Alberta raises royalty rates but rejects oil sands tax

Oct. 26, 2007
Alberta will raise royalty rates on production of oil, gas, and oil sands—but not by as much as a provincial advisory panel recommended last month.

By OGJ editors
HOUSTON, Oct. 26 -- Alberta will raise royalty rates on production of oil, gas, and oil sands—but not by as much as a provincial advisory panel recommended last month.

A key departure from the controversial recommendations in what Premier Ed Stelmach labeled "the New Royalty Framework" is elimination of an oil sands severance tax (OSTT).

According to the government, the new framework will increase royalty receipts by $1.4 billion in 2010, 20% above the level projected for current regime but $500 million less than the increase estimated for the recommendations of the Royalty Review Panel (OGJ, Oct. 1, 2007, p. 25).

Those recommendations triggered a flurry of objections from oil and gas producers, who warned they would suppress already slumping gas drilling and discourage oil sands investment (OGJ, Oct. 8, 2007, p. 32).

The framework
The new royalty framework takes effect at the start of 2009.

In place of the OSST, it will raise the royalty rate on oil sands production both before and after operators recover initial costs (payout).

At present, the prepayout oil sands royalty is 1%. The new rate will be 1% until the crude price reaches $55/bbl and increase in steps to a maximum of 9% when the oil price is $120/bbl or more.

The postpayout royalty, now 25%, will begin at that level and increase as the oil price rises above $55/bbl to a maximum of 40% at $120/bbl.

The government is in discussing participation in the new system with Syncrude and Suncor, whose oil sands mining projects are subject to royalty agreements expiring in 2016.

By June 30, 2008, it plans to have adopted a permanent, generic method for setting bitumen values for projects with low third-party sales.

The government rejected a recommended 5% upgrader credit envisioned as an inducement to build bitumen upgraders in Alberta, saying it would consider "other options."

For conventional oil and gas, the government will replace multitier systems with unified, elevated rates that vary with price and production rates, eliminating most special programs and vintages.

Oil royalty rates will rise to a maximum of 50% at an oil price of $120/bbl. The current oil maximum rates are 30% for the old tier and 35% for the new tier under lower price thresholds.

The maximum gas royalty will rise to 50% from the current 35%, and tiers will be eliminated.

The government retained and will revamp its deep-gas drilling program and will apply lower royalty rates over a wide price ranges for wells with limited productivity.

It also retained a program that eliminates royalty on gas that would be flared without the incentive.

Balanced response
One early response to the framework was balanced.

"Overall, the impact of the government's proposals will have a significantly less serious impact on oil sands economics than the panel's recommendations, although the industry is likely to remain concerned about the increase in prepayback take that the increase in base royalty implies," said Derek Butter, head of corporate analysis for Wood Mackenzie Ltd., Edinburgh.

The consultancy estimates the new system will reduce the net present value of current and planned oil sands projects by $10 billion (US) at a long-term, inflation-adjusted Brent crude price of $50/bbl. It estimated the value decline under the Royalty Review Panel's recommendations at $26 billion.

"From the point of view of new project development economics, the new royalty framework clearly recognizes the high break-even costs that the industry faces in the current operating environment," Butter said.

"We believe that there is a much reduced chance of the cancellation of proposed oil sands projects under the new framework than under the panel's proposals."