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In Alberta, Gas Is Royalty Revenue Leader

The Alberta government is predicting that sustained strength in natural gas prices will fuel a C$3 billion (US$2.8 billion) bonus in its royalty collections for its current fiscal year, ending March 31.

In a quarterly fiscal update the Alberta finance department forecast that 2008-2009 gas royalties will be C$8.7 billion (US$8.3 billion), up from a projection of C$5.7 billion (US$5.4 billion) in the provincial budget set in the spring. The government expects the windfall to be generated by strengthened gas prices averaging C$8.50/gigajoule (GJ) (US$8.48/MMBtu) for the current fiscal year. In the original budget, prepared when markets were stuck in a lull after a lean 2007-2008 for Canadian producers and exporters, gas was forecast to stagnate at C$6.75/GJ (US$6.73/MMBtu).

The new projections highlight the critical role of gas in the province's treasury and economy. Gas is expected to be the top royalty revenue earner despite much larger price gains forecast for oil.

The province raised its expectation for the fiscal-year average oil price to US$119.25/bbl, up a whopping $41.25 or 53% from initial expectations of US$78. But total royalties, including the provincial take on accelerating oilsands production, remain forecast to trail gas at C$8.5 billion (US$8 billion) for the 2008-2009 fiscal year. The new projections are based on prices rather than additional gains expected from royalty increases scheduled to go into force in 2009. The overhaul adjusts rates upwards but does not change the key principles. Royalties will continue to be calculated on sliding scales of prices and well productivity. In the future, as now, the system will amplify effects of price changes by raising and lowering royalty rates as markets go up and down.

The projected 2008-2009 Alberta government gas royalties of C$8.7 billion (US$8.3 billion) work out to about C$2,550 (US$2,430) for every one of the 3.4 million men, women and children who live in the province. But critics of the government -- keeping alive an angry year-old debate among industry and political leaders -- predict that the province will stunt its prospects of gas production and revenues if it goes ahead and enacts the new royalty rules on schedule in 2009. Gas investment is bound to migrate into British Columbia (BC) because it is not modifying a royalty regime enacted nearly a decade ago after extensive consultation on stimulating drilling with the Canadian Association of Petroleum Producers and other industry interests, Peters & Co. predicts in a research note. The Calgary oil and gas investment boutique describes the economics of drilling in northern BC and Alberta as becoming "vastly different" due to the conflicting royalty systems.

The BC regime is studded with rate reductions and outright holidays from paying royalties on a wide variety of wells depending on their depths, degrees of technical difficulty and whether they are discovering new gas reserves instead of only extending known supplies. The BC incentives also reward producers with royalty reductions if they spread the work load out over the year instead of continuing to drill almost all wells during the traditional peak winter season.

"Significant differences between the royalty structures in Alberta and BC impact project economics dramatically and need to be considered with any investment decision," the Peters analysts wrote. "BC-based developments provide greater leverage to rising gas prices."

Comparison calculations are complex and results vary depending on plays or geological targets. But the investment house predicts the net, bottom-line value of producing gas in BC will be as much as 30% greater than in Alberta. Break-even prices for tapping emerging targets such as the celebrated Montney formation, which requires sophisticated horizontal drilling, will also be higher in Alberta despite its claims that its new royalty structure continues to reward innovation, the Peters analysts calculate. A horizontal Montney well in Alberta is forecast to need gas to be C$5.92/Mcf (US$5.62), while the same project works in BC at C$5.50/Mcf (US$5.22).

Although Canadian industry and government experts quibble over such numbers and Alberta remains far from accepting such disparaging comparisons, the investment analysis highlighted an about-face in perceptions of the two top gas-producing provinces. Until Alberta conducted its lengthy royalty review inquiry and then opted to increase rates, industry captains routinely joked that BC stood for "bring cash" because expenses were invariably higher there due to taxes, remote locations and complicated regulations.

Critics of the new Alberta regime predict that it will continue to drive up industry purchases of government-owned mineral rights in BC Auction revenues fetched by BC gas prospects to date this year approach C$2 billion, or more than double Alberta sales. The new Alberta treasury outlook predicts that 2008-2009 sales of provincial mineral rights will approach C$1.5 billion (US1.4 billion), up C$627 (US$596 million) or 70% from initial projections of C$868 million (US$825 million). But the forecast Alberta mineral rights sales gain is credited to oil sands and conventional oil drilling targets that BC does not have rather than gas.

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