Alberta natural gas royalties will rise, but a year later than initially proposed and the increase will be less than two-thirds of what had been demanded by a government-appointed revenue inquiry.

A compromise announced by Premier Ed Stelmach postponed collecting the increase until 2009. The government estimated the new formula will increase the provincial treasury's annual gas royalties by C$470 million as of 2010. The inquiry's report, target of hot industry protests since its release Sept. 18, called for virtually immediate enactment of a new royalty scale that was forecast to raise provincial government gas revenues by $740 million per year as of 2010 (see NGI, Sept. 24).

The premier, who made royalty reform a top priority after he got his job by winning a Conservative party leadership contest last winter, insisted the new system delivers on his commitments to both voters and the industry.

"Future generations of Albertans will receive a fair share from the development of their resources," Stelmach said, with a nod to provincial ownership of mineral rights as an economic and revenue mainstay under the Canadian constitution.

"I offer stability and predictability to those in the oil and gas industry, and the time to adjust to royalty changes," the premier added with a nod to business and financial communities that insisted provincial ownership rights are meaningless unless they are managed in a way that nurtures private enterprise.

"And I can also assure investors that Alberta will remain an internationally competitive and stable place to do business," Stelmach said.

He scrapped a complex gas royalty formula, built up over decades, that set a wide range of rates between 5% and 35% by following a triple scale that includes the vintage of production, the productivity of wells and prevailing gas prices.

The simplified new regime sets rates within a range of 5-50% on a scale reflecting well productivity and prices. Prices have to rebound into double-digit levels to drive royalties to peak rates.

The reduced target for increased total revenues largely reflects special provisions that make royalty rates on low-output wells follow prices up more slowly than levies on big producers.

Without saying it in so many words, the Stelmach compromise effectively creates a low coalbed methane (CBM) royalty to carry out provincial hopes that the new supply source will replace dwindling conventional production. At current prices royalties will be 5% on CBM.

The Stelmach compromise also restored a deep drilling incentive that was dropped by the royalty inquiry report. The government made a commitment to ensure the new regime's lowered royalty rates for deep wells at least match the old system. Details will be announced later after further discussions with industry.

New formulas were also unveiled for conventional oil and the Alberta oilsands. Total annual revenue increases are forecast to be C$1.4 billion as of 2010, or 30% less than the inquiry's target of C$2 billion.

Wary industry leaders held back from saying much about the compromise, notably by not immediately withdrawing threats to cut drilling budgets if the government made significant royalty increases (see NGI, Oct. 22; Oct. 15; Oct. 8; Oct. 1). The devil is in the details, industry sources said as companies began studying the formulas in the Stelmach compromise.

Canadian Oil Sands Trust (COST), which is the largest stakeholder in the Syncrude Canada Ltd. oilsands venture, said Friday that it is willing to talk to the Alberta government on changing Syncrude's royalty structure, but noted that the changes will likely reduce oilsands activity.

COST, which holds a 36.74% working interest in the vast Syncrude project, said it and other Syncrude owners are willing to discuss any fair and equitable treatment, but noted that any transition to the new generic royalty terms must recognize and preserve our legal rights to the embedded value in its Crown royalty terms contract, which runs till the end of 2015. The Alberta government has established a 90 day period during which to renegotiate the terms.

"The significant increase in Crown royalties is a choice made by the Alberta government to respond to voter demands to extract more revenue directly in the form of royalties as opposed to pursuing the fuller potential of the resource through higher industry investment, which generates several times more in value through economic activity, employment and other benefits than do royalties," said COST CEO Marcel Coutu. "Furthermore, by reducing our industry's profitability, these changes likely will reduce oilsands activity. Some projects may no longer proceed on the same timetable, if at all, and some of the lower grade oilsands resource, which form part of every project, may never be recovered due to a now higher economic threshold."

Oilsands producer Suncor Energy said that while it had not had time yet to study all of the changes, there could be a significant economic impact on the industry. "Suncor recognizes that the oilsands resource we develop is owned by the people of Alberta, and Albertans have the right to benefit economically through royalties," said Suncor CEO Rick George. "However, the royalty regime changes proposed by the Alberta government are substantial and could have a significant impact on industry economics. We will need time to study the changes and their potential impact on our business."

The government outlined plans to work with Suncor to reach an agreement on a transition plan to the new royalty framework. "As an oilsands pioneer and a proud Alberta company, we will work with the government to find the right solution for Suncor and the people of Alberta," said George.

Cuts in gas producer drilling budgets made since 2006 would not be restored next year even if the Alberta government entirely abandoned royalty increases, FirstEnergy Capital Corp. predicted in a research note on the eve of Stelmach's announcement.

Prices are too low, storage is too full and liquefied natural gas is becoming too much of a competitive force to let the bygone Canadian gas drilling boom resume, FirstEnergy said.

"Even without the uncertainty over the royalty review, production companies were already forecasting lower budgets into 2008," the Calgary financial firm said. Producers were believed to be crafting two alternative budgets for next year, one reflecting purely market conditions and the second incorporating anticipated royalty changes. "We believe that for the most part both budgets will be at or below 2007 levels," FirstEnergy predicted.

EnCana Corp. president Randy Eresman, whose firm threatened to cut US$1 billion out of its Alberta spending if the royalty inquiry's report was enacted, confirmed that gas drilling would not revive quickly in the province that accounts for four-fifths of Canadian production.

"Industry needs sustained prices higher than we are currently seeing to bring on new production," Eresman said in releasing EnCana's third-quarter financial statements.

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