After decades of discussion, it finally happened: the Federal government raised capital gains taxes. However, the increase, which bumps the capital gains inclusion rate to 66.7% from 50%, only applies to individuals who realize more than $250,000 in gains in a year or on any gains realized by a corporation or trust. “The capital gains inclusion rate is clearly the new news here,” said Doug Porter, BMO’s Chief Economist and Managing Director, during the company’s “First Look at the 2024 Canadian Federal Budget” panel.  Porter, who was joined by John Waters, Vice President, Director of Tax Consulting Services at BMO Private Wealth, and panel host Camilla Sutton, BMO Capital Markets’ Director of Canadian and U.K. Research, said this was an unusual budget overall in that most of the spending measures were announced in the days and weeks leading up to it.  As for the day of, “the major questions were the details on how it will be funded,” said Porter, pointing out that the budget adds $36 billion in new additional spending over the next five years, while the budget deficit is estimated to come in at $39.8 billion in fiscal year 2024/2025.  Clearly, funding is coming from increased tax revenues, with Waters calling it a “spend and tax” budget. “We’re dedicating lots of funding towards housing and affordability in particular, but the main headline will be the increased taxes on the wealthy,” he noted.   Markets Plus is live on all major channels including  Apple, and Spotify.   Start listening to our library of award-winning podcasts.  Increasing capital gains While the capital gains inclusion rate increase is expected to impact a small fraction of Canadians, and potentially thousands of businesses, it’s “still a relatively meaty change,” said Porter. It could also impact average Canadians who may own a family cottage that’s climbed in value over time or an income property that needs to be sold.  As it stands, for individuals, any gains below $250,000 will still be taxed at the normal inclusion rate of 50%. If you’re in the highest tax bracket, you’d still pay approximately 25% in tax on that gain (depending on the province). If you realize more than $250,000, the new blended tax rate could now exceed 30% when you factor in provincial taxes.  Waters pointed out that the new higher capital gains rate is now similar to the top rate on eligible dividends. “The spread between the top rates on capital gains and dividend income that existed in the past is now much smaller,” he said.  It’s possible wealthier Canadians will rush to sell property or assets before the new rate kicks in in June, added Porter, and then hang on to their assets for a while before selling again. Indeed, that’s what the government is expecting to happen. While it estimates it will bring in $19.4 billion in revenue from this tax increase over the next five years, $6.9 billion of that is projected to be generated in 2024, increasing to about $4 billion to $5 billion in its fourth and fifth years. “We’re possibly going to see a big wave of selling now, and then a freeze up in a year or two,” he said.  Incentives for entrepreneurs  While the tax increase will impact some business owners, the government has helped entrepreneurs by increasing the lifetime capital gains exemption (LCGE) from approximately $1 million to $1.25 million (that number will be indexed to inflation starting in 2026). That will allow owners who sell their business to receive more proceeds from the sale of their corporation without being subject to tax. “There are some positive developments on the flip side of this increase in the capital gain,” said Waters.  In addition to the LCGE rising, the government’s new Canadian Entrepreneurs’ Incentive (CEI) could further reduce the tax rate on capital gains for business owners on a qualifying sale of the shares of their business – beyond the LCGE – by half (to 33%) on gains realized after 2024. The amount of gains potentially eligible for the lower rate will start at $200,000 in 2025, and increase by $200,000 every year thereafter up to a maximum of $2 million by 2034.  However, there are some caveats, as the new CEI is more restrictive than the LCGE. Notably, it does not apply to professional corporations, or companies in the financial, insurance, real estate, food and accommodation, arts, recreation, entertainment, consulting or personal care services sectors. You also have to be a founder of the business and have actively worked in the company for five years, amongst other criteria.  There’s one more nugget for entrepreneurs: those who sell shares of a company into an employee ownership trust – a trust that holds shares of a corporation for employees to help facilitate the sale of that business to its staff – can receive a $10 million capital gains exemption when those shares are sold to the trust. The exemption is per business, rather than per individual, so a group of owners would only get a collective $10 million in tax exemptions when selling shares to the trust, explained Waters.  Changes to AMT  The budget also offered fresh thinking on the Alternative Minimum Tax (AMT), which caught a lot of attention last year as some feared the proposed changes would deter high-net-worth individuals from making major donations to charities. The AMT is a parallel tax calculation that allows fewer deductions, exemptions, and tax credits than under the ordinary income tax rules and applies a flat tax rate on this adjusted taxable income, with them paying either the AMT or regular tax, whichever is higher.  Under the original proposal, many individuals who made significant donations of shares of publicly traded companies could have been subject to AMT. To lessen the impact on donors, the budget proposes to now allow individuals to claim 80%, up from the previously proposed 50%, of the charitable donation tax credit when calculating AMT.  “The changes in this year’s budget will try and deal with some of those concerns and allow a larger donation tax credit for the purposes of that separate AMT calculation,” said Waters, who added that this update is probably the most notable change in the budget for the charitable sector. “So, a positive development there.”  Other announcements  Most of the other announcements were already known. That includes increasing the amortization period to 30 years from 25 years for new homeowners buying newly built houses, upping the amount people can take out of their RRSP for the Home Buyers’ Plan to $60,000 from $35,000, and offering $40,000 low-interest loans for those adding a secondary suite to an existing home.  Ultimately, the budget didn’t go far enough to address the productivity problems Canada has been having, said Porter, but for those upset about the capital gains hike, he noted it could have been worse. “There’s actually been some modest relief here,” he said. “The tax measures weren’t aimed specifically at corporations through so-called excess profit taxes, and there were no changes in marginal rates and no broad wealth tax measures, which had all been rumoured in the weeks and even the hours leading up to the budget.” 

