π (R, qt , t) dt + (1 − ρdt)
(4)
t+dt
The rst-order Taylor series expansion of
e−ρt
about
t =0 over the interval dt is 1−ρdt, yielding the additional
discount term in equation (4). If there was no discounting, i.e.,
∫
ρ = 0,
then (4) would be
T
Vt (Rt , ~q, t) = π (R, qt , t) dt +
π (R (τ ) , q, τ ) dτ
t+dt
as in Dorfman. Equation (4) can be written in this way because
qt
is assumed to be xed over the interval
(t,t +dt), and is allowed to vary from t +dt to T. Equation (4) states that if the amount of reserves available
at time t is R and if the production policy ~
q is followed from then on, then the value of the land from period
t onwards consists of two parts:
1. The rate at which prots are earned during d
t
t
multiplied by the length of the interval d . This depends
on the current reserve stock, the time period, and the current value of the decision variable,
2. The value of the integral at
starting at
R (t).
t +dt.
t +dt,
discounted by
1 − ρdt,
which is precisely the same as in (3), but
The dierence is that the integral in (4) has a starting reserve stock of
t
The reserve stock changes over the interval d
qt .
in a manner determined by
R (t + dt),
not
qt .
We can use the fact that the integral in (4) has the same form as in (3) to write
V (Rt , ~q, t) = π (R, qt , t) dt + (1 − ρdt) V (Rt+dt , ~q, t + dt)
t
(5)
Now suppose that the rm makes the optimal choice of ~
q from period onwards. That is, at each period
τ ∈ [t, T ] the optimal qτ? is chosen. The value of land that results from this optimal choice of ~q can be denoted
?
as V (·), where
V ? (Rt , t) = maxV (Rt , ~q, t)
(6)
{q}
9
Note that
V ? (·)
~q
does not have
as an argument because it has been maximized out. The maximum value
that can be obtained beginning at date
t
R
with reserves
~q
does not depend on
obtained with those conditions from the best possible choice of
Now suppose that the production choice designated by
qt
q
but is the value that can be
in each period.
t
is followed in the short time interval from
t +dt, and that thereafter the best possible production policy is followed.
to
By equations (5) and (6), the result
of this can be written as
V (Rt , qt , t) = π (Rt , qt , t) dt + (1 − ρdt) V ? (Rt+dt , t + dt)
(7)
t
plus
R (t + dt).
The
The results of following such a production plan are the benets that accrue during the initial period
the maximum possible prots that can be realized starting from date
stock of reserves at
t +dt
with reserves
t
results from the decision taken in the initial period .
To nd the optimal choice of
zero:
t +dt
qt ,
V (Rt , qt , t)
dierentiate
from (7) with respect to
qt
and set it equal to
∂π (Rt , qt , t)
∂V ? (R (t + dt) , t + dt)
dt + (1 − ρdt)
=0
∂qt
∂qt
However,
V ? (·)
does not involve
qt
(8)
explicitly, and should be written as
∂V ? (R (t + dt) , t + dt)
∂V ? (R (t + dt) , t + dt) ∂R (t + dt)
=
·
∂qt
∂R (t + dt)
∂qt
As d
t
is a very short time interval,
R (t + dt)
can be approximated as
R (t + dt) ∼
= R (t) + Ṙdt
That is, the amount of reserves at
during the interval
(t, t + dt)
t +dt
is equal to the reserve stock at
t
plus the rate of change in reserves
multiplied by the length of the interval. Therefore,
∂R (t + dt)
∂ Ṙ
∂f (R, q, t)
=
dt =
dt
∂qt
∂qt
∂qt
t
t
∂V ? (R(t+dt),t+dt)
is the rate at which the maximum possible prot from time +d
∂R(t+dt)
onwards changes with respect to the amount of reserves available at time +d . It is therefore the marginal
By equations (1) and (6),
t
t
value of reserves at time t +dt. Denote the marginal value of reserves at time t by λ (t):
λ (t) =
So we have
∂V ? (R, t)
∂R
∂f (R, q, t)
∂V ? (R (t + dt) , t + dt)
= λ (t + dt) ·
dt
∂R (t + dt)
∂qt
Inserting this result into (8) we have
∂π (Rt , qt , t)
∂f
dt + (1 − ρdt) λ (t + dt)
dt = 0
∂qt
∂qt
The marginal value of reserves,
λ (t),
(9)
changes gradually over time, and can be approximated as
λ (t + dt) ∼
= λ (t) + λ̇ (t) dt
That is, the marginal value of reserves at time
is changing during the interval
(t, t + dt)
t +dt
is the marginal value at
t
plus the rate at which it
multiplied by the length of the interval. Therefore, equation (9)
t
becomes, after canceling the common element d ,
[
]
∂π (Rt , qt , t)
∂f
∂f
+ (1 − ρdt) λ (t)
+ λ̇ (t)
dt = 0
∂qt
∂qt
∂qt
10
t
Now allow d
to approach zero. The third term becomes very small, as does
ρdt,
so we have
∂π
∂f
+ λ (t)
=0
∂qt
∂qt
Suppose that
qt
qt
is chosen to satisfy the above. So
V ? (R, t):
is the optimal choice, and
V (Rt , qt , t)
will equal its
maximum possible value,
V ? (R, t) = π (Rt , qt , t) dt + (1 − ρdt) V ? (R (t + dt) , t + dt)
The optimal value of land
around
where
t =0 as
VR?
V ? (·)
at
t +dt
(10)
can be approximated using a rst-order Taylor series expansion
V ? (R (t + dt) , t + dt) ∼
= V ? (R (t) , t) + V̇ dt + VR? Ṙdt
is the derivative of
terms yields
V?
R.
with respect to
Substituting this into equation (10) and canceling like
[
]
ρV ? (R, t) = π (Rt , qt , t) + (1 − ρdt) V̇ + VR? Ṙ
Evaluating the above as
dt → 0
and rearranging yields
V̇ = −π (Rt , qt , t) + ρV ? (R, t) − VR? f (R, qt , t)
(11)
The above equation denes how the value of land changes as a function of prots in each period, the optimal
value of land in each period, and the change in reserves in each period. Equation (11) can be used as the
basis for an estimating equation for the change in the value of land with a natural resource stock.
4.2
The Value of Land with Uncertainty
Now suppose that there is some positive probability that the land owned by the rm will be expropriated
by the government in each period
time
t. F (t)
t.
