Ownership over royalties

Newfoundland opts for equity ownership of up to 10%; unveils draft natural gas royalties; industry likes ‘clarity, stability’

Gary Park

For Petroleum News

Newfoundlanders, in their own words, “will tell it to you straight, boy.”

That message has come across loud and clear over the past 16 months in the jarring test of wills and the high-risk gamble between firebrand Premier Danny Williams and some of the world’s oil and gas giants.

In the midst of considerable acrimony, the two sides suddenly cobbled together a memorandum of understanding and are working on a final contract to develop the 730 million barrel Hebron-Ben Nevis offshore oilfield, with the province as a 4.9 percent partner.

And Hebron now shapes up as a test flight for the province’s new energy plan, which sets a target of up to 10 percent government ownership of future oil and gas projects along with a possible equity stake in pipelines, refineries and processing plants.

In addition, the plan lays out a royalty package to finally see development of rich offshore gas resources.

Whatever the industry may think of Williams, he has delivered where previous governments failed, by crafting a policy aimed at “self-reliance and prosperity” for his habitually strapped province, while giving the industry some of the certainty it needs to make multi-billion-dollar investments.

On the line is an energy “warehouse” that includes 2.75 billion barrels and 10 trillion cubic feet of discovered oil and gas resources and more than 6 billion barrels and 60 trillion cubic feet of undiscovered oil and gas.

The initial reception from the industry has been positive.

Paul Barnes, Atlantic Canada manager for the Canadian Association of Petroleum Producers, welcomed the move towards “clarity and stability” along with the government’s apparent willingness to be flexible in negotiating final terms.

But he said it will likely take another year to determine whether the plan is a success, which means a revival of land sales and exploration activity.

Barnes said it did not matter much to the industry whether the government took a 4.9 percent or a 10 percent equity stake, given that the major players in the Newfoundland offshore all have global experience dealing with government partners.

“We don’t tell governments how to take their piece of the fiscal pie,” he said.

Gamble on oil prices

In return for agreeing to a basic royalty rate of 1 percent until the project costs are covered (similar to the fiscal regime in Alberta’s oil sands) — currently estimated at about C$6 billion to achieve output of 140,000 barrels per day, but widely expected to go much higher — Newfoundland stands to collect a “super-royalty” of 6.5 percent of net revenues when oil prices average more than US$50 per barrel for a month.

“It’s going to be a long time by anybody’s estimate that we’re ever going to see oil less than $50 a barrel,” Dunderdale said.

“We gave something on the downside, which is low-risk to us, to achieve a very high gain on the upside.”

Usually with offshore projects, the companies pay escalating royalties as they write down their capital costs.

Confident the “super royalty” will yield “unprecedented benefits” to a province mired in an unemployment rate of 13.6 percent, Williams sees even more gains from the director ownership stake for his government and the economic spin-offs.

Unyielding in his demand for a 4.9 percent equity position, he sweetened that demand by raising Newfoundland’s offer to C$110 million from C$100 million, as opposed to more generous royalties, and committed the province to a C$250 million share of the capital costs.

Joseph Doucet, a professor of energy policy at the University of Alberta, believes the government “wanted a bigger piece of the action and, by getting some equity stake, they manage their risk a little bit differently.”

Peter Linder, managing director of DeltaOne Capital Partners, said the MOU is “strictly politically motivated.”

“As long as Newfoundland gets its fair share through royalties, why do they need to own equity?” he asked.

Williams: no more giveaways

The end result is that Williams believes Newfoundlanders will become “masters in their own house” and will not be involved in any more “giveaways” of natural resources after what he regards as poor deal-making in the Upper Churchill hydroelectric project and the Hibernia offshore oil project — both of which he claims produced more benefits for the Quebec and Canadian governments, respectively.

Through its equity interest, the government will take its place as a full partner at the Hebron table, joining operator Chevron Canada, ExxonMobil, Petro-Canada and Norsk Hydro Canada.

But a 4.9 percent holding will deny it veto power over decisions made by the other partners.

The corporate partners have been low-key in explaining why they returned to negotiations in the midst of continuing bluster and threats by Williams and why they dropped earlier demands for C$500 million in various tax breaks.

Prices assumed to be driver

For Chevron Canada that includes the potentially lucrative Orphan basin, which could hold 6 billion to 8 billion barrels, more than the Jeanne D’Arc basin, which is home to the Hibernia, Terra Nova, White Rose and Hebron fields.

With Imperial, ExxonMobil and Shell Canada as its partners — and work commitments of C$628 million on the line — Chevron has had a less than encouraging start to its Orphan program, with the first wildcat hit by mechanical problems, delaying plans for a second well.

