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Message received, not understood Alberta tries to spread glad tidings; investment bankers unsure about status of oil sands contracts; producers target heavy cuts Gary Park For Petroleum News
Alberta’s Premier Ed Stelmach and Energy Minister Mel Knight are trying to spread a message across North America that their planned royalty hike has caused barely a ripple in stock markets and insisting they have no intention of voiding contracts.
A different, more telling verdict, is emerging from the full spectrum of oil and gas exploration and production companies, with Canadian Natural Resources shrinking its natural gas drilling by 30-50 percent in 2008 and Talisman Energy hinting it will trim drilling for deep, high-productivity wells.
Stelmach claimed the markets “recovered within a half-hour” of word that Alberta will raise royalties by 20 percent or C$1.4 billion by 2010, based on current prices and production, and were quickly followed by major announcements of “further investment in the oil sands.”
Trying to head off negative perceptions outside Canada, Knight met with several Wall Street firms, such as Goldman Sachs and Lehman Brothers, and members of the U.S. Senate committee on Energy and Natural Resources.
He found some misunderstandings in the investment community about the structure of royalty hikes scheduled to take effect Jan. 1, 2009.
Knight said that “people seemed relatively pleased” when he explained that the new royalties for oil sands production would be about 5 percent during the startup period and 33 percent once project costs had been recovered, capping at 40 percent if oil were to top C$120 per barrel.
Royalty agreements reopened His major damage control mission involved the government decision to reopen royalty agreements with oil sands giants Syncrude Canada and Suncor Energy that were not due to expire until 2016.
Knight said U.S. bankers and fund managers wasted no time suggesting the province was “ripping up contracts.”
“That is absolutely the farthest thing from the truth,” he told reporters.
He said Syncrude and Suncor have told the government they want a level playing field for the industry and that is what the Stelmach administration wants, which means there should be no exemptions under the new regime.
But Knight would not discuss what options might be on the table when contract talks get under way, or what might happen if there is no agreement with the two companies.
Most E&P companies are still evaluating the potential impact of the new royalty framework on their 2008 capital spending programs and some say the final answers won’t be known until the government tables legislation and regulations.
Gas expected to be hit But Canadian Natural and Talisman, two of the leading gas producers after EnCana, left no doubt that given the current pricing and cost environment the biggest reduction in activity will likely occur in the conventional gas business, which currently supplies about 15 percent of U.S. needs.
The challenge, according to newly installed Talisman Chief Executive Officer John Manzoni is to “run the numbers” based on a program that is so sensitive to prices, well depths and production volumes and therefore “well-specific.”
Ron Eckhardt, vice president of North American operations, said Talisman’s earlier forecast of a possible C$500 million cut in its Alberta spending next year remains “very accurate.”
He said the Deep basin play straddling the northern Alberta-British Columbia border is “relatively unaffected,” but the high-cost, high-productivity wells in the outer Foothills of the Canadian Rockies, which face very high initial royalties, will take the brunt of budget cuts.
Manzoni said market uncertainty in the light of royalty changes has forced Talisman to put on hold the disposition or spinoff of its midstream assets, valued at about C$1.7 billion.
Canadian Natural Chief Executive Officer Steve Laut said “it’s pretty clear the conventional gas business has been hurt very badly” by the planned increases.
Although the company’s 2008 capital budget won’t be released until Nov. 27, its Alberta well count will probably drop to 450-600 of the 900 wells it could have drilled and planned conventional light oil wells in Alberta will be reduced by 50 percent to about 70.
That 30-50 percent cut in gas wells will be short of the 67 percent Canadian Natural warned it would make, but will probably see about C$500 million chopped from its Alberta spending.
Three Horizon phases a go Canadian Natural also backed away from threats to scuttle billions of dollars in oil sands investment.
Laut said the first phase of the C$7.75 billion Horizon project, due to start production in the third quarter of 2008, is 76 percent completed and will be finished, while the second and third phases will proceed.
However, phases four and five will need rethinking, although Laut said they “do look okay,” and C$7 billion worth of thermal projects at Kirby, Birch Mountain and Gregoire Lake have been hit by severe erosion of “tolerance for risk … and we’ll be very cautious.”
Even without factoring in higher royalties, the troubles confronting the gas sector were hammered home by Compton Petroleum, an intermediate-sized producer, which has responded to stagnant prices by dropping 75 wells, or 44 percent of its program, from fourth-quarter drilling.
That will trim C$75 million from its 2007 capital budget, or about 17 percent of its planned C$450 million, which was boosted in July when it held out hope for a rise in gas prices.
Gas prices down Canada’s benchmark AECO-C hub prices are currently below C$6 per gigajoule, better than August’s C$4, but below the C$6.50-$7.50 range through most of the first half.
Farther down the food chain, Canext Energy, a junior operating on a C$12 million budget, said the new royalties forced it to bail out of a joint-venture drilling contract for an oil exploration well because of poor economics.
Chief Executive Officer Stephen Kapusta told the Calgary Herald the royalty structure has “changed the whole farm-in dynamics in the basin in Alberta.”
If the government collects another 20 percent or more, contracts must be readjusted in a sector that is already struggling, he said
Kapusta said it took less than 24 hours after the royalty announcement when Canext’s partner said it would not drill under the terms and conditions set out in the original agreement.
Gary Leach, executive director of the Small Explorers and Producers Association of Canada, said his whole sector is “collapsing” because of the impact increased royalties will have on already risky economics.
He said the new regime takes away the incentive for smaller companies to drill because it doesn’t understand the benefits of a junior drilling just one successful well in five.
Some indirect federal help While it struggled to convey its own optimism, the Alberta government got some indirect help from the Canadian government.
Finance Minister Jim Flaherty, in showering Canadians with a wide range of tax cuts, said Oct. 30 the government would accelerate reductions in the corporate income tax rate from 22.1 percent in 2007 to 15 percent in 2012 at a cost of C$14 billion. The rate was previously set to drop to 18.5 percent by 2012.
Suncor, EnCana and Canadian Natural, all of them involved in the oil sands, reaped an immediate gain on the Toronto Stock Exchange.
Andrew Potter, an analyst with UBS Securities Canada, said the preliminary analysis of Flaherty’s cuts “shows that if the changes go through the net present value per barrel of an onstream oil sands project would go up 1 percent-3 percent and the net present value of a greenfield project would increase in the 6 percent-12 percent range depending on price — a bigger potential impact than the royalty changes.”
Pierre Alvarez, president of the Canadian Association of Petroleum Producers, agreed the tax reductions will change the net effect of the royalty changes and other measures.
Alberta also got a morale lift from federal Industry Minister Jim Prentice who said Stelmach and his government struck the “right balance” between the industry and Albertans, who own their natural resources.
“In the world in which we live, where there is a premium on a secure supply of oil and gas in a stable environment, Alberta will continue to prosper and I think do very well,” he said in brushing aside warnings that Stelmach’s move would derail the province’s long-running economic boom.
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