Dene
F (t)
as the probability that the land will be expropriated by
is the cumulative probability density function of expropriation occurring. The instantaneous
probability of expropriation, given that expropriation has not occurred yet, is
h (t) =
h (t),
where
F 0 (t)
1 − F (t)
as in Kamien and Schwartz (1971a). The key feature of this is that
t
h (t) dt
is approximately the probability
of expropriation occurring in the next increment of time d , given that expropriation has not occurred at
t
time . The price a rm is willing to pay for a unit of land at
∫
V0 (R0 , ~q) =
T
t =0 is now.
e−ρt Et [π (R, q, t)] dt
(12)
0
where
Et [π (·)] = F (t) πE (R, q, t) + (1 − F (t)) πN (R, q, t). Here, πE (·) denotes prots after expropriation
πN (·) denotes prots without expropriation. As in Section 4.1, R0 is the initial resource
π (·) is net prots, and ρ is the discount rate. The equation of motion for the resource stock is as
has occurred, and
stock,
before, in equation (2). So equation (12) becomes
∫
T
V0 (R0 , ~q) =
e−ρt [F (t) πE (R, q, t) + (1 − F (t)) πN (R, q, t)] dt
(13)
0
t
Generalizing to period , equation (13) can be written as
∫
V (Rt , ~q, t) =
T
e−ρτ [F (τ ) πE (R, q, τ ) + (1 − F (τ )) πN (R, q, τ )] dτ
t
11
(14)
t
Again, let d
of
qt
be a short interval of time beginning at time
over the interval
(t,t +dt)
∫
Vt (Rt , ~q, t)
t
such that the rm would not change its choice
even if it could. So equation (14) becomes
T
e−ρτ πE (R (τ ) , q, τ ) dτ
= π (R, qt , t) dt + (1 − ρdt) h (t) dt
∫
(15)
t+dt
T
e−ρτ [F (τ ) πE (R (τ ) , q, τ ) + (1 − F (τ )) πN (R (τ ) , q, τ )] dτ
+ (1 − ρdt) (1 − h (t) dt)
t+dt
The above equation states that if expropriation has not occurred by time
available at time
t
is
R
and the production policy
t,
and the amount of reserves
~q
is followed from then on, then the value of the land to
t
multiplied by the length of the interval. This depends
the rm consists of three parts:
1. The rate at which prots are earned during d
on the current reserve stock, the time period, and the current value of the decision variable
qt .
2. The second term is the discounted value of future prots after expropriation occurs multiplied by the
t
t
probability of expropriation occurring over the interval d , conditional on not being expropriated at .
3. The discounted value of the integral at
an additional
1 − h (t) dt
t
t +dt,
as in equation (4). Notice that now the expression has
multiplying it. This is the probability that the land is not expropriated over
t
the interval d , given that it had not been expropriated at .
For simplicity, we assume that expropriation when it occurs is full, and without compensation. This means
that the rm no longer owns the land, and hence the resources, giving
π (R, q, t)
t
πE (R, q, t) = 0.
Let
πN (R, q, t) =
for all . These assumptions simplify equation (15) substantially, leaving us with
∫
T
e−ρτ [(1 − F (τ )) π (R (τ ) , q, τ )] dτ
Vt (Rt , ~q, t) = π (R, qt , t) dt + (1 − ρdt) (1 − h (t) dt)
(16)
t+dt
We can use the fact that the second integral in (15) has the same form as equation (14), as well as the
simplications shown in (16) to write
V (Rt , ~q, t) = π (R, qt , t) dt + (1 − ρdt) (1 − h (t) dt) V (Rt+dt , ~q, t + dt)
As in Section 4.1, assume that the rm chooses
period
t +dt
qt
in period
t,
(17)
and makes the optimal choice of
~q
from
onwards. By equations (6) and (17), the result of this production path can be written as
V (Rt , qt , t) = π (R, qt , t) dt + (1 − ρdt) (1 − h (t) dt) V ? (Rt+dt , t + dt)
(18)
t, plus the maximum
t +dt, given that expropriation has not occurred, with
The result of following such a production plan are the prots that accrue in period
possible expected prots that can be realized at time
a reserve stock of
with respect to
qt
R (t + dt).
To nd the optimal choice of
qt ,
dierentiate
V (Rt , qt , t)
from equation (18)
and set it equal to zero:
∂π (R, qt , t)
∂V ? (R (t + dt) , t + dt) ∂R (t + dt)
dt + (1 − ρdt) (1 − h (t) dt)
·
=0
∂qt
∂R (t + dt)
∂qt
As before, we approximate
R (t + dt)
using
R (t + dt) ∼
= R (t) + Ṙdt.
As only
Ṙ
is a function of
(19)
q, this yields
∂R (t + dt)
∂ Ṙ
∂f (R, q, t)
=
dt =
dt
∂qt
∂qt
∂qt
∂V ? (·)
is the rate at which maximum possible
∂R
expected prot changes with respect to the resource stock available, and is therefore the marginal value of
Furthermore, we know from equations (6) and (12) that
reserves, which was dened as
λ.
So we can write equation (19) as
∂π (R, qt , t)
∂f
dt + (1 − ρdt) (1 − h (t) dt) λ (t + dt)
dt = 0
∂qt
∂qt
12
(20)
The marginal value of reserves changes gradually over time, and is approximated using
λ̇ (t) dt.
So the marginal value of reserves at time
t
changing over the interval from
to
t +dt.
t +dt
is the marginal value at
t
λ (t + dt) ∼
= λ (t) +
plus the rate at which it is
t
After cancelling the common element d , equation (20) becomes
[
]
∂f
∂f
∂π (R, qt , t)
+ (1 − ρdt) (1 − h (t) dt) λ (t)
+ λ̇ (t)
dt = 0
∂qt
∂qt
∂qt
t
Now allow d
to approach zero. The third term becomes very small, as do
ρdt
and
h (t) dt.
So we have
∂π
∂f
+ λ (t)
=0
∂qt
∂qt
Suppose that
qt
is chosen to satisfy the above. So
V ? (R, t):
qt
is the optimal choice, and
V (Rt , qt , t)
will equal its
maximum possible value,
V ? (R, t) = π (Rt , qt , t) dt + (1 − ρdt) (1 − h (t) dt) V ? (R (t + dt) , t + dt)
Note that because
qt
is chosen optimally, we allow production to change in response to the expropriation
V ? (·) at +d can again be approximated using a rst-order Taylor series
t
threat. The optimal value of land
expansion around
(21)
t =0 as
t
V ? (R (t + dt) , t + dt) ∼
= V ? (R (t) , t) + V̇ dt + VR? Ṙdt
Substituting this approximation into equation (21) yields
]
[
V ? (R, t) = π (Rt , qt , t) dt + (1 − ρdt) (1 − h (t) dt) V ? (R (t) , t) + V̇ dt + VR? Ṙdt
Evaluating the above as
dt → 0
and canceling like terms gives
(ρ + h (t)) V ? (R, t) = π (Rt , qt , t) + V̇ + VR? Ṙ
Rearranging the above equation, we can nd an expression for
V̇ ,
the change in the value of a unit of land,
as a function of prots, land value and the change in reserves:
V̇ = −π (Rt , qt , t) + (ρ + h (t)) V ? (R, t) − VR? Ṙ
Under perfect information,
h(t)
(22)
will be the actual probability of expropriation occurring. If the rm lacks
information, or has beliefs that are biased in any way, then the expropriation probability
perceived
h(t)
will be the
probability of expropriation. Equation (22) can be used to specify an estimating equation that can
identify the probability of expropriation,
h(t),
occurring over the interval
h(t)
(t,t +dt).
This is a key feature of
the model, and is possible because the parameters ρ and
are additively separable. By comparing the
?
estimated coecient on V (R, t) in a period when there is an expropriation threat to a period when there
is no perceived threat, the probability of expropriation,
h(t),
can be identied.
The methodology will be
further explained in Section 5.
