Struggling to get it right: Alberta backtracks on royalties

It’s been a year of almost unmatched embarrassment for the Alberta government.

At a time of incredible, seemingly limitless riches, the province under newly installed Premier Ed Stelmach decided in 2007 it wasn’t getting its “fair share” from the oil and gas industry.

So, against all sorts of warnings, it made a grab for a hike of about 20 percent in royalties.

Regardless of commodity prices that were then generating corporate cash flows never before seen, the industry reacted sharply to government meddling with a royalty regime it had viewed as sacred and untouchable.

Companies slashed billions of dollars from their Alberta spending plans, diverted money to British Columbia, Saskatchewan and the United States and generally behaved like a wounded animal.

Faced with a potential loss of revenues that would more than wipe out its projected royalty increases, the Stelmach government dug in, creating an ever deeper hole for itself.

For all of this year, there has been a continuing rumble of discontent from industry ranks, lobbying the government to live up to its promise and deal with any “unintended consequences” of the new regime.

The only concession was offered in April, when the province offered a C$1 billion break over five years on deep natural gas royalties and C$185 million over the same period for deep oil wells.

Otherwise, it was full steam ahead until six weeks from the Jan. 1 transition date to the new royalties.

Devastating indictment

By any standards, Edwards’ comments earlier in November were a devastating indictment of wrong-headed government thinking.

“A lot of the Alberta assets (acquired by CNR when it took over Anadarko Canada) have become uneconomical or marginally economic with higher royalties.

“A bunch of the value of Anadarko, about one-third, is right now stymied, or put on hold for development because of the current fiscal regime proposed by the government,” he said.

Not something others haven’t said in various forms, but a shiver had to pass through the corridors of the Alberta legislature when Edwards said: “The changes are far more punitive than the industry can really live with for the long-term economic development of gas in Alberta.”

The proof of that assessment was already emerging in industry forecasts that Alberta would see its well count drop by thousands in 2009.

Meltdown an escape route

With almost unseemly haste, the government backtracked, saying change was needed to reverse a downturn in Alberta drilling and the global economic crisis.

“The world has changed in recent months and we must respond,” said Stelmach. “We must be competitive so we’re making this change to encourage new activity in the oil patch.”

Some might question the term “new activity,” when the objective seems to be staunching the outflow of capital.

“This is all about accessing risk capital and ensuring that the jobs are maintained here in the province of Alberta,” Stelmach said.

The goal is to spur the drilling of new, conventional oil and gas wells between 1,000 and 3,500 meters deep by giving companies a one-time option of selecting “transitional” or new royalty framework rates, rather than paying the rate increases scheduled for Jan. 1.

But all wells that adopt the transitional rates in the 2009-2013 period will be required to shift to the new royalty framework in 2014, while all current wells and all oil sands projects will move to the new royalty system on Jan. 1, as planned.

The government figures the royalty break will cost C$1.8 billion over the five years, starting at C$172 million in 2009 and building to C$512 million in 2013.

Producers must decide before they start drilling whether they will opt for royalty relief. Re-entry wells that are given a new spud date will also be eligible.

Based on government estimates that 20 percent of wells will qualify over the five years, Energy Minister Mel Knight argues the C$1.8 billion in lost royalties (projected for 2009) will be more than offset by revenues generated from increased production.

He said “it’s like investing $1 to get a $5 return,” adding the government still believes it will achieve its royalty increases of C$1.8 billion in 2009 and C$2.1 billion in 2010.

You have to search hard to find anyone who shares that optimism.

Praise muted

The service sector, which had already cut staff and tightened budgets, doubts much will change entering Canada’s peak drilling season in the winter.

Kevin Neveu, chief executive officer at Precision Drilling Trust, Canada’s largest rig contractor, said the announcement is six weeks too late for companies to order a dramatic increase in their activity, although he said the deferral of royalties might yield some positive results next fall or winter.

Robert Geddes, chief executive officer of Ensign Energy, which has Canada’s second largest rig fleet after Precision, went one step further, suggesting the timing of the announcement might even be harmful.

He now expects there will be a drop in wells planned for the balance of 2008 as companies hold back until the transitional royalty is available.

