http://www.canada.com/calgaryherald/news/calgarybusiness/story.html?id=7c661e4b-547a-4476-8186-0d6bec3ca836
'Fair share' flirts with breach of contract
It might be easier to understand the sound and fury emanating from the oilpatch if last week's recommendations by the royalty review panel are viewed in the context of three discrete segments: oilsands, conventional oil and natural gas, and land sales.
From the oilsands perspective, the most troubling aspects of the panel's report have to do with the suggestion that there be no grandfathering for existing projects under a new royalty structure.
From a legal standpoint, this could be construed as a breach of contract.
Or as Canadian Natural Resources vice-chairman Murray Edwards pointedly acknowledged last week with respect to the company's multibillion-dollar Horizon oilsands project: "We believe we have a contract in place for that project."
Energy companies that buy the right to explore and develop lands pay an upfront cost to the government. There are three basic elements that have to be in evidence for a contract to exist: offer, acceptance and consideration. Companies that own the leases effectively have a contract to develop them under existing conditions.
Nowhere does the fine print say the government reserves the right to change its mind once the process is underway.
Moreover, there is a history in legislative practice that embraces grandfathering as a principle. Think of this in the context of budgets brought forward by governments; it's tough to find instances where taxes have been levied retroactively. Generally speaking, legislative principles suggest applying tax changes on a go-forward basis, not a retroactive one.
The notion of levelling the playing field by eliminating any sort of grandfathering is false; most people take the definition of a level playing field to mean that everyone knows the rules and there are no exceptions made.
The other issue regarding the oilsands that is causing great consternation is the proposed severance tax. Not only does it add another layer of complexity -- even though the report states its aim is to make things simpler -- it's simply a bad idea.
That's because it effectively renders any oilsands project that does not have an upgrader associated with it, uneconomic. The prices received for bitumen are not as high as they are for the upgraded product; add another layer of tax starting when oil is at $40 or higher, and getting a reasonable rate of return given the current cost structure is next to impossible.
As Richard Lewanski, former chief executive officer of Atlas Energy and Amber Energy, points out, if the government wants to capture a bigger share of oilsands revenues, the most prudent move would be to add an element of price sensitivity to the existing structure, much like what currently exists with conventional oil.
"Keep the existing one per cent and 25 per cent in place, but tie the 25 per cent rate, which is triggered when a project reaches payout, to the oil price. This means that it would be 25 per cent up to a certain price, increase incrementally after oil prices pass through certain thresholds, and be capped at a fixed price," said Lewanski.
If the oilsands represent the long-term revenue stream, the conventional production of oil and natural gas represent the current and short-term end of the curve. The numbers suggest that in total this segment of the industry would bear the brunt of the changes -- increasing by $1.2 billion in 2010, compared with $666 million for the oilsands.
From the natural gas standpoint, the number of wells that would fall under the low-productivity category account for about six per cent of total production in the province. The net effect is that the more prolific wells are the ones that will be penalized from a royalty standpoint, which in turn, will decrease the incentive to reinvest in Alberta.
Industry types point to all sorts of challenges that exist today for companies looking to explore in a mature play like the Western Sedimentary Basin -- costs are higher, prices have fallen -- if things looked so good here, there would be more interest shown by foreign players in exploiting Alberta's natural gas prospects.
Instead, with the exception of the Abu Dhabi National Energy Co., precious little has happened in the context of companies looking to set up shop here since the U.S. companies, who made big bets on natural gas between 2000 and 2002, have since left.
The same applies to the world of conventional oil. The proposed changes effectively boost royalty rates -- even for low productivity wells. And all this means is that the amount of money realized per barrel to reinvest will fall, decreasing what will be reinvested in the sector from existing levels.
Indeed, numbers published by U.S. research firm John S. Herold show returns from Canadian conventional production -- both oil and natural gas -- at 12 per cent. That's dead when compared to a universe of 16 energy-producing countries.
In case the government needs a reminder, capital is mobile; it flows to where the returns are highest. Moreover, the bigger companies tend to be structured along distinct business lines and compete for dollars internally. Anyone with interests outside Alberta is going to be looking at putting that money to work elsewhere.
Finally, the conclusion that a $2-billion bump in additional monies if the report is accepted in its entirety is virtually impossible.
Hike up royalties and there will be an accompanying drop in land sales that could reach as much as $2 billion.
This would not only negate any positive impact from the perspective of enhancing the provincial coffers, but it would put the entire exercise into a Macbeth-like, Shakespearean context; a tale full of sound and fury, told by a group of people who did not understand what they were saying, and ultimately, signifying nothing.
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