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Vol. 15, No. 12 Week of March 21, 2010
Providing coverage of Alaska and northern Canada's oil and gas industry

Alberta pays the price

Backtracks on year-old royalties to heal rift with old friends, push competitiveness

Gary Park

For Petroleum News

The Alberta government of Premier Ed Stelmach has decided the petroleum industry was right after all, rolling back most of the royalty hikes imposed a year ago and opting for job creation over a quick cash grab in a desperate bid to retain power.

In its sixth and final attempt to craft an acceptable royalty regime, the government has slashed the highest royalty rates for conventional oil and natural gas and unconventional gas and launched a study designed to cut regulatory red tape.

Abandoning the trumpeted objective to deliver a “fair share” of oil and gas profits to the 3.5 million people of Alberta, Stelmach said “building competitiveness (against the other oil and gas jurisdictions of North America) is at the top of the government’s agenda.”

He said the latest changes, which will take effect Jan. 1, 2011, “will help us use innovation to unlock our energy resources, create opportunities and jobs in communities large and small across our province and strengthen Alberta’s economic recovery.”

He said the “realities of the energy sector have changed and Alberta must change, too, or risk losing its competitive edge.”

Eroding investment levels

Newly installed Energy Minister Ron Liepert said the government could no longer “pretend that oil and gas investment levels haven’t eroded or that we don’t have a responsibility to current and future generations of Albertans to address that.”

Without being a full-fledged apology, that was a tacit admission by Liepert that his government’s three year process of reviewing, tweaking and implementing a new royalty framework had failed.

Government officials now acknowledge that they have no time to waste to sharpen Alberta’s competitive edge against the neighboring provinces of British Columbia and Saskatchewan and similar jurisdictions in the United States, having been ranked dead last on that scale by experts such as University of Calgary economics professor Jack Mintz.

The most sweeping overhaul of Alberta’s royalty regime since it was first introduced was supposed to generate an extra C$1.4 billion a year in government revenues from a 20 percent average hike.

Instead it collided with commodity prices heading in the opposite direction, then a recession.

The combined result was the loss of billions of dollars in capital spending to other provinces and the U.S. and thousands of jobs.

Job creation projected

The changes announced March 11 are projected to create 8,000 jobs in 2011-12, then 13,000 each year across the economy, but cost the government C$785 million in previously forecast royalty revenues in the 2012-13 fiscal year.

However, the government expects oil and gas companies will reinvest an additional 2 percent of their cash flow (up from the current 60 percent) or C$700 million a year, as a result of changes starting in 2012.

The maximum royalty rate on conventional oil will drop to 40 percent from 50 percent and for natural gas to 36 percent from 50 percent. The bottom rate for both will remain at 5 percent.

The government has also indicated it might be open to further concessions for deep new wells using new technology to develop oil and gas pools.

An interim 5 percent rate on the first year of production from new gas wells will be made permanent.

The price curve which will establish royalty rates between the high- and low-end commodity prices will be set by May 31, giving companies time to develop their capital programs for the 2010-11 winter.

Further royalty refinements are possible as a result of government and industry talks over the next 60 days.

Regulatory barriers targeted

A government task force has been given 90 days to remove regulatory barriers and speed approvals of pilot projects to use new extraction technologies, opening the way for Alberta to join British Columbia in the development of Canada’s shale gas.

Stelmach noted that Alberta would have to impose a 16 percent sales tax to replace its oil and gas revenues.

The government estimates that energy development accounts for 30 percent of the province’s gross domestic product and is responsible for one in seven direct or indirect jobs.

Over the next 25 years, conventional oil and gas development has the potential to add C$2.5 trillion in new economic activity.

Those calculations exclude the oil sands sector, which is now the largest single source of government revenue, but Liepert said it did not need royalty stimulus because it is attracting strong investment.

End of nasty fight

If the government’s objective was also to end its nastiest fight in memory with the industry and start rebuilding trust, the changes appear to have succeeded.

David Collyer, president of the Canadian Association of Petroleum Producers — the industry’s most powerful lobbying group — said that although it will “take a little while” to work out final details of the fiscal revisions, the substance and tone of what was announced “are both very positive steps.”

But, reflecting the prevailing mood of the last three years, he noted that the government can’t expect to “restore credibility and respect overnight.”