5 Empirical Specication
The nal equation in Section 4.2 is simple, and can be adapted to provide an empirical specication that
allows the identication of an expropriation probability. It is important to note, however, that because any
estimation of an expropriation probability is based on the rm's willingness to pay, and hence its beliefs
about the probability of expropriation, that the estimated probability will be a
perceived
probability. The
true probability will always be unknown, but in some sense, the perceived probability is more interesting, as it
is the market-based probability of expropriation. In developing equation (22) into an empirical specication,
?
the parameters ρ, h (t), and VR become coecients to be estimated. We assume that
=0 when there is
no presence of an expropriation threat by the government. As such, in order to model this reality properly in
h(t)
13
an econometric setting, this requires the use of a dummy variable which is one when there is a threat present,
and zero if there is not. Equation (22) becomes
V̇it = −πit + ρVit + h (t) (Dt ∗ Vit ) − VR Ṙit + εit
Here,
t
D
(23)
is the dummy variable representing the presence of an expropriation threat, and
indexes time. The change in the value of land,
V̇it ,
is equal to
Vi,t − Vi,t−1 .
i
indexes rms and
Prots can be approximated
using a translog function, or some other suitable general functional form. Davis (2001) approximates prots
by calculating
(P − AC) ? Q.
Notice that the perceived expropriation probability,
h,
is still a function of
time, rather than a xed parameter.
A simplifying assumption that can be made is to assume that the cumulative probability density function
F (t) = 1 − e−ht , so that h(t) simplies to h (t) = h. The coecient for the
of expropriation occurring is
probability of expropriation to be estimated is now a xed parameter, and equation (23) is very easy to
25 If an assumption about the form of
estimate, given the appropriate data.
derive a functional form for how
h (t)
depends on time. Estimating
F (t) is not made, then we cannot
h(t) without restricting it to be constant
would require assuming that (23) is the reduced form of a system of equations, and
Dt ∗ Vit
is a function of
all the variables of interest, including time.
The value of an asset such as a mine or a pool of oil is a function of current prices, costs and production,
as well as future prices and costs, and future production, which depends on the current reserve levels. Being
able to directly estimate the loss in asset value as a result of an expropriation threat, let alone calculate the
expropriation probability, requires very specic data. In any politically unstable environment, it is dicult
to nd accurate data. In a developing country, few resources are devoted to data collection, posing further
problems for this research path. The ideal data set would involve information on the value of a unit of land
in each period. This could be approximated by the market value of the rm, if the rm owns a single asset,
as in Davis (2001). A dierent approximation would use a panel of rms, and use the value of dierent units
of land purchased by the same rm. However, this requires assuming that all units of land have the same
characteristics, which is a strong assumption to make.
The model developed in Sections 4.1 and 4.2 abstracted from the possibility of exploration creating
additional reserves, and assumed that only extraction aected reserve levels.
Ṙ = −qt and only data
then Ṙ will depend on
assumption,
is relaxed,
production.
If keeping strictly to this
on production is required to estimate equation (23). If that assumption
reserve additions through exploration and reserve depletions through
If this is the case, then information on reserves is required to estimate (23).
For the prot
function to be correctly specied, information on the resource price and production costs must be readily
available, as well as the quantity of the resource produced.
For simplicity we assume that changes in reserves are strictly a function of production, and not of exploration. Adding the possibility of exploration will complicate the model and the resulting estimating equation.
So, we have
Ṙ = −qt .
A further simplifying assumption is with regard to the functional form of the prot
function. There is only one output, the production of the resource. Implicitly, prots were taken as given
in the models developed in Section 3. We have assumed an (exogenous) world price for the resource, and
exogenous costs of extraction, in the sense that the rm can only vary cost by varying production. Prots
for rm
i
πi = (p − ci ) · qi ,
p
ci
is the rm-specic
V̇it = α0 + β0 (pt − cit ) · qit + β1 Vit + β2 (Dt ∗ Vit ) + β3 qit + γX + εit
(24)
take the form
where
is the exogenous world price, and
marginal cost of production. With these assumptions, equation (23) becomes:
where X is a vector of provincial and time-specic control variables. From the model developed in Section 4.2,
the signs of the coecients should be
of an expropriation threat,
β2 = 0
β0 < 0, β1 > 0, β2 > 0,
and
β3 > 0.
Note that without the presence
As β1 is interpreted as
0 < β1 < 1. The coecient β2 is the
0 < β2 < 1. The total required rate of return
with the other coecients unchanged in sign.
the discount rate for rms, or the required rate of return, we expect
expropriation probability or risk premium, requiring that
during the threat period is
25 The
β1 + β2 .
choice of this cumulative probability density function imposes a constant hazard rate. Future work will involve relaxing
this to allow for non-zero duration dependence. This allows
h(t) to vary with time.
14
6 The Data
The market value of land purchased by a rm for the purpose of natural resource production would ideally be
observed from actual market transactions by rms. Market values of oil rms in Alberta and Saskatchewan
would be dicult to use for this sort of exercise as large rms would have had investments and interests in
other nations. In addition, any between-rm sales of land may involve dierent geographical areas, making
the value of a specic tract of land dicult to determine. To compound these diculties, rm-specic data
is unavailable for the time period in question. In this data set, the value of a unit of land is proxied by yearly
expenditures in a province by the petroleum industry on land. Land leases and the petroleum and natural
gas rights associated with the leases are auctioned by the provincial governments in a rst-price, sealed bid
auction. In Alberta, the auctions occur, on average, 24 times per year. In Saskatchewan, the auctions occur
six times per year.
We dene the threat period in which the perceived probability of expropriation in Saskatchewan was
positive as the period from 1944 to 1952. We choose 1952 as the cut-o point because it was near the end
of 1952 that the legal proceedings against the Saskatchewan government by Canadian Pacic Railway were
resolved. Prior to 1948, the CCF government was not clearly disavowing its nationalizing interests. However,
if the threat period was dened as 1944 to 1948, we would be limited by the few observations in this threat
period denition, as the data set begins in 1947. Further, this period coincides with the period during which
there had been no oil discoveries in Saskatchewan which would make it dicult to determine if the eect
arose from the expropriation threat or just the higher risk that there would be no oil to nd. We explore
an alternative specication for the threat period, which would be for the period where the CCF government
held power in Saskatchewan, from 1944 to 1964.
26 We choose this denition of the threat period since the
historical literature on this topic infers that the CCF's nationalization rhetoric and policy actions of its rst
term left a lasting reputation for the government. To strengthen our possibility of identifying the threat of
expropriation in Saskatchewan, we also include observations for the Province of Alberta where we assume
that Alberta was a jurisdiction recognized by oil companies as absent of a risk of expropriation.
Vit
The variable
is the value of a unit of land. It is approximated by the value of annual expenditures on
land by the petroleum industry in province
i
in year
t.
in order to get a per unit measure of the value of land.
value. The term
(pit − cit ) · qit
V˙it
t
is the change in this
i at time t, where pit is the
qit is aggregate production.
is aggregate prots for the oil industry in province
28 price of crude oil,
province-specic
We divide this value by reserve additions in year
27 The dependent variable,
cit
is the average cost of production, and
The dummy variable for the threat period,
Dit
, is interacted with
Vit
in order to determine the perceived
expropriation probability.
The Canadian Association of Petroleum Producers (CAPP) publishes detailed information on the Canadian petroleum industry in its
Statistical Handbook.
The data are collected through company surveys, and
CAPP intends them to provide a historical summary of the petroleum industry's progress. For most variables of interest in our study there are annual data for 1947 to 2006, including prices of crude oil per cubic
metre; expenditures on exploration, development, operations, land and royalty payments; volume of production; and several measures of reserves. The data is reported by province and geographical area.
29 Table 1
contains summary statistics and variable denitions for the model. The data set consists of observations for
Alberta and Saskatchewan from 1947 to 2006 giving a total of 120 annual observations. Once the dependent
variable,
V˙it ,
26 Tommy
is calculated, the data set reduces to 118 observations.
