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British Columbia Follows Alberta in Slashing Royalties

August 10, 2009
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The latest economic stimulus package in British Columbia (BC) has taken the form of slashed royalties on new natural gas wells. BC cut royalties to a token, a flat 2% for one year on wells drilled between this September and June of 2010. The move is seen as a way to compete with rival Alberta, which has its own stimulus package for drillers.

On top of granting the temporary royalty break, the package makes permanent adjustments. The depth requirement for BC horizontal wells to qualify for deep drilling rate cuts is reduced to 1,900 meters (6,200 feet) from 2,300 meters (7,500 feet). And royalty deductions for all natural gas deep drilling are increased by 15%.

The province also announced plans to simplify technical aspects of its regulatory regime, including rules for "commingling" gas output from different geological zones and for starting production without changing the legal status of mineral rights exploration assets.

"BC is one of the most competitive oil and gas jurisdictions in North America, and this stimulus package will further strengthen the sector while increasing provincial revenues," said Blair Lekstrom, minister of Energy, Mines and Petroleum Resources. "In this day and age capital investment is very fluid and we want to encourage the oil and gas sector to invest in British Columbia."

Northeastern BC is the location of the Montney and Horn River gas plays, which have been attracting a lot of industry attention. Some speculate that the Horn River could hold Canada's largest-ever natural gas discovery. ExxonMobil Corp. recently spent more than $100 million to acquire land in the area (see NGI, July 13).

The industry is embarking on nothing short of a "gas renaissance" and in Canada, BC is at the forefront, EnCana Corp. Vice President Richard Dunn told an industry conference held in June in Calgary by the Canadian Institute. "I've been working on gas for 30 years. We've never seen such a change." Dunn recited a new consensus forecast that by 2020, shale development will double or triple BC production into a range of 6-9 Bcf/d, and he speculated that BC could one day surpass Alberta as Canada's leading gas bread basket (see NGI, June 8).

The royalty reduction announced Thursday is seen as a way for BC to compete with rival Alberta, which in June extended by 12 months its own incentive program for drillers (see NGI, June 29). The announcement of the Alberta incentive extension was timed to give gas producers a chance to incorporate the incentives into budgets for the 2009-10 drilling season and possibly increase numbers of wells planned. In Canada, field activity peaks during the coldest months because the industry relies on frozen ground for moving and operating heavy equipment.

Industry officials applauded the changes, including the mid-summer timing of the announcement to match company planning cycles. BC drilling mostly happens in the coldest months of the year, when heavy equipment can be moved and used on the vast northern muskeg marshlands where most activity takes place.

During a conference call last Friday to discuss quarterly earnings, EOG Resources Inc. CEO Mark Papa said the changes to the BC royalty scheme would positively affect his company's plans in the Horn River. EOG last year said it had accumulated about 140,000 net acres in the play (see NGI, Mar. 3, 2008).

"We've been talking to the BC government in the past few months, and we feel we've gotten something very positive in place in relationship to the Horn River situation," Papa said. "It would be quite a significant royalty stimulus."

BC officials are concerned about the surge in Lower 48 state gas, and the stimulus package would ensure that their province's gas production could compete price-wise in the marketplace, Papa said. "The BC government recognized that Horn River gas was competing with Haynesville, Barnett, Fayetteville [shale] gas, and they are taking very proactive steps," he said. "We're very pleased with the situation as it is, and how it is turning out."

No forecasts of the industry welfare program's costs were released. As in Alberta, such projections are complex and uncertain at best because royalty rates and revenues vary with prices, field activity levels, and types of drilling. The benefits will be repaid after the main rate reduction expires in any case, Lekstrom predicted. Long experience shows that every short-term sacrifice of $1.00 by an incentive program eventually generates $2.50 in new revenue from added wells, he said.

Financial analysts said that Lekstrom's relief program will keep BC in the ballpark in competition for industry spending. The break-even gas price for a typical new BC well drops to C$5.25 (US$4.88) per Mcf from C$5.92 (US$5.50), Peters & Co. estimated. The same well in northern Alberta, under drilling incentives announced last spring and earlier this summer, breaks even at an estimated C$5.48 (US$5.10) per Mcf.

Since the break-even prices are still higher than the current market, no immediate guesses were made about effects of the programs on drilling activity. That still depends on expectations of the market's future, whether drilling targets are deemed to have enough reserves to stay in production until prices revive, and whether producers are financially strong enough to keep on spending in expectations of the recovery.

The package includes four royalty initiatives:

Regulatory initiatives also included in the package are:

The new incentives "offer a little something for virtually all producers that plan to be active in British Columbia," FirstEnergy Capital Corp. observed. As in Alberta, "those able to enjoy maximum exposure to this plan are producers with the financial flexibility to accelerate drilling activity over the tenure of this offering."

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