Months of uncertainty for Canada’s oil sands industry soon will end. That’s the good news. How uncertainty over the Albertan fiscal regime will end remains, well, uncertain. And that could be bad news far outside the region that leads the world in production of bitumen and synthetic crude oil.
Last February, Alberta Premier Ed Stelmach formed an independent panel to study the royalty and tax regime “to ensure Albertans are receiving a fair share from energy development through royalties, taxes, and fees.” Initially, the panel was to make its final report by Aug. 31. The web site of the Alberta Royalty Review Panel now says recommendations will go to the government by mid-September.
Producers worry
Except where participation terms are onerous and can only improve, producers worry when governments talk about adjusting fiscal regimes. Production investments expose capital to heavy risk for a long time and are sensitive to, among other things, the rates and timing of payments to governments.
For Alberta’s burgeoning oil sands industry, hints of change come at a bad time. Capital and operating costs, which technology had lowered impressively, have spurted lately in a development boom. Profit margins, never lavish in a business with high production costs and low product values, are feeling the squeeze. And the industry faces new uncertainty from federal regulations under development covering emissions of greenhouse gases.
The provincial government knows what’s at stake for Alberta. A fact sheet from the review panel notes the province collected a record $14.3 billion (Can.) from nonrenewable-resource activity in the 2005-06 fiscal year-nearly 40% of all provincial revenue. It projects nonrenewable-resource receipts in 2006-07 of $11.7 billion. Of that, $3.7 billion will be from oil sands royalties and lease bonuses. The panel also acknowledges that bitumen from oil sands will claim a growing share of future production as conventional oil and gas output declines.
In the system under review, producers pay lease bonuses and rentals plus royalties that vary by production type. For conventional oil and gas, the royalty rate depends on variables that include vintage, well productivity, and commodity price. In 2005, average royalty rates were 15% of production for conventional oil and 20% for gas. For oil sands, the royalty rate is 1% of gross revenue until a project recovers invested capital plus a financial allowance. After payout, the royalty rate is the greater of 25% of net revenue or 1% of gross revenue.
According to speculation, the review panel might propose an increase of a percentage point or two in the oil sands royalty rate, possibly accompanied by an easing of the bite on conventional production. Such a change probably would delay some oil sands projects, perhaps permanently. Labor and material shortages already hamper oil sands work. Further delays might poison the economics of some projects.
More important than immediate effects on current plans, however, would be the appearance that Alberta used price elevation as an excuse to grab money. Precedents like that chill investment. The government might avoid trouble by leaving the royalty rate alone and focusing instead, if it must change anything, on how rising costs hurt it along with producers by extending payout periods.
Beyond Alberta
Alberta’s royalty reform is important well beyond provincial borders. Canada isn’t the only place with unconventional oil. It just has a larger identified heavy-oil resource and produces more bitumen than any other country. It thus leads the world in finding solutions to problems heavy-oil producers elsewhere eventually must face, such as lowering inputs of energy-especially natural gas-and water, handling wastes and byproducts, and controlling emissions of greenhouse gases.
Producers should have no quarrel with Stelmach’s assertion that “Albertans must be confident that the royalty structure will meet the needs of the province.” Indeed, if that confidence has weakened then the royalty review is much in order. But there’s more at stake than loonies in the treasury. The oil sands of Alberta aren’t just yielding bitumen; they’re generating knowledge and know-how crucial to future supply of affordable energy. In that, everyone on Earth has an interest.