Companies in the Canadian energy sector have been focused on streamlining operations and lowering greenhouse gas emissions to stay competitive with other global energy powerhouses; however, those efforts are often not reflected in company valuations. The sector is using share buybacks and dividends to entice investors, especially as large institutional investors retreat from carbon-based energy investments, but valuations have yet to catch up. “It’s a missed opportunity,” my colleague Randy Ollenberger, Oil & Gas Producers Analyst at BMO Capital Markets, explained at the BMO Capital Markets CAPP Energy Symposium in Toronto. Valuations in the sector remain attractive even after the strong performance it’s already had this year. “We’re on the cusp of delivering significant amounts of surplus cash flow to shareholders, and we think that that cash flow will start to positively influence the valuation of the sector,” he told the crowd gathered at the preeminent energy conference featuring more than 300 delegates and roughly 60 companies. That sentiment was echoed in the “Balancing Growth & Return of Capital Initiatives” panel that I moderated. The panel featured:   Jonathan Wright, President and CEO, NuVista Energy  Jim Riddell, President and CEO, Paramount Resources  Grant Fagerheim, President and CEO, Whitecap Resources  These CEOs try to balance shareholder demand for dividends and share buybacks with earning a better return on that free cash flow by investing in their own growth. Return of capital   NuVista Energy’s Jonathan Wright explained that those initiatives account for between two-thirds and 80% of the company’s cash flow, depending on commodity prices, while capex has been constant. Paramount has adopted a similar strategy, focusing on dividends. Still, as much as Jim Riddell knows shareholders are looking for that payout, the priority is reserving some of its free cash flow to fuel its growth. “We’ve definitely heard loud and clear from investors that they want to see more return of capital,” he said. Riddell understands where investors are coming from. They want to see an industry grow less and generate more free cash flow than in recent years. However, the other challenge is that there isn’t enough differentiation between the companies, with some prioritizing returning cash to shareholders, which may not always be the most productive way to use that cash flow.  He expects the industry will shift toward the best opportunities. “The industry has to find a way to allocate capital to the best opportunities and not all the opportunities,” said Riddell. Investors are looking for dividends and buybacks, but they also want to invest in companies with scale. They want to see that the energy companies can deliver in all markets. Regarding M&A, the panel believes consolidation to increase size and scale could boost valuations.  Size does matter, and it can demonstrate more return on sustainability and profitability, said Whitecap’s Grant Fagerheim. “The ability to demonstrate that your company does feature both sustainability and profitability at various price levels is key,” he explained. “Just introducing size, potentially, could advance trading multiples.”  Top takeaways from the Q&A session  Q: Do you expect to see increased U.S. investor activism here in Canada as we’ve seen in the U.S.?  A: Fagerheim responded, “The discussions will increase as we advance closer to October 2025, which is an election year here in Canada. There will be opportunities for U.S. producers and investors to come up here and potentially be more aggressive. Capital investment is mobile and goes where it is welcome and can provide a return.” Q: How is access to capital different today?   A: Riddell responded that it hasn’t had much impact because Paramount hasn’t relied as heavily on raising money in the equity market. “We’ve always tried to have a business that we’ve grown without having to use equities, so it feels like the playing field has been leveled a little bit, but the access to capital for the entire industry has been massively restricted,” he said.   Q: What would it take for mid-cap companies to capture some of the LNG market?   A: Wright explained that it continues to be challenging. “LNG has been a market that’s closed to smaller companies or intermediates, which is why we’re one of the founding members of Rockies LNG, a partnership of Canadian natural gas producers working together to advance West Coast LNG opportunities,” he said. “Separately, a company our size can’t compete in this part of the market, but together, we have 20% to 25% of the production and reserves in Canada.”  For the closing remarks, summarizing the opportunity in the Canadian energy sector, Wright noted how natural gas producers have grown while substantially reducing overall emissions. “We have the best environmental ethics in the world. We have the best human ethics in the world. And as an industry, we have delivered huge reductions in methane and greenhouse gas emissions while being able to grow. That’s what the world should want.” 

