Conoco Phillips Response

ConocoPhillips Canada

September 26, 2007

Alberta Royalty Review

ConocoPhillips Canada

ConocoPhillips Canada (“CPC”) is one of the country’s largest oil and natural gas production and
exploration companies. Headquartered in Calgary, Alberta, we are a top three producer of natural gas in the country, with a world-class portfolio including assets in western Canada, the Arctic, Atlantic Canada, and the Alberta oil sands.

CPC is a significant contributor to the Alberta economy. In 2006 we:

• Paid $1.2 Billion in royalties,
• Invested $3.5 Billion in Alberta’s economy (capital, exploration and operating),
• Paid $169 Million in taxes,
• Provided jobs to 2,100 Albertans and hundreds of contractors,
• Paid $50 Million in municipal property taxes, and
• Made charitable donations of $6 Million to Alberta’s communities.

Our Response to the “Our Fair Share” Report

On September 18, the Government of Alberta released ‘Our Fair Share: Report of the Alberta Royalty Review Panel’ (“the Report”). The Report claims that its recommendations would see an increase in Government take from oil and gas developments in Alberta, while continuing to ensure that the Province attracts capital for future developments.

As a participant in the Panel’s June 19th public meeting, we would like to continue our dialogue on these complex issues in order to reach the best decision for all Albertans. We have now completed an assessment of the Report and offer our observations in this white paper.

We believe that the Report’s recommendations, if fully implemented, will threaten continuing investment in the Province, undermine the tremendous growth in the Alberta economy over the past 10 years and lead to a substantial loss of jobs in Alberta.

We believe that Albertans want a healthy rate of economic growth, a low level of unemployment, sustainable development and a fair return from their natural resources. For the following reasons, it is our view that the Report will upset this balance to the detriment of Albertans.

The analysis in the Report is flawed

• The recommendations are based on misleading comparisons. The Panel based its conclusions on a comparison of government take in Alberta to other jurisdictions. The development of a well functioning royalty regime must consider not only the level of government take, but must also assess relative geological risk, costs, economic return, and access to capital. The Report’s attempt to benchmark Alberta is misleading as it fails to appropriately consider the relatively high cost, low reserves, and rapid decline rate inherent in the Western Canadian Sedimentary Basin and the true cost and multi-decade commitment of oil sands development. Direct comparison against other jurisdictions without proper consideration of their vastly different economic returns has led to flawed conclusions.

• Contrary to claims, all gas wells will pay higher royalties. While the Report states that 82% of gas wells will pay reduced royalties, our analysis indicates that at break-even prices ($7-$8/mcf AECO i) all gas wells would incur a higher rate royalty under the recommendations. Only at uneconomic prices in the $4/mcf range do lower productivity wells deliver lower royalties. Accordingly, the recommendations threaten to drive thousands of marginal wells below the economic threshold and potentially remove them from the Province’s royalty base.

• The recommendations will make most Deep Gas wells uneconomic. In 2006, the provincial government reaffirmed a Royalty Adjustment Program to encourage investment in marginal Deep Gas wells. This program is working, with approximately 1,500 Deep Gas wells drilled each year at an average cost of $3 to $5 million per well. The recommended termination of this program threatens ongoing multi-billion dollar capital investment, along with its associated jobs and royalties.

• The Oil Sands Severance Tax ("OSST") threatens marginal projects. This super-royalty is based on revenue with no consideration given to cost or profitability. It represents a huge cash drain for start-up projects at a time when they are trying to recoup investment. The OSST is triggered well below the break-even price and will result in marginal projects being burdened, on a relative basis, more than robust projects. The OSST dramatically erodes the value of many oil sands projects and will lead to project cancellation or postponement.

• The Recommendation on bitumen value is not based on the laws of supply and demand. The proposed artificial Bitumen Valuation Methodology is in direct contravention of the Panel’s goal to “minimize distortions in economic activity and investment”. Global markets and international transfer pricing are based on market driven valuations of commodities. Given the foreseen step change in bitumen production, Alberta will be able to rely on an efficient and established bitumen market that will fairly represent value. Furthermore, any attempt to artificially impact a market may come under the scrutiny of international trade agreements.

