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Too Little, Too Late? Alberta Clips Controversial Royalty Plan

November 24, 2008
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The Alberta government last week scaled back its controversial royalty rate plan for natural gas and oil producers, citing job losses and lower energy prices, but the revisions may be too late for producers that already have set exploration budgets for 2009, some to the benefit of neighboring provinces.

A provincial task force last year recommended imposing higher royalties on new and existing projects to increase Alberta's revenue by 20% a year (see NGI, Sept. 24, 2007). The plan immediately led many of the region's producers to begin cutbacks and move drilling plans to nearby provinces. Under pressure, Alberta in April revised the proposal to allow tax breaks for deep drilling projects (see NGI, April 14).

The new royalty regime was scheduled to take effect Jan. 1. However, under the new phased-in scheme, producers that are drilling new wells 1,000-3,500 meters deep will be offered a one-time option to select transitional royalty rates to ensure that they have access to the cash flow needed to invest in new projects. The transitional program would end by Jan. 1, 2014, and at that time the full royalty rate plan would take effect. Only oilsands projects would be required to adopt the new framework by Jan. 1, as scheduled.

The transition phase is designed to encourage "the development of new drilling projects and keeping thousands of Albertans at work," said Premier Ed Stelmach. "This is all about a different world position we're in, in terms of credit...The world has changed, and this is all about creating Alberta jobs."

Phasing in the royalties would cost the province around C$1.8 billion over the next five years, but the premier insisted the changes would not constitute a "royalty holiday."

"In light of the current global financing crisis, governments around the world are taking action to stimulate their economies; Alberta is no different," Stelmach said. "The global chill on credit and capital markets has put serious pressure on Alberta's extraction companies."

The province is "confident that in the long run, the new royalty framework is the right plan," said Alberta Energy Minister Mel Knight. However, "with the impact of the global financial crisis on investment and jobs in Alberta, we need to be flexible to ensure this core economic activity continues and keeps Albertans at work."

Only sketchy details of the transitional formula were released, but government documents indicate that the changes would effectively cut the maximum rate on new natural gas wells to 30% from a previously planned 50%. As an added boost for the industry, the lowered ceiling would be in place for well productivity rates that range from 200 Mcf/d to 1 MMcf/d.

The restoration of cash to the Alberta energy sector is projected to be substantial. Financial analysts who have fought provincial royalty increases for more than a year immediately insisted the changes are too little and too late to prevent deterioration of investor interest in Alberta, but industry leaders applauded the move.

Unless the royalty plan had been changed, the Canadian Association of Petroleum Producers (CAPP) estimated that in 2009 the number of wells drilled in the province would have fallen 30% to 9,500 wells.

"We're encouraged that the government has taken this action," said CAPP President David Collyer. "Directionally, it encourages and stimulates activity, and it's a step in the right direction."

CAPP's David Pryce said the changes may enable Alberta to better compete with Saskatchewan and British Columbia for energy projects. Alberta's neighbors benefited from the original royalty regime announcement, and several of the province's big producers moved some of their exploration and development funds to the emerging basins in the next-door provinces.

Peter Linder, an energy analyst with Calgary's Delta One Energy Fund, agreed that while the latest royalty scheme may not help producers immediately, it could bring more energy money back to the province down the road.

"It puts us more on a level playing field with economics offered in British Columbia and Saskatchewan," Linder said. "It had to be done. I'm glad it was done before Jan. 1 and not the middle of next year."

The Small Explorers and Producers Association of Canada (SEPAC), which represents more than 450 junior producers based in Alberta, cheered the news. "This will certainly help Alberta's home-based junior oil and gas sector," said SEPAC executive director Gary Leach.

"What we're pleased to see is an Alberta government that recognizes that they needed to be a little bit helpful here to the Alberta-based junior sector," Leach said. "While the companies are small, they create thousands of jobs in Alberta with the investment they make mostly in rural Alberta. We still have some other challenges out there, but certainly I think the Alberta government realized they can be part of the solution here instead of part of the problem for the junior sector."

At a news conference to discuss the transitional scheme in Edmonton Wednesday, provincial authorities made note of the rising gas reserves and production in the United States, thanks to previously unexpected and surging development of unconventional supplies led by shale deposits. Speakers this week at the annual meeting of the Canadian Society for Unconventional Gas in Calgary also predicted the new sources tapped by advancing technology could have startling results.

Echoing reports by U.S. energy analysts, AJM Petroleum Consultants' Dave Russum said the United States may be headed for a period of surpluses when productive capacity exceeds demand. For Canadian gas producers, this isn't good news because U.S. market conditions are critical to the Alberta gas outlook in particular and the Canadian industry in general. About four-fifths of Canadian production comes from Alberta, and more than half is exported to the Lower 48 states.

Canadian analysts, reviewing past performance and the possibility of more uncertainties on the horizon, have become increasingly wary of making price predictions. However, Russum was blunt.

"Natural gas prices will reach unimaginable highs and ridiculous lows in the next decade," he told conference attendees. One of his forecasts already has come true. Half a day before the province surprised the industry by announcing its partial turn-about, Russum predicted that "the Alberta government will reduce royalties on natural gas."

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