  Oil and gas companies have recently managed to court some interest from generalist investors, such as pension funds and broad-based mutual funds, and now face the challenge of increasing investment from this important source of capital.   Over the past year, generalist investors have taken an interest in the sector partly because crude oil has climbed more than 25% so far this year1, while many energy companies have cleaned up their balance sheets and are investing in growth. Also, many continue to increase shareholder value by buying back shares. Since January, the S&P/TSX Capped Energy Index is up about 24%.2   How can producers continue increasing interest among generalist investors? That’s what was discussed in the “Access to Capital” panel I moderated at the recent BMO Capital Markets CAPP Energy Symposium in Toronto. The panel featured:  Rob Broen, President and CEO Athabasca Oil  Jason Jaskela, President, CEO and Director, Headwater Exploration  Steve Loukas, President and CEO, Obsidian Energy   Brian Schmidt, President and CEO, Tamarack Valley Energy  It’s still the early days when it comes to generalists moving into the energy space, said Athabasca’s Rob Broen, but investors are looking for companies that provide competitive returns, durability through commodity cycles, and can scale. With a clean balance sheet, plenty of cash, a large reserve base and good trading liquidity, Broen said Athabasca is in a good position to give investors what they’re looking for. Headwater’s Jason Jaskela said generalists are starting to move down cap and invest in companies with long-duration assets. Strong balance sheets are critical, too. “People want to see sustainable resources for a long period of time,” he said. “Those organizations are starting to see multiple expansions, and hopefully that continues.” It also helps to be in the S&P/TSX Energy Index, added Obsidian’s Steve Loukas, whose company, among many other smaller producers, is not yet included. He’s seeing interest from high-net-worth family offices, but “there’s a line in the sand that’s been drawn, and you need to be indexed.” A multi-strategy approach   For companies to continue attracting capital, they’ll need to take a multi-prong approach to increase value, noted the panelists. One common strategy to boost value is through share buybacks. Athabasca, for instance, is allocating 100% of its free cash flow to share repurchases. In 2023 alone, it bought back 58 million shares. “Based on today’s price, that was a good investment,” said Broen. “We’re in the market every day through an automatic repurchase plan, and through those buybacks, you get compounded cash flow per share growth. That’s a formula that’s been working.” While Loukas’ company has also bought back shares, he’s wary of only relying on repurchases. “If you’re operating at a high level and you buy back new shares, are you raising the point that it’s not as attractive on a relative basis relative to some of your other opportunities?” Growing production, improving cash flows, and repurchasing shares at accretive prices “is a powerful combination when things go your way, and they certainly are right now,” he said. Growing interest from U.S. investors   Some panelists noted that they’re seeing more interest from U.S. investors, with Tamarack’s Brian Schmidt pointing out that some of the biggest generalist investors in Canada – Canadian pension plans – continue to move away from the sector. “We used to be about 45% owned by Canadian pensions, and that’s gone down to about 7%,” he said. For him, the big question is how to replace that capital, and so far, it’s by attracting U.S. investors. They’re interested in buying assets that have tier-one inventory and low decline rates, he explained. “That’s resonating with U.S. investors, and it’s where we’ve had the biggest impact over the last, say, six months,” he said. Although, the pendulum may be swinging back when it comes to Canadian investors, as many have a solid understanding of the oil and gas sector. The energy sector’s significant progress around emission reduction is something investors may also want to pay closer attention to. As Lisa Baiton, CAPP’s President & CEO said in her opening remarks to the symposium, the conventional oil and gas sector has grown production while reducing emssions over the past decade. Many operations, however, don’t bring up their progress enough. “When the industry speaks about their investments and progress on emissions, they don’t call it out because it’s just part of their day-to-day business,” she said. More focus on performance   Going forward, companies should expect more scrutiny from investors, especially around performance. Broen said he’s noticed people asking more questions about asset performance and operational results, where they used to focus almost solely on the balance sheet. “The meetings are much, much deeper on the quality and predictability of the asset base in terms of performance, and investors are more knowledgeable about what we have,” he said. Investors now want to know how companies can “turn one dollar into three,” noted Jaskela. A couple of years ago, people wanted companies to give as much money as they could back to shareholders. Now they want to know how much more can the business grow and what the opportunity set looks like. It's a process  While attention from generalists is increasing, it will still take some time before more oil companies and investors start thinking beyond dividend yields and buybacks, added Loukas. For too long, people thought you could engineer a big multiple with a large dividend, and then many clamored for buybacks. But Loukas pointed out that conversations have changed since Obsidian announced a three-year growth plan last September.   “Some investors embraced those plans because they recognize that the returns are more attractive than dividends, while there’s an upper bound on how many shares you can buy. It’s taken time, though,” he said. “The return of some of our development programs has validated the decisions we’ve made, but it’s a process.”    1 https://www.cnbc.com/quotes/@CL.1   2 https://www.spglobal.com/spdji/en/indices/equity/sp-tsx-capped-energy/#overview

  Western Canadian natural gas producers expect to see an increase in demand in the latter half of the year on the back of a project coming online in months. The LNG Canada project is a significant liquified natural gas plant and pipeline emanating from Kitimat, British Columbia.   The facility will allow Western Canadian producers to reach global markets such as Asia, where there is significant demand for natural gas. This is one reason why BMO sees room for valuations to increase in the sector, particularly as supply gets incrementally tighter over the course of the year and into 2025. The positive outlook is a welcome change, but producers will still have to navigate a series of challenges that could constrain their output.   Understanding the market forces at play was the focus of the “Outlook for Western Canadian Gas” panel that I recently hosted in Toronto at the BMO Capital Markets CAPP Energy Symposium, featuring:  Jamie Heard, Vice President of Capital Markets, Tourmaline Oil Corp.  Chris Carlsen, President and CEO, Birchcliff Energy  Jean-Paul Lachance, President and CEO, Peyto Exploration & Development Corp.  Outlook for natural gas  “There’s certainly some pessimistic views on the summer gas price, which we’ll need to get through first,” said Birchcliff’s Chris Carlsen. However, he says the LNG Canada project and a potential increase in demand for power generation in Alberta are encouraging for the sector. With that pick-up still several months away, Birchcliff is deferring some of its capital spending to the second half of the year to ensure any new production can capitalize on higher demand.   Peyto’s Jean-Paul Lachance estimates that LNG Canada will represent 10% of Western Canadian gas once the facility comes on stream. “That’s material,” he said. “Anytime you can put up a market into tension like that, it’s going to be good for the market.” LNG Canada may not have an immediate impact on Peyto’s current output, but it will be constructive to the basin's egress capacity.   What’s more, the development of LNG Canada is important to Western Canadian producers, but other new LNG facilities in the U.S. and Canada can also affect this sector.   As important as it is for the sector to have a global footprint, Tourmaline’s Jamie Heard is also encouraged by the potential for higher demand in North America, with the growing use of heat pumps, electric vehicles and data servers. “In our view, I would agree, we will continue to see weak cash pricing both locally and in the U.S. firming through the summer, and then more rapidly in the fall,” he said.   Expanding LNG  In Canada, other liquified natural gas projects are also in the works. Rockies LNG, a partnership of Western Canadian natural gas producers looking to develop LNG export opportunities, can also change the landscape.   The way these LNG projects are being developed is noteworthy. In the case of Rockies LNG, the project leads have partnered with the Nisga'a Nation, which owns the traditional territory where the floating LNG facility will be located. Nisga’a Nation also has an ownership stake in the project, which is helping the project gain traction and reach new milestones.   “Our partners in Ksi Lisims have a pipeline that’s permitted all the way to the West Coast,” said Carlsen. The project already has an offtake agreement, and it’s working on others. “From a producer point of view, it’s the access to global markets that we’re really after for Canadian producers,” he said.   Constraints on supply  As much as natural gas producers want to get their products to market, there are limitations. As Carlsen explains, finding capacity on the TransCanada Pipelines can take up to four years due to the consultation periods, system modeling, and regulatory process. “All those have added up,” he said, noting that wait time is almost double what it was many years ago.   Finding skilled workers is another challenge that affects all energy produced in Western Canada, causing companies like Birchcliff to carefully pick which projects to develop.   Nevertheless, Birchcliff’s Chris Carlsen is looking forward to a second-half pick-up in energy demand this year. “We see some real positives in terms of the demand-pull that’s coming,” he said.