Saving the Golden Goose

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October 1, 2007

Saving the Golden Goose

By Hal Kvisle, CEO, TransCanada Corp.

The Alberta oil and gas royalty review panel has completed its work, and Alberta's energy industry is anxiously waiting: What will the Alberta government do? Will royalties be raised across the board, will they stay at current levels, or will Alberta introduce a new royalty regime that somehow maximizes industry activity while delivering higher revenues to the provincial treasury?

Certainly, there is a reasonable argument for higher royalties when world oil prices are at record levels. But maximizing royalty income to Alberta's treasury ought to be the secondary objective. The real prize comes from high levels of exploration and production activity in low productivity oil and gas fields, which literally stretch from one end of Alberta to the other.

Oil sands megaprojects are an important contributor to Alberta's economy, and the provincial government must proceed carefully to ensure that approved and committed projects are not shelved as a result of higher royalty burdens.

But the oil sands do not dominate the industry to the extent many people believe: In fact, more than half of all industry expenditures in Alberta are directed towards low productivity oil and gas fields. The conventional oil and gas activity that has driven prosperity in Alberta for more than six decades is still the engine of the Alberta economy. It just takes a lot more effort and money to get our gas and oil out of the ground than it did even 10 years ago.

Alberta's finding and development costs have quadrupled, from about $4 (US) per barrel of oil equivalent (BOE) in 1996 to between $15 and $20 today. And production costs have more than doubled over the same period, from $4 to about $10 today. It now costs between $20 and $30 to bring a BOE of Alberta's conventional oil and gas to market. And that's the average: The thousands of below-average wells that come into production every year must struggle with even higher cost structures.

Global light sweet crude currently sells for about $80 a barrel, but that is not the average price in Alberta where most production is either heavy oil, bitumen or natural gas. Most of Alberta's production sells for $30 to $50 per BOE, well below the global benchmark. With a cost structure approaching $30 per BOE, there is not much room left for higher royalties and taxes.

This does not mean that conventional production is a "sunset industry". Our small oil and gas pools are expensive to find and produce, but there is still a lot of oil and gas in the ground. Under the right terms Alberta can enjoy high levels of conventional activity for many decades to come.
And high-cost production is not necessarily a bad thing. Most of Alberta's high costs flow to Alberta-based service companies, employing thousands of rig hands, fabricators, world-class specialists, truckers and production operators. Less than 15 per cent of industry expenditures occur in Calgary - it's the service centres of Medicine Hat, Red Deer, Drayton Valley, Grande Prairie and Edmonton that really thrive when activity levels are high. And the billions of dollars spent from one end of Alberta to the other are recycled many times in the shops, car dealerships, restaurants, hotels and bars of our province.

A 20-per-cent increase in oil and gas royalties would put another $3 or $4 into Alberta's treasury for each BOE produced. But that incremental royalty burden would render many marginal properties and prospects uneconomic, taking $20 to $30 out of the Alberta economy for each BOE that is left in the ground. Is that what Alberta wants?

Certainly, there is room for higher royalties when oil and gas prices are high. But Alberta must be careful to ensure that higher government takes do not cause thousands of marginal wells and exploratory prospects to fall below the economic threshold. Our industry has become very good at creating huge, broad-based value from marginal activity, recovering enormous quantities of oil and gas that would be left behind in most parts of the world. Our government would be wise to sustain the remarkable industry we have built here in Alberta.

Hal Kvisle is chief executive officer of TransCanada Corp., the country's largest transporter of natural gas. TransCanada is investing several billion dollars to construct a new oil pipeline system to connect Alberta oilsands production to Midwest U.S. markets. The company does not produce or sell either oil or natural gas. The article originally appeared in the Globe and Mail on September 21.

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