Alberta rethinks royalties; Hike in rates may deter investors as federal initiatives put pressure on oil sands

Posted May 17, 2007 in [Energy]

Heather Scoffield & David Ebner, May 14, 2007, TORONTO and CALGARY -- Conditions in Alberta's energy business have changed considerably since last fall's leadership campaign to replace Ralph Klein as premier, and talk of raising royalties needs to be considered in a new light, says provincial Finance Minister Lyle Oberg.

While Mr. Oberg is adamant that he is not prejudging a public review of the royalty regime that continues today in Edmonton, he warns that the oil sands are facing significant pressures on their profits, and a hike in royalties may render paltry rates of return for new investors.

"The world is very different now than when we started the panel," Mr. Oberg told The Globe and Mail's editorial board at the end of a tour to speak to investors in New York and Toronto.

In the 2006 race to replace Mr. Klein, all the candidates, including Mr. Oberg, adopted a call for a royalty review, sensing public pressure, but no one advocated a higher take for government. Now, Mr. Oberg pointed out that oil and natural gas companies have been hit by various federal Conservative government initiatives, such as Ottawa's move to tax income trusts, a loss of a small tax break for oil sands operators, and new rules on greenhouse gases.

Mr. Oberg, adopting the argument used by industry executives, argued these measures in sum cut significantly into companies' rates of returns, estimating that the loss of the tax break and climate changes measures could cost as much as $3 a barrel.

However, financial analysts, such as UBS Securities Canada, have estimated the impact would be smaller, and stock of oil sands firms such as Suncor Energy have climbed in the past two months as the measures have been introduced.

Even before the new measures, Mr. Oberg said the economics of an oil sands project, even at $55 (U.S.) a barrel, were mediocre, with projected return of 9 per cent. In a speech in Toronto last Thursday, Mr. Oberg said higher royalties could deter investors.

The key question is the oil sands royalty, which was put in place a decade ago to spark development, and charges just 1 per cent on gross revenues until construction costs are recovered, before rising to 25 per cent revenue minus operating and capital costs.

The review aims to cover the whole fiscal system for oil and natural gas in Alberta, including royalties, money spent for exploration rights and taxes. A report last year by consultancy Wood Mackenzie, done for the Alberta government, found other jurisdictions, such as the energy centres of Texas and Louisiana, get more from oil and gas revenues and profits.

(In the United States, royalties are mostly privately owned while in Alberta they are generally held by the Crown for the public.)

A section of the comparison with U.S. states had been censored in an earlier version of the report, a move that was criticized by Hugh MacDonald, the Liberal party energy critic, in the provincial legislature. In an exchange, Mr. MacDonald pressed for an explanation, to which Energy Minister Mel Knight responded: "You can take a snapshot of a royalty from any place in the world and compare apples to oranges. The royalty structure in the province of Alberta has served Albertans very well for many, many years."

Part of the mandate of the six-member panel conducting the royalty review is to compare Alberta with other jurisdictions. The public sessions began in Grande Prairie in April, continue in Edmonton today, before moving to Calgary, Fort McMurray and Medicine Hat. A final report is due by the end of the summer. The panel is led by Bill Hunter, a retired forestry executive, and includes three economists, a retired oil executive and a technology entrepreneur.

The format has some critics. Pembina Institute, an environmental group, said the bias is towards industry, arguing that a citizens' forum would have worked better.

Mr. Oberg, speaking with The Globe's editorial board, said no one should assume royalties will not go up here and there. The royalty regime in Alberta actually is a combination of various royalties covering different commodity prices and production rates, as well as the age of a well.