Tim Shufelt... G & M article New tax unlikely to change use of stock buybacks by oil and gas companies
With the introduction of a tax on share buybacks, a source of returns for Canadian investors is now squarely in the government’s crosshairs.
Earlier this month, the federal Liberals announced a plan to impose a 2-per-cent tax on companies buying back their own stock.
Buybacks have increasingly come under scrutiny from policy-makers who characterize them as a misuse of corporate funds, benefiting shareholders and management to the detriment of workers and the broader economy.
The controversy has intensified in the aftermath of the pandemic as the corporate sector in North America has furiously repurchased shares in the midst of soaring profits.
Over the past 12 months, Canadian companies have bought back almost $70-billion worth of their own stock, which is about 50 per cent higher than the previous two years combined, according to a CIBC World Markets report.
The oil and gas sector has been at the heart of the buyback spree. Elevated energy prices amid the war in Ukraine has led to towering profits that have largely been funnelled back to shareholders.
While the buyback is an instrument prone to questionable use, it makes sense for oil and gas companies generating more cash than they can otherwise deploy, said Ryan Bushell, president and portfolio manager at Newhaven Asset Management in Toronto.
The new tax is unlikely to change that dynamic. “The tax will be a factor, but it’s pretty far down the list,” Mr. Bushell said. “I think this is more just policy for policy’s sake.”
How to deal with excess profits is a relatively new problem for the oil patch. Investors in North American oil and gas are much more accustomed to the sector being fixated on growth at all costs. But then the era of relentless drilling gave way to a global supply glut triggered by the U.S. shale boom, the lack of pipeline capacity in Canada, and the divestment movement predicated on phasing out fossil fuels.
Having spent years cutting costs, reducing debt and consolidating, the industry now has few options to invest its many billions in excess profits.
“The rapid rise in commodity prices has created a nice problem for CEOs: how to spend all that cash,” Hugo Ste-Marie, a strategist at Scotia Capital, wrote in a recent report. “Clearly, buybacks have been the answer.”
In the third quarter, resource sectors accounted for nearly half of all buybacks by TSX-listed companies, the report said. “This is a complete reversal of historical patterns,” Mr. Ste-Marie said. Mining and energy companies have traditionally been on the other side of the ledger – aggressively issuing equity rather than buying it back.
That role reversal has driven net buybacks as a proportion of the total Canadian stock market to their highest level in at least 20 years, the report said. This has narrowed the gap against the U.S. stock market, which has been much more heavily skewed toward buybacks in recent years.
The U.S. corporate sector has a poor record of timing the market, typically piling money into buybacks in the heat of a bull run, when valuations are peaking. “Certainly in the tech space over the last two years, there was no way to justify buying back stock as a good use of shareholder funds,” Mr. Bushell said.
In August, U.S. President Joe Biden signed a bill into law that imposed a 1-per-cent surcharge on corporate buybacks, on the basis that they sap money from investments in growth and productivity.
The Canadian government echoed that rationale while proposing to double the rate of the U.S. buyback tax. Ottawa’s levy will be introduced in the 2023 federal budget, to take effect the following year.
But plowing money into expansion is not a viable option for the oil patch right now. “If, on one hand, governments want them to invest massively, they cannot, on the other, be pushing hard to eliminate fossil fuels,” Mr. Ste-Marie wrote.
As long as energy prices are high, the motivation for returning money to Canadian shareholders will remain, with or without a tax on buybacks.