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Alberta Government Not Ready to Grant New CBM Incentives

August 22, 2005
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Developers of new Alberta natural gas supplies, led by the budding coalbed methane harvest, have received official notice that this is the wrong time to ask for government incentives in Canada's chief producing province. Erosion of the Alberta government share of revenues generated by increased gas and oil prices has ignited questions even among the province's ruling Conservatives and a government review of the royalty structure is under way.

Energy Minister Greg Melchin, an accountant in private life, told the provincial legislature's energy policy committee that while the government believes investment must be encouraged it is "a fair question" to ask whether industry pays Alberta enough for access to its resources. "We're in the midst of a review of the whole question of fair share," Melchin said.

He set a fall target for reaching conclusions. They will not necessarily be announced formally at that time, but will be reached in the midst of the planning cycle for the next provincial budget to be handed down in March or April.

The energy minister was peppered with questions about a draft of his department's annual report that recorded uneven effects of rising oil and gas prices. Although the dollar value of Alberta royalties has climbed, the total oil and gas pie has grown faster and the province's piece has shrunk. Between 2001 and 2003, the last fully counted year, the crown energy revenue share dropped to 21% from 23%, said a "performance measure" in Melchin's report.

The yardstick is the number-one "core business" benchmark set by the department that collects one-third of all provincial revenues. The figure compares royalties to total net oil and gas production revenues after deducting industry taxes, operating costs and general and administrative expenses such as wages. The slippage cut the province's revenue share number into the low end of its target range, which is 20-25%.

For American newcomers to the Canadian industry, the royalty debate is an education in a major difference between the operating environment in Alberta and gas producing jurisdictions in the United States. In Alberta, 81% of mineral rights, including oil and gas, belong to the provincial government and are a cornerstone of public services at all levels. Crown ownership was established by a 19th-Century fiat long before Alberta became a province.

The government in Ottawa reserved for the Crown all mineral rights associated with newly-minted land titles as railways and settlers spread west across Canada following its creation by Confederation in 1867. The rights were transferred by a 1930 constitutional amendment that followed 25 years of crusading by Alberta leaders after the province was created in 1905. In Canada, there is a counterpart to states' rights. But especially in western Canada, provincial rights are about natural resource ownership and control.

In Alberta, gas has emerged as by far the most valuable part of the heritage. In the 2004-05 provincial fiscal year that ended March 31, total "non-renewable resource revenue" was C$10 billion (US$8 billion), including a record C$1.25 billion (US$1 billion) in sales of mineral rights leases. Gas royalties were C$6.4 billion (US$5 billion). About 70% of industry's lease purchases were driven by gas drilling programs. Oil royalties, formerly the lion's share of Alberta resource revenues, are currently a low proportion of the total due to a combination of two factors.

Conventional output is on the decline due to age and the slow pace of devising and introducing new production methods in an industry still built on discoveries rather than efficiency. Royalties are deferred on the big Alberta oil action, which is a C$60 billion (US$48 billion) lineup of oilsands projects that U.S. Vice-President Dick Cheney is scheduled to visit next month.

The recent performance of the province's royalty share goes far towards explaining stalwart resistance to introducing more development incentives. Coalbed methane developers have repeatedly asked for special recognition to cover extra costs such as field equipment for higher densities of wells and compressors and especially for water handling. A provincial government-appointed coalbed methane advisory committee rejected all such requests in a report this summer, with the lone exception of a temporary royalty break for pilot wells into hitherto untapped geological zones.

The industry is preparing a reminder that the Alberta government is still a big winner from high oil and gas prices. The Canadian Association of Petroleum Producers will release its own review of the royalty system soon, CAPP vice-president Greg Stringham said. "The royalty formula does go up dramatically with higher prices," Stringham said.

CAPP calculates 2005 provincial royalties -- forecast to be C$7.6 billion (US$6 billion) in the last spring budget -- will come in much higher than officially expected. The total would jump by C$6.4 billion or 84% to C$14 billion if prices stayed at their summer peaks of about US$66 US for oil and $9.50/Mcf for natural gas, CAPP estimates. Of the increase, C$4 billion or 62% would come from gas.

The spikes may not last, Stringham said. But average prices are staying high enough to accelerate dates when oilsands royalty deferrals run out and new plants have to pay 25% royalties, new CAPP research shows. At least potentially, some of the political pressure on the government to draw the line against gas development incentives could come off.

While making it plain to industry this is not a good political moment to be asking for new breaks or incentives, Melchin also cautioned Albertans against expecting dramatic action to put the province back into the high end of its target income bracket or to set the goal higher.

The government will continue to seek a balanced and stable relationship with the oil and gas industry that encourages development, he indicated. "Changing structures is not something we should do frequently," Melchin said. "One of our real economic strengths is to be predictable."

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