Douglas resigned as Premier in 1961 to found the New Democratic Party of Canada, a coalition of the federal CCF
party and the Canadian Labour Congress. In 1964, the CCF government under Woodrow S. Lloyd was defeated by the Liberals.
The Saskatchewan CCF subsequently renamed itself as the Cooperative Commonwealth Federation, Saskatchewan Section of
the New Democratic Party of Canada. In 1967, the party dropped the CCF label, becoming the Saskatchewan New Democratic
Party (NDP). The NDP returned to power in 1971 under a program of nationalizing natural resources, stating that it would
give rst priority to public ownership in the form of Crown corporations, and where feasible the government would reclaim
ownership and control of foreign owned resources.
(New
Deal for People, 1971). To this end, several Crown corporations
were founded to develop Saskatchewan's oil, natural gas, potash and mining industries. (Saskatchewan Encyclopaedia, Crown
Corporations.)
27 The (average) price of land per hectare is only available from 1955 onwards, and so cannot be used for this study.
28 Provincial prices dier because of dierences in quality, transportation costs, and distances from markets.
29 The geographical areas are British Columbia, Alberta, Northwest Territories, Saskatchewan, Manitoba, Ontario,
Eastern
Canada and East Coast Oshore. The exception to this is the data on production, which only includes New Brunswick and
Ontario in Eastern Canada. The reserves data disaggregates the Northwest Territories into regions (Arctic Isles, Beaufort Sea
and McKenzie Delta), but the production data does not.
15
The data on reserves usable for the purpose of this paper are the remaining established reserves at year
30 Government reports from the provinces of Alberta and Saskatchewan were used to determine reserve
end.
levels from 1945 to 1961. Data on Alberta's reserves (1948 - 1967) are from the Oil and Gas Conservation
Board Report 68-18. The reserve observations for 1945 - 1947 are from Hanson (1958). His source for reserves
information was the Petroleum and Natural Gas Conservation Board, the previous incarnation of the Oil and
Gas Conservation Board. For Saskatchewan, reserves data (1953 - 1963) are from the Saskatchewan Petroleum
and Natural Gas Statistical Yearbooks 1900 - 1959, 1960, 1961, 1962 and 1963. The rst ocial report of
Saskatchewan's reserves was in the 1952 Annual Report of the Department of Natural Resources.
Prior
to that, Saskatchewan had relatively few producing wells and elds, making reserves dicult to estimate.
Reserves for the period 1945 - 1952 in Saskatchewan were approximated by letting reserves equal production.
Average wellhead price in each province is available from CAPP from 1951 to 2006. Prior to 1951, we use
31 We convert
the Edmonton par price in current dollars per barrel from the Historical Statistics of Canada.
price per barrel to price per cubic metre with the conversion factor being 6.292 barrels per cubic metre. Data
for the Toronto Stock Exchange 300 Composite Index are from the Historical Statistics of Canada (1956 1977), Series J4819 through J494 and CANSIM II, series V122620 (1977 - 2006).
32 All current dollar values
are deated to constant 1947 values using the consumer price from CANSIM II, series V737344 with a base
33
year of 2001.
Production and reserve data from CAPP are reported in thousands of cubic metres, which were adjusted
to cubic metres.
Reserve data for both provinces prior to 1963 are reported in millions of barrels, which
we convert to cubic metres. Cost data includes annual industry expenditures by province, for exploration,
development, operations, and royalties in millions of current dollars, but does not include specic extraction
costs.
We approximate the total cost of production as operating expenditures plus royalty expenditures.
Exploration and development expenditures are a xed cost, while royalty and operational expenditures are
variable. Average cost of production is calculated by dividing total cost by annual production. This can be
considered the working costs for oil production, but the cost information is for the entire petroleum industry,
which includes oil and natural gas. This means that the average cost calculated is higher than the actual
average cost per cubic meter of oil produced.
The dummy variable for Saskatchewan,
Si ,
captures the average dierence in the value of land sales
in Saskatchewan compared to Alberta after controlling for the quantity and protability of oil reserves.
Interacting the dummy variable for Saskatchewan with land value,
Vit ,
reveals the dierence in the risk-free
rate of return between Saskatchewan and Alberta. We also include several variables to account for policies
and events that likely impacted the petroleum sector in Saskatchewan and Alberta.
The eect of royalty
renegotiation in Alberta under Premier Lougheed (1971 - 1972) is controlled for using a dummy variable.
30 The
34
data on reserves includes initial volume in place by year of discovery (1947 - 2006) and geological age (as of December 31
2005), yearly production (1947 - 2006), initial established reserves by year of discovery (1947 - 2006), and remaining established
reserves at year-end (1962 - 2006), and reserve additions.
CAPP denes initial established reserves as established reserves
before production; remaining established reserves as initial established reserves minus cumulative production; and cumulative
production as production of oil/gas to date. Initial established reserves by year of discovery credits additional discoveries or
reserve additions in a given oil pool in subsequent years back to the year of the initial discovery. As such, the data would not
reect the actual knowledge of the oil industry at the time of the land sales and could not be used to determine its investment
decisions.
31 This comes from dividing total
32 For the years prior to 1956, a
value produced (Series Q20) by quantity produced (Series Q19)
rough estimate of the stock index was created by averaging the stock indices for Mines,
Industrials, Banks and Utilities from the Historical Statistics of Canada, Series J490 through J493. The base year used was
1947, with the index in 1947 equal to 100.
33 The CPI was converted into a 1947 base year by dividing all values by the CPI entry for 1947 and then multiplying by 100.
34 When he became Premier of Alberta in 1971, Peter Lougheed was able to enact radical changes to Alberta?s royalty structure
so that Alberta could capture a greater share of resource rent. Lougheed unilaterally re-wrote Alberta's royalty policies to capture
more of the resource rents, and aggressively developed a public presence in the resource industry. Soon after the election of
his Conservative government, Lougheed set to work to increase the royalty rate in place during the 36-year reign of the Social
Credit party. Eort was made to maintain the sanctity of the original contract agreed to by the Social Credit government of
1949 by changing the maximum royalty rate only on remaining oil reserves. This had the eect of raising the royalty rate to
23% of gross production. Dramatic increases in oil prices following the rst OPEC price shock would soon cause the government
to abandon this agreement and tie royalties to the price of oil. Weir (2003) calculates that between 1975 and 1982, Alberta's
eective royalty rate averaged 31%.
With the eects of the 1980 National Energy Program and declining world oil prices,
royalty rates fell to an average of 23% between 1983 and 1991 and to an average of 17% from 1992 to 2000. Saskatchewan also
increased royalty rates after the OPEC oil shock. The NDP government of Allan Blakeney in Saskatchewan had a mean annual
eective royalty rate of 38% between 1975 and 1982, 23% from 1983 to 1991 and 18% from 1992 to 2000. Lougheed's activist
approach was criticized by pro-free enterprise conservatives in Alberta as his government promoted ownership in companies
16
A dummy variable from 1975 - 1982 captures the eect of Premier Blakeney increasing royalty rates in
Saskatchewan relative to Alberta. The Toronto Stock Exchange Composite 300 Index is included, to pick up
economy-wide eects and economic changes over time. The remaining dummy variables account for federal
policy regimes and the eect of OPEC on the petroleum industry in Canada.
Oil production was prorationed in Alberta from 1949 until 1973 since the capacity of the province to
produce exceeded the level of demand for oil (Hanson, 1958). Two federal programs were the National Oil
Policy (1961 - 1972) and the National Energy Program (1980 - 1982).