• The Report incorrectly suggests that the Oil and Gas industry has direct control over their costs. In reality, an increasing percentage of total industry costs are driven by the global market. For instance, the infrastructure dependent oil sands developments are very sensitive to the escalation in global steel prices and fluctuations in the demand for modular fabrication.
The Report ignores the economic realities occurring in Alberta today

• The Report fails to appropriately incorporate the industry’s future cost profile that will form the basis of all future investment decisions. Our current royalty base benefits from lower historical costs, but future production is burdened with rising costs that have outstripped commodity prices and now pose a significant risk to future investment.

• Drilling activity in the Western Canada Basin is at a five-year low. The Canadian drilling rig fleet is at 43% utilization and a permanent slowdown of this magnitude would impact some 37,500 direct field workersii. The 29% decline in licensing activity since last year is a further indicator that marginal projects are no longer considered economically viable. Knock-on effects from this declining activity will impact the overall tax base of the Province as sector revenue declines for individuals, service companies, and indirect businesses.

• The Report understates cost estimates and inflation, and fails to consider the significant impact of the rising Canadian dollar. Since 2002, Western Canada Basin capital costs have risen over 100%iii, and the dollar has risen from C$0.62/US$ to parity, an increase of over 60%. Similarly, our experience shows that the cost to build a SAGD project without upgrading is outside of the Report’s quoted range of $11,400 to $25,650 per flowing barrel. Public data also indicates that oil sands mining projects with upgrading are projected to cost closer to $100,000 per flowing barrel rather than the cap of $83,000 per flowing barrel quoted in the Report.

Finally, the industry’s commitment to sustainable development and the reduction of emissions has to be more fully incorporated into the analysis.

The Report fails to consider the significant impact the recommendations would have on future investment in Alberta

• When we layer the true impact of the Report with a current view of costs, it is clear that the recommendations will have a substantial negative impact on Alberta and Canada’s economy. If implemented, these measures will at best slow and at worst eliminate investment. Accordingly, we believe that Albertans will not realize the incremental $2 Billion of royalties sought by the Report as they will end up with a larger piece of an increasingly smaller pie.

Our Recommendations

A change in the royalty regime is possible if it balances all the elements that Albertans require. In order to develop a progressive royalty regime that provides a fair share to Albertans while attracting investment in sustainable development, the government should commission a joint industry/government study to analyze the Report’s recommendations and develop a regime that works for the economic realities faced by Albertans.

Rather than focusing on royalties in isolation, a goal of the review should be the creation of a stable and durable fiscal regime that encourages the long-term investments required to fuel Alberta’s future.

Further consultation is our clear preference and we would be happy to work with the provincial government to develop a progressive fiscal regime. With the magnitude of this decision, leadership must be shown through a measured approach that arrives at the right outcome for Albertans.

Since the tight timeline put forward by the government may not allow for a full consultation process, we request that consideration be given to the following specific comments.

Specific Concerns

• The fiscal terms for existing projects should be honoured. In the spirit of Alberta’s continued fair and equitable treatment of investors, the current deal for existing projects must be maintained.

Western Canada Basin

• The current Royalty Adjustment Program for Deep Marginal Gas Wells should be maintained. The proposed “one size fits all” approach will undo years of work designed at encouraging economically challenged projects to proceed.

• The thresholds for the sliding rate royalty scales need adjustment. If the proposed formula is implemented, the thresholds for the sliding rate royalty scales must be adjusted to reflect current break-even prices so as not to drive projects under the economic threshold.

Oil Sands

• The Oil Sands Severance Tax should not be implemented. It would be more appropriate to modify the existing regime such that it is progressive with the percentage of government take increasing as profitability increases.

• The lease tenure should not be changed. The proposed escalation of rentals after six years does not recognize the long development time required for new SAGD projects. Even portions of the resource that are feasible with today’s technology require approximately 15 years of investment to properly assess the resource, design the project, secure regulatory approvals, and construct the facilities to realize first production. Lands which need technology development require even longer time periods from lease acquisition to first production.

i Ziff Energy

ii Per the CAODC, every drilling rig supports 75 direct field jobs, 37,500 workers = 500 of 870 rigs idle multiplied by 75 field
workers per rig

iii Ziff Energy