Alberta’s oil patch relieved at results of royalty review

04 February 2016 Week 04 Issue 389

Alberta’s oil producers are breathing easier after a provincial government royalty review left rates unchanged – at least for now.

After eight months of uncertainty, oil companies were pleasantly surprised to find that they would not be subject to higher payments and may in fact qualify for credits after the provincial government announced details of its new royalty framework on January 29. The announcement took almost everyone – industry supporters and critics alike – by surprise. Most had been expecting the government to hike rates at a time when industry could least afford it.

Instead, most oil companies may qualify for royalty credits provided they can reduce costs.

Royalties are not taxes, levies or fees. Rather, they are a share of production that amounts to “economic rent” for the owners of the resource, which is the Crown or the people of Alberta. These are publicly owned resources. The government relies on royalty payments for nearly half of its revenues, which are used to fund public services to build roads, hospitals and schools. By definition, they are volatile, based on the oil price. In the past, the issue of oil and gas royalties has been extremely divisive and required a balancing act between reaping the rewards when times were good and encouraging development when times were bad – as they are now.

The move marked a shift for a government that had campaigned on a promise of ensuring that Albertans received their “fair share” of resource revenues in the run up to the May 2015 elections that saw the left-leaning New Democratic Party (NDP) topple the Conservatives, who had been in power for 44 years. Instead, a panel concluded that Albertans were already receiving their fair share and recommended that the government stick to nominal rates. This means there will be no increases in oil sands royalties or in those for conventional oil and gas wells drilled prior to 2017. 

The changes agreed will not affect any existing wells for a period of 10 years. New wells drilled after next year will be subject to a flat 5% royalty until costs are paid out, whereupon they will be charged escalating rates based on oil prices – similar to what is currently in place.

The difference is in the details and it is a subtle one.

Whereas the previous royalty system was based on net profits, the new framework is based on gross revenues. Canada is home to some of the highest-cost barrels in the world. There was a concern –especially in the oil sands – that calculating royalties on profits after deductible costs encouraged inefficient growth based on hyper-inflated cost numbers. Now, the government is hoping to implement a more transparent process that will erase those doubts.

The government is also hoping that incentives to reduce those costs will provide more revenue and thus more royalty payments down the road. Credits will be based on benchmarked averages that will be made public. Companies that beat the curve will be entitled to lower royalties, while inefficient operators will pay more. Details are forthcoming, and Alberta Premier Rachel Notley conceded that it may take several years for those higher payments to materialise.

“Now is not the time for a cash grab” on the industry, she said at a press conference in Calgary, surprising critics and supporters alike. She added that her thinking had changed in the eight months since she was elected. 

For the oil companies, it was welcome news. For her political base of union supporters and environmental activists, it smacked of a sell-out. Oil companies will be allowed to deduct carbon taxes as allowable costs, for example. The Alberta Federation of Labour complained the changes could have come from a right-wing government. Indeed, previous Conservative governments under former premier Peter Lougheed in the 1970s took a tougher line with the oil companies when prices were high.

Then, as now, diversification remains a priority. A separate addendum will see credits granted for new petrochemical plants. Petrochemical producers do not pay royalties, but they will be allowed to sell credits back to natural gas producers up to a limit of C$500 million (US$364 million). Like the broader royalty framework, the move is aimed at spurring investment and creating up to 4,000 new jobs in an industry that has been hit hard by layoffs.

In isolation, the moves add up to incremental changes that barely rock the status quo. But taken in the totality of the government’s climate change policies, they amount to the biggest changes Canada’s energy sector has seen in a generation.

 

Edited by

Anna Kachkova

Editor

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