The National Oil Policy (NOP)
guaranteed a market for western-produced oil at a price that was higher than the world price, and was
guarded against competition from cheaper oil (Doern and Toner 1985, 81). The National Energy Program
(NEP) kept oil prices in Western Canada below the world market price from late 1980 to 1982. The formation
of OPEC (1973) was also likely to have had an eect on investment in Alberta and Saskatchewan. To reect
the structural the changes within the OPEC era, two dummy variables were used for the periods 1973 - 1985
and 1985 - 2004. From 1973 to 1985, the OPEC cartel's prorationing agreement increased the world price of
oil. In 1985, the agreement was broken, leaving the OPEC members free to produce at capacity, driving the
world price down.
7 Empirical Analysis
We estimate the model for the value of land given by equation (24), with the addition of the variables
mentioned to control for exogenous political and economic events.
(24), the coecient
β2
From the model specied in equation
is the risk premium associated with the Cooperative Commonwealth Federation. The
estimated coecients for the full data set are reported in Table 2, where the change in aggregate expenditures
on land per cubic meter of reserve additions is the dependent variable.
Columns 1 and 2 show results when the dummy for the threat period (1947 - 1952) is interacted with the
value of land. Recall that the value of land is approximated by aggregate expenditures per cubic meter of
reserve additions. Columns 3 and 4 use a dummy variable for the entire period the CCF was the government
of Saskatchewan interacted with the value of land to show the full risk premium associated with the CCF.
Columns 1 and 3 report results for the simplied model without the exogenous controls for political events.
The constant in Table 2 can be interpreted as the growth rate of the value of land over the period 1947 to
2006. In all cases, it is positive but small in magnitude and not statistically signicant from zero. The dummy
variable for Saskatchewan captures the dierence in the growth rate relative to Alberta. These coecients
indicate the growth rate of expenditures per cubic meter is positive for Alberta, and lower for Saskatchewan.
When the political controls are included, the growth rate becomes negative for Saskatchewan.
The coecient on the value of land is positive and statistically signicant, but has an unexpected magnitude. A coecient greater than one implies the required rate of return in Alberta was over 100%. The
required rate of return in Saskatchewan is lower compared to Alberta, and when controls were added, was
negative. This result suggests that expenditures per cubic meter is not an acceptable proxy for the value
of land. The reason for this is that there are two margins for adjustment in this measure. Both price per
unit and the quantity of land sold can adjust in response to a perceived expropriation threat. As we cannot
identify which change, aggregate expenditures on land cannot be used to measure the value of land. This is
further corroborated by the coecient for the eect of the CCF on land value. It is negative, the opposite
sign from what was predicted. This yields a negative risk premium, which is contrary to the assumptions of
the model. If one ignores the interpretation of a risk premium, and only considers the sign of the coecient,
the CCF reduced the change in expenditures, suggesting that expenditures on land were lower relative to the
post-CCF period. However, once the control variables are included, the coecient becomes positive, though
relatively large in magnitude, and is not statistically signicant.
This suggests that the control variables
are important for removing confounding factors. The coecients on prots and change in reserves are also
the opposite sign from what was predicted. The results from Table 2 indicate that further work is required
with the data. A dierent measure of land value must be used before any sensible conclusions can be made
that competed with existing and ourishing private rms in the economy. Perhaps anticipating this criticism, two days after
he was elected Lougheed declared that We stand for free enterprise - not socialism. We stand for social reform and individual
rights - not big government control. (Alberta
in the Twentieth Century, Volume 11, 49). Lougheed also emphasized in 1975
that Alan Blakeney's NDP government?s participation in the economy made Lougheed's own government look laissez-faire in
comparison. (Alberta
in the Twentieth Century, Volume 11, 57).
17
about the eect of the Cooperative Commonwealth Federation on the development of the natural resources
industry in Saskatchewan.
As a benchmark for evaluating the model, we now use the average price of land per hectare in each
province as the proxy for the value of land. All other variables remain the same. As data for the per hectare
price of land begins in 1955, this cannot be used to examine an expropriation threat. However, it can be used
to test the validity of the model with the available data, as well as any lingering eects of the Co-operative
Commonwealth Federation government. The results for these regressions are reported in Table 3. Columns
1 and 2 show results when the dummy variable for the CCF is interacted with the value of land, price per
hectare. Column 2 includes the control variables. Columns 3 and 4 show results when the dummy variable
for the CCF is interacted with the value of land only in 1965. This is the year following the election where the
Liberal Party became Saskatchewan's government, and indicates the change in the risk premium as a result
of the end of the CCF era.
and economic eects.
Column 4 includes the variables intended to control for exogenous political
As the model specication in (24) is essentially a dierences equation, the dummy
variables are equal to one only in the period where the political event started (i.e., OPEC). This enables us
to determine the one-time level eect on the growth rate of land value.
In these regressions, all coecients specied by the model are of the expected sign and magnitude. The
constant term indicates that the average price per hectare has been declining over time, with the decline
occurring at a lower rate in Saskatchewan.
The required rate of return is estimated to be 16%, which
increases to 30% when political controls are included. This indicates some of the exogenous events increased
the protability of the resource sector, and hence decreased the required rate of return. It is important to note
that the required rate of return is signicant only when controls are included, indicating their importance
for removing confounding factors.
This also indicates the presence of noise in the data.
There dierence
between the rate of return in columns 2 and 4 can be attributed to the gradient and level eects.
The
dummy variables in column 4 show the level eect of a given change as a result of political events, while
column 2 shows the change over the entire period of each event. The coecient on the interaction of the
Saskatchewan dummy with the value of land allows us to distinguish between the risk-free rate of return in
Alberta and in Saskatchewan. The coecient is negative, small in magnitude and not statistically signicant,
indicating that the risk-free rate of return is similar for the two provinces over the time period.
The coecient for the eect of the CCF on land price is positive, but not statistically signicant. The
large magnitude of the coecient suggests there was an eect of the CCF government, but we are unable to
reliably determine it's magnitude. In comparing columns 1 and 3, we see that the risk premium declined by
over 10% once the CCF were no longer the government. The similarity between the coecient in columns
2 and 4 is interesting, suggesting that controlling for other factors eliminates the decrease in risk. However,
since the eect associated with the CCF is not statistically signicant from zero, conclusions as to the size of
the risk premium should bear this in mind. An alternative explanation for the magnitude of the risk premium
is that because of the CCF policies, land in Saskatchewan had a lower value compared to Alberta, and hence
only the relatively riskless leases (in terms of the probability of nding oil) were purchased. The quality of
the leases would yield a high rate of return relative to Alberta and the post-CCF period with more lease
purchasing occuring in Saskatchewan.
The coecients on prots and the change in reserves are of the expected sign, but not statistically
signicant, are small in magnitude and have limited economic signicance. It is possible that these variables
have such a small eect because production relative to the aggregate resource stock levels is small.
The
coecients on the control variables are signicant, with the exception of the National Oil Policy dummy,
the Lougheed dummy, the Blakeney dummy in column 4 and the rst OPEC dummy in column 2. The sign
on the National Oil Policy coecient was positive, an expected result as the NOP guaranteed a market for
western oil. The negative sign on the National Energy Program coecient is also expected, because the NEP
kept the price of oil below the world price. The sign for the rst OPEC dummy is negative in column 2 and
positive in column 4, suggesting that the incidence of OPEC had a positive eect on the change in the value
of land, but overall had a negative eect. The coecient on the second OPEC dummy is negative in both
columns 2 and 4, suggesting that the end of OPEC's prorationing agreement had a negative eect overall.