Geddes also doubts there will be any pullback from British Columbia or Saskatchewan, where the industry welcomes the “consistent direction” taken by those companies.

David Collyer, president of the Canadian Association of Petroleum Producers, said the royalty rollback might help Alberta regain some of its lost competitive edge by dealing with the near-term cash flow concerns of small- and medium-cap producers.

But the longer-term future of the Western Canada Sedimentary basin, rated the costliest basin on the planet, and the full impact of the fiscal regime in Alberta will take longer to assess.

Nancy Malone, manager of economic analysis at the Canadian Association of Oilwell Drilling Contractors, said it is too early to say whether the transitional system will have a significant impact on drilling.

“Whether it’s the solution in the long-term, we’re really not sure yet,” she said. “At the end of the day, most people would agree that the royalty review could have been handled a little better.”

Andrew Plourde, a University of Alberta energy economist and a member of the government panel that recommended the royalty hikes, rejected Knight’s view that revenues from new production will counter the lost royalties.

He said that what the government is now clearly signaling is that it values increased exploration activity over improved returns for the people of Alberta, who own the natural resources in the province and were originally deemed by the government to be getting short-changed on royalties.

—Gary Park

Alberta unloads a bundle

Just the perfect time to unload a report that has been sitting on the shelf for a year — one that effectively gave a failing grade to the government’s handling of the Heritage Savings Trust Fund that has been running on idle for most of its 32-year existence.

The government also found time to clean up one bit of unfinished business with its royalty overhaul, striking an agreement with Syncrude Canada, the world’s largest producer of synthetic crude.

Evans tried offering the full range of soothing message in the midst of what she also conceded was a “very difficult week … I’ve never seen anything like it.”

She estimated the provincial surplus will shrink to C$2 billion by the end of the fiscal year on March 31, 2009 — a staggering roller-coaster since the budget, when unveiled in April, predicted a surplus of only C$400 million.

When the numbers were updated in August, based on the staggering rise in oil prices, Evans was comfortable hiking the surplus target to C$8.5 billion.

Just three months later, surrounded by a slump in commodity prices and market chaos, those expectations were tossed out the window.

Even so, she tried to reassure Albertans by telling them that despite “dramatically deep” recessionary conditions they were “in better shape than almost anywhere in the world.”

Total oil royalties for the fiscal year are now pegged at C$5.9 billion, off C$2.6 billion from the August budget update, and natural gas royalties are expected to generate C$7.1 billion, C$1.6 billion down from the August estimate.

The government now forecasts WTI crude prices will average US$93.50 per barrel for the full year, a drop of US$25.75 from the August forecast and natural gas is targeted at C$7.50 per gigajoule, a drop of C$1 from August.

Regardless of the turmoil, Evans said the government won’t back down from its plan to spend C$2 billion to help develop carbon capture and storage technology and C$2 billion to promote greater use of public transit systems.

Syncrude terms settled

Both companies operate under 1997 agreements that cover their royalty payments through 2014, but other producers are subject to the new royalty schedule that takes effect on Jan. 1, 2009.

To level the playing field, the government insisted on renegotiating the Syncrude and Suncor deals. As a result, Syncrude will pay an additional C$975 million over a six-year transition period to the end of 2014 when it and Suncor will join the rest of the oil sands sector in paying 1 percent-9 percent until project costs are recovered, then 25 percent-40 percent depending on oil prices.

Marcel Coutu, chief executive officer of Canadian Oil Sands Trust, the largest of Syncrude’s seven owners with a 36.74 percent stake, said the new terms provide a clear and stable regime that allows owners to proceed with expansion plans.

Fund growth recommended

A special commission, named by the government in 2007 to assess the Heritage Fund, completed its work before a June report by the Organization for Economic Cooperation and Development that said Alberta should invest and save its energy revenues, rather than lowering taxes.

“To preserve today’s prosperity and pass on the benefits to current and future generations of Albertans, we urge (the government) to make savings the new fiscal anchor for Alberta,” without which Alberta could face provincial tax hikes of 40 percent by 2030 as a results of declining oil and gas revenues.

Evans denied the government had deliberately held back release of the report while it rolled out a major infrastructure spending program during the March provincial election, promising — without offering details — that “several and maybe more or most” of the recommendations would be adopted.

—Gary Park