Alberta royalties stay low, promote industry expansion

The Alberta government’s $3 million royalty review, which had the energy industry tied in knots for months, turned out to be an expensive lesson.

“There was this deep suspicion that somehow the industry was just ripping off the province,” said Dr. Robert Skinner, an executive fellow at the University of Calgary. He was referring to the NDP’s successful campaign pledge last year that Albertans should get fair compensation for their resources. But the review process showed that the province is a high-cost jurisdiction and there is not much more to trim off the profits.

“The other good thing is, surely, it’s a lesson to other governments who make promises in elections campaigns.”

Under Alberta’s new framework, oilsands companies will continue paying the government the same royalties they have paid before, but the province’s take is changing for other unconventional oil and gas producers.

“Our biggest challenge… is that our largest market is becoming our largest competitor,” she said, referring to the rapid development of oil and gas through fracking in the United States.

“The previous system did not do a good job of the cost of drilling,” said Ben Dachis, senior policy analyst at the C.D. Howe Institute. “This system is much more closer to companies only paying royalties after they have recouped their costs, so it moves it a lot closer to the oilsands model.”

The updated “revenue minus costs” approach is designed to give the Alberta government royalties based on the industry’s average returns, rather than royalties based on the price of oil and gas.

“We haven’t found a way to change oil prices or gas prices so our focus was on costs,” ATB Financial president and CEO Dave Mowat, who led the review panel, said during a press conference.

Since energy companies’ revenues rise with oil and gas prices, the system is designed so that the government’s take will also rise when commodity prices increase – assuming that the energy industry can drive down its costs.

Mowat said the panel’s recommendations, which the province has adopted wholesale, were designed to reward competition and innovation in Alberta.

The system also allows companies to include its recently increased carbon taxes among the costs it deducts from its operations before they pay royalties to the province.

The royalty framework requires the province to collect and publish producers’ average costs to produce oil and gas in order to determine what royalties it will collect.

“Greater certainty means less risk, means greater investment,” said energy economist Peter Tertzakian, one of four panel members. “I think there was a base of investors who had sort of threw their hands up and said ‘I don’t understand this’ (the previous royalty regime).”

Friday’s announcement was met with relief from the energy industry. The Canadian Association of Petroleum Producers said that the new structure was a signal that the government is serious about encouraging investment in Alberta.

“We will be engaging government to understand further the implementation phase and proposed value-added programs, two areas where we have some initial questions,” CAPP president Tim McMillan said.

Precision Drilling Corp. president and CEO Kevin Neveu said the new system’s emphasis on cost-cutting puts pressure on oilfield services providers to continue grinding down their fees, but said, “We’re used to pressure.

“Those that can manage to drive down their costs the lowest, win the game. So I’m not afraid of the pressure on costs,” Neveu said.

Cenovus Energy Inc. said it was “pleased” with the recommendations, and expected minimal impact to its oilsands and conventional business segments.

The new framework doesn’t kick-in until 2017, and existing wells will continue to be charged based on the old royalty system for the next 10 years.

The new royalty regime could help lift the cloud hanging over Alberta-focused oil and gas stocks, says Michael Harvey, analyst at RBC Capital Markets. “Overall, we would expect a moderate positive move in Alberta-focused stocks, largely by virtue of a perceived overhang being removed and a structure that does not appear to be much more punitive to producers,” Harvey said.

The S&P/TSX Capped Energy Index rose 1.28 per cent Friday, but is down 3.21 per cent year-to-date.

However, Michael Scholz, president of Canadian Oil Wells Drilling Association, said the report did not address Alberta’s competitiveness gap with Saskatchewan and British Columbia.

“It’s ironic that the Alberta Government wants to encourage cost leadership by the industry when it has effectively increased industry’s costs through increased corporate taxes, carbon levies and minimum wage. The Alberta Government should show its own cost leadership in order to support lower costs in the basin,” Scholz said.

[End of item]