Getting Hebron back on track was pivotal to the province in that face of predictions by the Canada-Newfoundland and Labrador Offshore Petroleum Board that, failing any new finds or development of satellite pools, production could slump from 138 million barrels in 2007 to 84 million barrels in 2011.

It seems the consortium partners simply decided they had more at stake than a feud with Williams, although they were conspicuously absent from a St. John’s, Newfoundland, news conference to announce the MOU.

Taking the high road, Chevron Canada President Mark Nelson told the Financial Post the tentative deal “balances the government’s desire for the development of resources while meeting our shareholder expectation for a competitive investment.”

“It compares well enough to other options around the world,” he said.

Nelson described the equity stake as a way for the province to collect its revenue in a different manner.

Williams’ government is scheduled to unveil a new energy plan before an October 9 election in Newfoundland that he is expected to win in a romp.

The indications are that the plan will entrench the province’s claims to equity positions in all future offshore developments.

“Step by step, we are becoming masters of our own house,” Williams said in unveiling the MOU. “We firmly believe that having a meaningful and real ownership of our resources will help us achieve long-term prosperity.

“We look forward to an era of consultation and partnership and co-operation with our oil industry partners.”

Learning a costly lesson

To paraphrase that line: Does the state have any place in the boardrooms of the nation either?

When it comes to Canada’s energy industry, the answer has been a resounding “no” over the past couple of decades — a pattern the Newfoundland government has broken with its determined push to get a seat at Hebron’s table and likely all future offshore projects.

Otherwise, the Canadian federal and provincial governments have absorbed some hard lessons and either divested themselves of various holdings, or spurned efforts to have them serve as financial backers of mega-projects.

Canada unloaded shares

To gain a foothold in the industry, Petro-Canada went on a sanctioned buying binge, spending C$6 billion of taxpayers’ money to buy assets and C$1.3 billion exploring the Arctic and East Coast.

In the process, it created an industry behemoth with 11,000 employees (now barely 5,000). Carried on the backs of taxpayers, it generated only paltry returns.

Since being cut loose from the government’s apron strings, Petro-Canada has made its way in the real world and is now one of the best performers among Canada’s leading producers.

In the early-1970s, the Alberta government launched its own enterprise, Alberta Energy Co., which later merged with PanCanadian to form EnCana.

Initially AEC was held 50 percent by the province and 50 percent by 60,000 individual shareholders, who bought in at C$10 a share and — for those who built on their shareholdings — have accumulated considerable wealth.

Over the next 18 years, the government steadily phased itself out.

The end result for Petro-Canada and AEC could be declared unqualified successes — but both needed the initial government backing to remain upright.

Others less memorable

The Canadian, Alberta and Saskatchewan governments contributed C$365 million to built Husky Energy’s C$1.6 billion heavy oil upgrader on the Alberta-Saskatchewan border.

Because of low prices for heavy oil, the facility wasn’t able to cover its costs for the first few years and struggled to remain afloat until more recent times when the price gap between heavy and light crudes closed.

To kick start Newfoundland’s first offshore oil project, the Canadian and Newfoundland governments became active players in Hibernia, with Ottawa contributing a grant of C$1 billion and loan guarantees of C$1.7 billion to cushion capital spending of C$5.2 billion initially, rising to C$8.5 billion. A federal corporation still holds an 8.5 percent interest, which the Newfoundland government would dearly like to take over.

In the category of near-misses, the Canadian and Alberta governments bailed out of the planned OSLO oil sands project — a consortium of industry and government partners hoping to produce 77,000 barrels per day, rising to 130,000 bpd, and stimulate more private enterprise development of the resource.

Ottawa at one point pledged C$1.25 billion in aid and loan guarantees to underpin capital spending of C$4.5 billion, but bailed out when confronted with the then-shaky economics of the oil sands.

Future oil price unknown

Asked to offer some wisdom on the Alberta government’s review of oil and gas royalties, he urged legislators to be “very careful and recognize that none of us know what oil prices are going to be — none of us.”

Tillerson told policymakers they should: “Look at the past, what failed and what provided what you wanted for the development of the oil sands.

“If you are unhappy with the way the pie is being shared today, we will talk about it. But you have to be careful about dealing with ongoing projects, as opposed to stimulating new development, because all of that risk is still up front.”

Citing interventionist government policies in Canada, such as the National Energy Program in 1980, he said there has been a history in Canada “of failed energy policies and fortunately sensible people came in and fixed that.”

—Gary Park