The reversal of signs on the Lougheed and Blakeney coecients is unexpected, as increased royalty rates
were expected to have a negative eect on willingess to pay and hence on the change in land value.
18
7.1
Other CCF Impacts on Natural Resource Development
The results displayed in Table 2 are inconclusive regarding a credible threat of expropriation associated with
the CCF government in Saskatchewan, though the results from Table 3 indicate there was a positive risk
premium. It is possible, however, that the CCF had other economic eects on the development of the oil
and gas resources in the province, and on the wealth of the province. Following Bohn and Deacon (2000), we
estimate linear models to explain exploration and development activity measured by wells drilled per year
and annual oil production.
Variable denitions and summary statistics are presented in Table 4 and the
estimated coecients for the models specied in (25) and (26) below are presented in Table 5.
It may be the case that expropriation risks not only aect reserve values, but as Bohn and Deacon argue,
exploration and development of resources may also be aected. The purpose of this model is to isolate the
political eects of changes in parties and party leaders on exploration decisions made by rms in Alberta and
Saskatchewan. Exploration and development intensity is approximated by the number of wells drilled. The
model takes the form:
log (wells)it
= αi + β0 CCFit + β1 N DPit + β2 SCit + β3 Liberalit + γ0 log (price)t
+γ1 log (avgDepth)it + γ2 t + δ0 Lougheedit + δ1 Blakeneyit
+δ2 OP EC1t + δ3 OP EC2t + δ4 P rorationit + δ5 N EPt + δ6 N OPt + t
(25)
The model regresses the logarithm of number of wells drilled per year on ownership instability (the presence
of the CCF), the logarithm of price, the logarithm of average well depth, a time trend, and dummy variables
35 the NEP and NOP were included
for OPEC. In addition, dummy variables for the presence of prorationing,
as these are expected to have an eect on exploration decisions. Dummy variables for when the other political
parties in Alberta and Saskatchewan were in power were also included (New Democratic Party, Social Credit
Party and Liberal Party). The Progressive Conservative Party is the omitted category, as it was the only
36 Average well depth was calculated by dividing
political party that has been in power in both provinces.
total metres drilled by the total number of wells drilled. Data from CAPP on number of wells drilled and
total meters drilled was only available from 1955 to 2004. For data from 1947 to 1954, government reports
were used.
For Saskatchewan, the Petroleum and Natural Gas Statistical Yearbook 1900 - 1959 was the
source for total wells drilled and total footage drilled. For Alberta, Hanson (1958, 117) was the source for
total footage drilled and average well depth. Number of wells drilled was found by dividing total footage by
average well depth. For both provinces, depth in feet was converted to meters.
Following Bohn and Deacon (2000), a similar specication to (25) for production intensity is approximated
using the ratio of production to reserves yields (26).
(
log
production
reserves
)
= αi + β0 CCFit + β1 N DPit + β2 SCit + β3 Liberalit + γ0 log (price)t
+γ1 log (avgDepth)it + γ2 t + γ3 t2 + δ0 Lougheedit + δ1 Blakeneyit
(26)
+δ2 OP EC1t + δ3 OP EC2t + δ4 P rorationit + δ5 N EPt + δ6 N OPt + t
The model regresses the logarithm of production in terms of yearly output per reserve levels on ownership
instability (the presence of the CCF), the logarithm of price, the logarithm of average well depth, a time
trend, and dummy variables for OPEC. Data on yearly production and reserves by province are from CAPP.
As with the exploration model, dummy variables for the presence of prorationing, the NEP and the NOP
were included.
The same additional dummy variables included in the exploration model were included in
this model to test the eects of political parties on production levels.
The year-squared term is included
because production may be characterized by Hubbert's peak, where production in Canada peaked in the
early 1970s.
Where Bohn and Deacon computed an ownership risk index using an estimated investment model, we
account for ownership instability using a dummy variable for the presence of the CCF. The data set used
by Bohn and Deacon for oil exploration was annual observations on 27 countries for the period 1957 - 1988.
35 Government
36 The models
allocation of production among pools and wells. See Hanson (1958).
include dummy variables for the periods when various political parties were in power in both Alberta and
Saskatchewan. In Alberta, political parties tend to remain in power for a long time: since Alberta became a province, only three
political parties have held power and only two have held power over the sample period.
19
The data set for the oil production model used by Bohn and Deacon was for 26 countries over the same time
period. Here, the data set has 3 more years of observations, but the panel has much less depth. We do not
include API gravity, which Bohn and Deacon included as a measure of oil quality for a given country. Land
area was also omitted as Alberta and Saskatchewan are similar in total area, and because Bohn and Deacon
intended the variable as a control for geologic abundance.
For explaining exploration and development activity, the CCF had a positive, but not statistically signicant inuence. This is not unexpected, given the results of the previous models estimated. In addition,
in order to attract rms, the CCF government oered concessions and stated it would not expropriate. The
coecient is likely capturing these positive eects.
The CCF government was also aggressively pursuing
resource development along with its socialist policies, which can partly explain the positive eect on exploration and development levels. The coecient for the Liberal government is positive and signicant. The
coecient for the NDP government is negative and signicant. For the time period in question, both the
NDP and the Liberals had never been in power in Alberta, and so the eects are purely from Saskatchewan.
These eects are interesting, as the NDP was the successor party to the CCF and formed crown corporations
in the petroleum industry, so a negative eect on exploration is not unexpected. However, the absence of a
signicant positive inuence of the Social Credit Party in Alberta is surprising. The populist party sought
to attract external capital to develop Alberta's oil resources and was in power in Alberta from 1935 to 1971.
It is possible that the coecient could be capturing other eects, such as collinearity with the pro-rationing
regime variable.
In the production model, the estimated coecients for the political parties are not signicant, with the
exception of the Social Credit party. The coecients for the CCF, NDP and Liberal parties were positive,
and the coecient for the Social Credit party was negative. These results indicate that the CCF party did
not have a major eect on exploration or production intensity, and any eect it has was positive.
These
results indicate that activity in the resource sector did not fall due to a perceived expropriation threat, and
that production and exploration decisions were positively aected. This suggests that the eect of the CCF
was only on the value of the xed factor, land. The model specied by Bohn and Deacon includes capital
and labour, but not a xed factor. Given the positive risk premium found, this implies that only when the
value of the xed factor is driven to zero is will exploration and production be aected.
The logarithm of price has a small positive but statistically insignicant eect on exploration. The positive
sign is expected: as price increases, the protability of production increases, giving rms an increased incentive
to explore for new reserves. It is important to note, however, that the number of wells drilled is total wells, not
just exploratory wells. Price may have a larger eect on the incentive to drill development wells as opposed
to exploratory wells. The logarithm of average well depth had a positive eect that was large in magnitude
as well as statistically signicant. The sign was not expected, as drilling deeper wells costs more, and should
have a negative eect on the number of wells drilled. However, the unexpected sign could be due to technical
changes in exploration and drilling, making deeper wells less costly. An additional explanation is that when
oil rms have a signicant cash ow, they may drill more and deeper wells. The positive coecient could be
picking up this correlation. The time trend has a small, positive and signicant eect on wells drilled, which
likely reects improvements in technology. The rst OPEC period had a positive and statistically signicant
eect on the number of wells drilled; the second period had a negative but not signicant coecient. The sign
of these coecients is consistent with the previous models estimated. The small magnitude of the coecients
can be attributed to time lags in response to the OPEC production adjustments. Another possible reason
for the smaller coecients is that increased rents were captured in land prices and royalty payments rather
than by the rms.