He said the divisions have “made it very difficult for Alberta producers” to participate in the rapid growth of unconventional gas resources that has dominated the last three years across North America.

“Investors need to know Alberta is back in the game,” Collyer said.

“A strong oil and gas industry means a vibrant economy, which contributes in many ways to our quality of life.”

Declaring Alberta “is back,” CAPP Chairman Andrew Wiswell, who is also chief executive officer of NAL Oil and Gas Trust, said the changes are a “very important step in re-establishing investor confidence in Alberta” by giving investors the stability and predictability they need to allocate their capital.

Government gets an A

Roger Soucy, president of the Petroleum Services Association of Canada, said reduced royalties “give incentive to the industry to look harder at bringing capital back to Alberta.”

John Dielwart, chief executive officer of ARC Resources and one of the government’s most outspoken critics, said Alberta is “back to a competitive regime, which we had originally.”

Mike Tims, chairman of investment dealer Peters & Co., said, “Nothing anybody does will absolutely please every person, but I think you have to give (the government) a pretty good score this time.”

He awarded the government an A for “consultation, tone and spirit (in conducting its competitiveness review). This time, it was based on looking at factors such as the real rates of return and what drives capital spending.”

“I think they have found a good balance between the government representing the people who own the resource and the industry that creates value from it,” he said.

No apology

Danielle Smith, leader of the Wildrose Alliance party, which has come from nowhere in the last year to within 4 percentage points of the governing Conservatives, gave the government credit for “making some pretty good changes.”

But she said the royalty rollback failed to include “the words that I think the industry wanted to hear: ‘We were wrong and we’re sorry.’”

Andre Plourde, an energy economist at the University of Alberta and a member of the government’s 2007 royalty review panel, said the Stelmach administration is “basically saying to the (resource) owners, we’re willing to take a lower return on your behalf in order to get more activity in the present.”

“I remain to be convinced that this is, in fact, the right kind of tradeoff to make for Albertans,” he said.

Chris Severson-Baker, policy director at the Alberta-based Pembina Institute, said he was concerned that Alberta’s resources are being given away too cheaply in return for drilling and jobs, noting the government had only consulted the industry.

“By only listening to the developers of the resource, you end up with very skewed input.”

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Land bidders bide their time

The run-up to Alberta’s royalty revamp was a mixed signal, with a government land sale generating strong returns, but falling far short of the C$900 million some had anticipated.

The fourth auction of 2010 raised C$168 million, close to half this year’s total to date of C$377 million — edging past the halfway point for the $742 million in successful bids for all of 2009 — from the disposal of leases and licenses covering 628,714 hectares (1.55 million acres) at an average C$517 per hectare. The per-hectare average so far this year is C$602.

Gary Leach, executive director of the Small Explorers and Producers Association of Canada, said each land sale in 2010 has grown in total dollar returns, pointing to a “healthy trend that shows growing optimism about future investment trends in Alberta.”

He said it was possible that uncertainty over the government’s royalty announcement the next day might have deterred some bidders.

But Chris Theal, an analyst with Macquarie Capital Markets Canada, who forecast the inclusion of a vast tract of Devonian Duvernay shale gas prospects in the sale could attract successful bids of C$800 million-C$900 million, said he was “underwhelmed” by the disposal of the shale rights.

As usual, most of the bidding was done by brokers for clients who have five years to disclose their identities, or allow their rights to lapse.

The largest single bid was C$21.4 million for a 4,096-hectare parcel by Britt Resources, while the per-hectare high was C$36,239 by Scott Land and Lease. A large number of other bids exceeded C$20,000 per hectare.

Dave Russum, vice president of geoscience with AJM Petroleum Consultants, said buyers were probably targeting a wide range of plays from shales to tight sand and the hot prospects such as the Cardium, Montney and Duvernay formations.

Russum said advances in drilling and production technologies are yielding new life in oil fields and rocks that were previously viewed as uneconomic.

Greg Scott, president of Scott Land and Lease, which placed bids worth C$65 million, said the results reflected activity throughout the province.

The next sale on March 24 also has extensive postings in the shale region of northern Alberta and will be the first real chance to measure industry response to the new royalties.

—Gary Park