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Alberta Cuts Royalties in Bid for Gas Development

The Alberta government reached out Thursday to retrieve a share in the next generation of natural gas supply development by cutting royalties on all types of drilling and giving the industry a chance to make a special case for more reductions for shale projects.

Changes announced by Premier Ed Stelmach and Energy Minister Ron Liepert chop the maximum royalty on all types of gas to 36% from 50%, regardless of how high prices go in the future. In the adjustment rated as most significant for bringing Alberta into the shale era by industry spokesmen, the Conservative regime made permanent a 5% rate for the first year of production by all wells. The pro-drilling incentive was introduced as a temporary counter to slumping prices and field activity last year.

The government also gave industry until May 31 to present arguments in favor of extending the period of the 5% rate for as long as it takes to recover extra costs of deep, complex horizontal wells and hydraulic fracturing injections required for the production from dense rock formations.

Further changes are foreshadowed by the report of a months-long "competitiveness review" that focused heavily on why Canada's share in new unconventional drilling has to date skipped Alberta and gone into northern British Columbia (BC). The review, unlike a 2007 inquiry that led to hotly resisted 2009 royalty hikes, included senior producer and financial figures and was an entirely private affair of consultation with industry representatives.

"Geological estimates show Alberta as possessing a shale gas resource in place -- 1,000 Tcf -- that is comparable to that of BC," the report said. Combined with its remaining conventional natural gas resources of 82 Tcf, coalbed methane resources of 500 Tcf and tight gas resources of 400 Tcf, Alberta is certainly well positioned with good long-term prospects," the review said.

"However, realization of this opportunity is not guaranteed. Deliberate action will be required on a variety of fronts." The review's second recommendation, after an overall demand for the government always to keep competitiveness in mind, is "develop programs if necessary to support strategic initiatives focused on specific resources or technology." Target areas proposed for special action include shale gas and deep drilling.

At the government's current conservative price outlook total royalty reductions for conventional oil as well as all gas types are forecast to be worth an annual C$785 million (US$760 million) to the industry as of the province's 2012-2013 fiscal year commencing April 1. The projected revenue gain is 28% less than forecast by the partially abandoned 2009 royalty hikes, but still C$2.1 billion (US$2 billion) more than the province's take would have been under the pre-reform old regime. About C$1.7 billion (US$1.6 billion) of the anticipated gain comes from increased net-profit royalties on growing oilsands production that was excluded from the competitiveness review because mild changes in the 2009 reform package had no discernible effect on northern bitumen belt projects and were quietly accepted by the industry.

But the government price forecast, while calling for oil's annual average to reach US$89.50/bbl in 2012-2013, officially sees gas languishing at C$5.50/Mcf (US$5.34). Saying prices and production levels have impossible to forecast with any strong confidence, the government refused to estimate the value of the reduced gas royalty rate if markets recover.

The adjustments -- which also included pledges to try accelerating the provincial regulatory apparatus and create a permanent forum for consultations with producer and investor interests -- drew praise from the industry.

"It had to be done. It's positive. It's an improvement," said Dave Yager, chairman of the Petroleum Services Association of Canada and an ally of an emerging threat from the political right to the ruling Tories, Wildrose Party leader Danielle Smith. "They did what they promised -- they engaged with the industry," said Don Herring president of the Canadian Association of Oilwell Drilling Contractors, who also predicted that field activity will likely start showing fresh signs of life by this fall.

In private industry briefings on the adjustments "everybody expressed a view that the process has gone a long way towards establishing a new level of understanding, dialogue and a way of keeping it going," said Gary Leach, executive director of the Small Explorers and Producers Association of Canada. "The government has made -- both in substance and in tone -- a significant change," said David Collyer, president of the Canadian Association of Petroleum Producers.

"These changes will help us use innovation to unlock our energy resources, create opportunities and jobs...and strengthen Alberta's economic recovery," predicted Stelmach. It was left to his energy minister to acknowledge that the 2009 royalty hikes backfired because they were adopted on the eve of the global economic and energy contraction. Liepert said, "we can't pretend that oil and gas investment levels haven't eroded or that we don't have a responsibility to current and future generations of Albertans to address that."

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