The prorationing dummy has a positive, large but not statistically signicant eect on exploration intensity. Prorationing restricted output per well but not total output, creating an incentive to explore and drill
more wells. Prorationing articially restricts supply, increasing the price, which gives rms an even greater
incentive to increase production to capture higher rents. Because output per well was restricted, in order to
increase production levels, a rm would have to drill more wells. The coecient for the NEP was negative,
but not signicant. Since the NEP kept the Canadian price substantially below the world price in Canada,
the negative sign on the coecient makes sense, and the lack of signicance can be explained by the price
used in the regression was a Canadian price. The coecient for the NOP was negative and signicant. The
sign is not expected as the NOP guaranteed a market for western oil which should have had a positive eect
on exploration levels.
20
For the production model, the estimated coecient on the logarithm of price is positive, but very small
and insignicant.
This result could reect the fact that there is a lag between price changes and output
adjustments, or that production is price inelastic. The coecient on the logarithm of average well depth is
negative, and signicant. The deeper a well, the more costly production is, and the harder it is to get oil
out of the ground. The time trend has a negative coecient that is large in magnitude and signicant. The
time-squared coecient is positive, very small in magnitude and signicant. This suggests that production
has been decreasing over time, as suggested by Hubbert (1956). The prorationing coecient is negative but
not statistically signicant. The negative coecient is an expected result, as production per well was held
below maximum capacity. The coecient for the NOP was positive and signicant reecting that the NOP
caused an increase in production in Alberta (Richards and Pratt 1979, 168).
The coecient for the rst OPEC period is negative, and for the second OPEC period the coecient
is positive, opposite the expected results. However, both coecients are small in magnitude and only the
coecient for the second OPEC period is signicant. The unexpected signs for the OPEC variables could
reect technological change in secondary recovery and just the discovery and development of more reserves
from which to produce.
The coecient for the NOP was positive and signicant.
The NOP caused an
37 and so the sign is expected. The coecient for the NEP is positive and
increase in production in Alberta,
not signicant. The positive coecient is likely due to the exodus of investment in the oil and gas sector from
Alberta after the institution of the NEP. The NEP held the Canadian price below the world level, and as a
38
result, investment in both exploration and development decreased, by approximately $11.5 billion dollars.
The loss of investment meant that as production declined but then steadied, reserve levels declined, causing
the production to reserves ratio to increase.
8 Conclusion
Government policy can have a signicant eect on economic outcomes, as well as investment decisions by
rms. The most important way a government can aect positive economic outcomes is by ensuring secure
property rights. The objective of this paper was to develop a model of the value of land with an extractable
natural resource when there is uncertainty in the form of an expropriation threat by the government. The
derived result is that the change in the value of land to a rm is a linear function of current prots, the current
value of the land, and the change in the resource stock. This simple specication allows identication of the
probability of expropriation, as perceived by the rm. The model presented in this paper is similar to that
presented by Davis (2000), but is simpler and more tractable. A key feature of this model is its simplicity
and the linearity of the expropriation probability parameter, making it attractive for empirical work.
A signicant portion of Western Canada's wealth is generated by the oil industry, and this source of
wealth was thought to have been under the threat of expropriation in Saskatchewan during the governance
of the CCF. The purpose of this paper was to estimate the perceived probability of expropriation occurring
in Saskatchewan in the 1940s and 1950s, and to determine the eect of the expropriation threat on the
oil industry in both Alberta and Saskatchewan. Due to limited data, no conclusions can be made about an
expropriation probability during the threat period. However, use of price per hectare as a proxy for land value
in the latter period of the CCF regime suggests a positive risk premium existed in Saskatchewan. Further
analysis shows that the CCF government had a signicant positive eect on exploration and development
and oil production in Saskatchewan. These conicting results suggest that the CCF did not have a signicant
negative eect on investment in capital and output in the Saskatchewan oil industry compared to Alberta,
but did increase the required rate of return for operating in Saskatchewan, and decreased aggregate land
sales. This indicates that the eect of the threat from CCF policies was to lower land values, the xed factor
in production, rather than to decrease development and production. Future work will involve extending the
price per hectare data to enable us to examine the eect of the CCF in the early part of the regime. We also
intend to examine duration dependence in the risk premium, as we expect it will decline over time.
37 Richards and Pratt (1979, 168)
38 Mansell and Percy (1990, 32)
21
Appendix: Tables
Table 1: Summary Statistics
Variable
Denition
Mean (std. deviation)
1947 - 2006
V˙it
Vit
i from t
t +1 in constant 1947 Canadian dollars
The change in the value of land in province
to
0.741
0.778
(18.278)
(12.150)
Value of land in 1947 Canadian dollars
Net expenditures on land per cubic meter of reserve
3.423
additions
(13.103)
Price per hectare of land
Pit
t
at
in constant 1947 Canadian dollars
i
at time
t
in constant 1947 Canadian dollars
Annual production of conventional crude oil in province
at time
πit
i
(25.107)
Average cost of operation per cubic meter of production
in province
Qit
24.499
Average wellhead price per cubic meter in province
time
Cit
t
in cubic meters
Aggregate prots for province
i
at time
t
i
in constant
1947 Canadian dollars
Si
earlyCCFt
CCFt
earlyCCFt ∗ Vit
1955 - 2006
Dummy variable for the province of Saskatchewan
15.481
16.378
(7.918)
(7.962)
10.274
11.375
(9.951)
(10.253)
2.66e+07
3.02e+07
(2.11e+07)
(2.04e+07)
1.02e+08
1.13e+08
(2.07e+08)
(2.20e+08)
0.500
0.500
(0.502)
(0.502)
Dummy variable for the threat period from the CCF
0.050
government in Saskatchewan (1944 - 1952)
(0.219)
Dummy variable for the time the CCF was in power in
0.150
0.096
Saskatchewan
(0.359)
(0.296)
Value of land in Saskatchewan during 1947 - 1952
0.239
(1.384)
CCFt ∗ Vit
Si ∗ Vit
Rit
Value of land in Saskatchewan during 1947 - 1964
Value of land in Saskatchewan
Oil reserves in province
i
at time
t
in cubic meters.
