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Canada’s NatGas Glut Squeezing Royalties
Over-abundant markets and fallen prices have gutted government natural gas royalties in both of Canada’s main producing provinces, Alberta and British Columbia (BC), according to disclosures by their treasury departments.
The financial bruising has prompted Alberta’s Conservative regime and BC’s Liberal administration alike to lower their expectations with one exception: BC is clinging to high hopes that proposed liquefied natural gas (LNG) exports will more than make up for the North American slump.
As the top Canadian producer, Alberta is suffering the worst revenue deterioration. Statements posted by Finance Minister Doug Horner show Alberta gas royalties shrank to C$345 million in the first nine months of the 2012-2013 fiscal year ending March 31. The performance was $591 million, or 63% poorer than the first three-quarters gas royalty forecast of C$936 million that the Conservatives made in its last spring budget, a buoyant document that they presented before calling an election.
Barring a price spike that no economic analysts see coming, including the province’s own experts, Alberta’s full-year gas royalties for 2012-2013 now are forecast to be about C$460 million, or less than one-half of the budget estimate of $1.2 billion and a stunning 94% below their best performance eight years ago.
The 2012-2013 royalty total would be the lowest in living memory. Natural gas was previously the Alberta government’s cash cow, enabling the treasury to make the province debt-free and stockpile surplus funds in the first years of the 21st century.
Annual Alberta royalties peaked at C$8.3 billion in 2005-2006, when gas averaged C$8.42/MMBtu after Gulf of Mexico hurricanes blew up fears of shortages by damaging production, which inflated prices across North American markets that had not yet heard of shale drilling and hydraulic fracturing.
During the province’s flush years of 2000-2008, the treasury collected a total of C$52.7 billion in gas royalties, which averaged C$5.8 billion per year. More than half of the bonanza arrived from the United States. Up to 60% of Alberta production went into pipeline exports. The chastened Conservative regime has lowered its forecast for the 2012-2013 average Alberta gas price to C$2.26/gigajoule (GJ) (US$2.37/MMBtu) from its budget prediction of C$3.00/GJ (US$3.15/MMBtu).
Besides poor prices, the treasury’s gas revenues are being eroded by falling production and a sliding-scale royalty structure that amplifies market lows. From the provincial government’s vantage point, not only does the total revenue pie shrink, the share that the treasury takes simultaneously shrivels because the royalty percentage rates automatically go down as prices and production drop.
The BC government is suffering from the same gas revenue shock as Alberta but on a smaller scale, based on the numbers in the 2013-2014 provincial Liberal budget presented by Finance Minister Mike de Jong last week. Royalties are projected to stay at modest levels of C$282 million in 2013-2014, C$318 million in 2014-2015 and C$359 million in 2015-2016. For the current 2012-2013 fiscal year, gas royalties are coming in at C$144 million, down 64% from the original provincial budget forecast of C$398 million.
Like Alberta, BC has lowered its gas price expectations. In BC’s case, the forecast figures are even lower because remote and expensive production locations reduce the net prices that the industry and government see for purposes of counting total revenues and the shares that each receive. BC coined a phrase for the exercise: “forecast prudence.” Instead of counting on an arithmetic average of annual forecasts by financial and industry analysts to come true, the government will collect their reports and set a target in the lowest 15th percentile of their range of projections.
For BC, the new procedure lowers government gas price forecasts by 19%. Anticipated royalties drop by C$224 million over the next three years. The lowered projections of annual average BC prices are C$1.46/GJ (US$1.53/MMBtu) for 2012-2013, C$1.85/GJ (US$1.94/MMBtu) for 2013-2014, C$2.25/GJ (US$2.36/MMBtu) for 2014-2015 and C$2.65/GJ (US$2.78/MMBtu) for 2015-2016.
In the new fiscal year that begins April 1, gas royalties will only be 0.7% of BC’s total anticipated provincial government revenues of C$42.5 billion. Unlike Alberta, where oil and gas revenues amount to as much as 40% of provincial revenues during highs on the energy price cycle, BC relies heavily on income and sales taxes. De Jong’s new BC budget anticipates zero revenues from LNG exports over the next three years, but it includes expectations of netting gains from LNG exports along the Pacific Coast at Kitimat and Prince Rupert.
The BC budget documents recite results of revenue potential studies that the government commissioned from accounting firms, Ernst & Young and Grant Thornton. The consultants’ forecasts, while vague in a wide range, unanimously foresee colossal accumulations of new provincial wealth from LNG exports: C$79 billion to C$185 billion over the first 20 years of the proposed tanker sailings.
The prospects have prompted BC’s Liberal government, which is due to call an election this spring, to promise creation of a “Prosperity Fund.” The political promise holds out hopes of pouring up to C$100 billion over 30 years into the proposed provincial savings account, which is a variation on the Alaska Permanent Fund and an Alberta version called the Heritage Fund for accumulated royalty surpluses.
In BC’s case, the government foresees the gravy train as becoming rich enough to go beyond royalties as the primary source of treasury income by adding a special LNG revenue regime. The proposal remains only a vague phrase in sketchy government documents, and wary leaders of the Calgary-based Canadian gas industry are warning BC to hold its tax regime down to an internationally competitive level as discussions on possibilities begin.
Observers with an eye for the fine print in government documents — including research staff in the BC opposition parties, Conservatives on the right and New Democrats on the left — are describing the vision as building castles in the air.
Although the National Energy Board has granted long export licenses to three LNG export terminal projects, none have landed Asian contracts, begun construction or set firm target dates for shipments to begin. Sunset clauses in the licenses give project sponsors at least 10 years to start tanker sailings. BC’s glowing LNG outlook is built on rapid terminal construction swelling annual provincial gas royalties into a range of C$4 billion to C$9 billion.
The projections also rest on past forecasts that Asia will remain a promised land of premium-priced markets, tying gas to oil. Wary industry observers point out that the BC vision increasingly looks like a case of looking ahead through rose-colored glasses, in light of evidence that prospective Asian customers for the growing lineup of Canadian and U.S. export terminals are trying to change the market by seeking to index LNG prices to North American gas prices.
At the same time as BC talks about potential new revenue sources, the Canadian Association of Petroleum Producers is asking the federal government to grant a special capital cost allowance that would enable accelerated write-offs of LNG terminal construction expenses, in the name of staying competitive with projects in the U.S. and Australia. BC government documents, prepared using forecasts that predate the latest international market developments, make a glowing prediction: “Over the longer term, global LNG prices are expected to be about 2.5 times higher than average domestic natural gas prices.”
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