Previous reserves plus reserve additions minus production
Ait
T SEt
N OPt
N EPt
Lougheedt
Reserve additions in province
i
at time
t
in cubic meters
0.293
0.265
(1.392)
(1.027)
0.683
8.246
(1.702)
(16.206)
3.93e+08
4.38e+08
(3.90e+08)
(3.97e+08)
3.02e+07
2.94e+07
(3.66e+07)
(3.69e+07 )
Toronto Stock Exchange Composite 300 Index with
991.312
1125.070
1947=100
(1053.531)
(1070.890)
Dummy variable for the years where the National Oil
0.217
0.250
Policy was in eect (1961 - 1973)
(0.413)
(0.435)
Dummy variable for the years where the National Energy
0.050
0.058
Program was in eect (1980 - 1982)
(0.219)
(0.234)
Dummy variable for the time period where Premier
0.017
0.019
Lougheed renegotiated roaylaty rates in Alberta (1971 -
(0.129)
(0.1382)
1972)
Blakeneyt
Dummy variable for the time period where Premier
0.067
0.077
Blakeney increased royalty rates in Saskatchewan
(0.250)
(0.268)
substantially above those in Alberta (1975 - 1982)
OP EC1t
OP EC2t
Dummy variable for the OPEC period with prorationing
0.217
0.250
1973 - 1985
(0.414)
(0.435)
Dummy variable for the OPEC period 1985 - 2006
22
0.367
0.423
(0.484)
(0.496)
Table 2: Eect of the CCF on Expenditures on Land
Dependent variable:
Annual change in expendi-
tures on land per cubic meter of reserve additions
Value of land
CCF*V
Prots
Change in reserves
(production)
Saskatchewan dummy
S*V
TSE Composite Index
(1)
(2)
(3)
(4)
1.013***
1.066***
1.013***
1.066***
(0.055)
(0.065)
(0.055)
(0.065)
-0.539*
0.758
-0.530
0.916
(0.322)
(0.860)
(0.043)
(0.928)
1.12e-08**
7.73e-09
1.09e-08**
7.71e-09
(5.42e-10)
(5.21e-09)
(5.42e-09)
(5.34e-09)
-1.70e-07*
-2.67e-07
-1.71e-07*
-2.74e-07*
(9.19e-08)
(1.55e-07)
(9.21e-08)
(1.58e-07)
-0.248
-1.336
-0.197
-1.608
(0.924)
(1.994)
(0.924)
(2.087)
-0.230
-1.470
-0.243*
-1.567*
(0.142)
(0.904)
(0.135)
(0.937)
National Oil Policy
National Energy Program
Lougheed
Blakeney
OPEC1
OPEC2
Constant
0.003
0.003
(0.003)
(0.003)
3.090
3.337
(2.268)
(2.389)
14.309*
14.457*
(8.359)
(8.402)
0.097
0.185
(7.039)
(7.077)
-3.336
-3.087
(5.003)
(5.004)
0.991
1.259
(3.585)
(3.653)
-2.327
-2.028
(6.205)
(6.147)
0.761
0.629
0.792
0.597
(1.601)
(1.676)
(1.612)
(1.660)
R2
0.5092
0.5391
0.5092
0.5394
n
118
118
118
118
Note: Columns (1) and (2) have CCF=1 for 1947 - 1952; Columns (3) and (4) have CCF=1 for 1947 - 1964
robust standard errors in parentheses
***: signicant at 1%; **: signicant at 5%; *: signicant at 10%
23
Table 3: Eect of the CCF on Price per Hectare of Land
Dependent variable:
annual change in the price
per hectare
Value of land
CCF*V
Prots
Change in reserves (production)
Saskatchewan dummy
S*V
TSE Composite Index
(1)
(2)
(4)
0.160
0.302***
0.161
0.221**
(0.109)
(0.098 )
(0.109)
(0.094)
0.530
0.699
0.404
0.675
(0.411)
(0.672)
(0.366)
(0.443)
-5.23e-09
-3.98e-09
-5.20e-09
-3.54e-09
(5.80e-09)
(6.44e-09)
(5.79e-09)
(6.19e-09)
3.38e-08
1.84e-07
2.59e-08
-9.48e-10
(9.61e-08)
(1.28e-07)
(9.43e-08)
(1.20e-07)
3.717
7.818*
3.884
3.623
(4.094)
(4.283)
(4.127)
(4.342)
-0.030
-0.009
-0.040
-0.017
(0.154 )
(0.167)
(0.154)
(0.153)
National Oil Policy
National Energy Program
Lougheed
Blakeney
OPEC1
OPEC2
Constant
(3)
0.002
2.30e-04
(0.002)
(0.001)
2.274
1.090
(3.147)
(1.543)
-33.532***
-27.024*
(6.228)
(15.898)
-2.441
3.216
(3.536)
(2.690)
16.358*
-1.267
(8.404)
(1.201)
-6.615
6.487*
(4.977)
(3.487)
-8.174*
-15.821***
(4.692)
(3.789)
-5.335
-13.142**
-5.009
-5.520
(4.968)
(5.578)
(4.891)
(4.900)
R2
0.0960
0.4392
0.0944
0.2116
n
102
102
102
102
Note: Columns (1) and (2) have CCF=1 for 1955 - 1964. Columns (3) and (4) have all dummy variables equal to 1 only for
the change.
robust standard errors in parentheses
***: signicant at 1%; **: signicant at 5%; *: signicant at 10%
24
Table 4: Summary Statistics for Exploration and Production Models
Variable
Denition
Mean (std.
deviation)
log(wells)it
(
log
Qit
Rit
)
Logarithm of number of wells drilled per year in
province
i
at time
i
7.49
(1.15)
Logarithm of output (production) divided by
current reserves in province
CCFt
t
at time
t
Dummy variable for the time the Cooperative
Commonwealth Federation was in power in
-2.47
(0.77)
0.16
(0.36)
Saskatchewan, measures ownership security (1944
- 1964)
log (P )t
Logarithm of the Edmonton par price of crude oil
in constant 1972 Canadian dollars
log(avgDepth)it
t
Logarithm of average well depth in metres in
province
i
at time
t
Year
3.52
(0.47)
7.00
(0.24)
1975.5
(16.81)
t2
Year squared
OP EC1t
Dummy variable for the OPEC period 1973 -
3.90e+06
(6.64e+04)
1985
OP EC2t
Dummy variable for the OPEC period 1985 2004
P rorationit
Dummy variable for the presence of prorationing
in Alberta (1949 - 1973)
N OPt
Dummy variable for years where the National Oil
Policy was in eect (1961 - 1972)
N EPt
Dummy variable for the years where the National
Energy Program was in eect (1981 - 1982)
Liberalit
SCit
0.22
(0.42)
0.34
(0.48)
0.47
(0.50)
0.26
(0.44)
0.02
(0.13)
Dummy variable for the time the Liberal party
0.07
was in power in either Alberta or Saskatchewan
(0.25)
Dummy variable for the time the Social Credit
0.21
party was in power in either Alberta or
(0.41)
Saskatchewan
N DPit
Dummy variable for the time the New
Democratic Party was in power in either Alberta
or Saskatchewan
25
0.22
(0.42)
Table 5: Exploration and Production Model Results
Dependent variable:
log(wellsDrilled)it
log (P )t
0.044
t
(
Qit
Rit
)
0.050
(0.187)
log(avgDepth)it
log
(0.210)
1.400***
(0.305)
-1.843***
(0.360)
0.094***
(0.008)
-3.425**
(1.370)
t2
8.61e-04**
(3.45e-04)
OP EC1t
0.700***
(0.212)
OP EC2t
P rorationit
N OPt
N EPt
-0.284
0.441***
(0.230)
(0.130)
1.252***
-0.586*
(0.294)
(0.330)
-0.664***
0.390*
(0.154)
(0.223)
-0.124
0.063
(0.145)
CCFt
Liberalit
(0.124)
0.325*
0.354*
(0.189)
(0.212)
0.599***
(0.166)
SCit
0.005
-0.582***
(0.206)
-0.548***
(0.140)
Lougheedt
Constant
0.145
(0.128)
-0.016
-0.250
(0.167)
Blakeneyt
0.162
(0.166)
(0.208)
N DPit
-0.151
(0.148)
(0.200)
-0.201
-0.352***
(0.253)
(0.127)
-188.966
3416.659**
(16.533)
(1357.485)
R2
0.9038
0.7296
n
116
116
Note: robust standard errors in parentheses
***: signicant at 1%; **: signicant at 5%; *: signicant at 10%
26
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