Royalties should be the Keystone of Saskatchewan’s Petroleum Policy

The Saskatchewan Party has appropriated the province’s name, flag and football team. More recently, it asserted a new symbol of Saskatchewan patriotism: the proposed Keystone XL pipeline. Earlier this year, provincial energy and resources minister Tim McMillan had the following letter in Regina’s Leader-Post:

Province Needs XL (January 28, 2013)

I write in regard to recent Leader-Post coverage of the Keystone XL Pipeline. As Saskatchewan’s minister responsible for energy and resources, I strongly support this project as it has considerable benefits for Saskatchewan’s oil industry and the people of this province.

Saskatchewan crude oil receives a price based on the West Texas Intermediate (WTI) price for barrels of light oil. For 2012, this price was around $18 less than the Brent price for internationally traded barrels of light oil. This $18 WTI-Brent discount is in addition to the normal discounts from WTI (a light oil) faced by Saskatchewan’s heavier crudes and additional transportation costs to market. This additional WTI-Brent $18 discount has a significant impact on Saskatchewan. It is caused by transportation bottlenecks that are addressed by Keystone XL.

In a recent report, CIBC estimated that Canadian oil industry loses $18 billion a year because of the WTI-Brent oil price differential. The discount between WTI and Brent directly cost the industry in Saskatchewan approximately $2.5 billion in 2012. As a direct result, the Saskatchewan government is missing out on up to $300 million a year in revenue. When you consider the cost of building a new school, this unrealized revenue alone could fund the equivalent of 15 elementary schools.

The government refuses to sit by while Saskatchewan residents lose out on $300 million a year due to a lack of pipeline infrastructure. It is imperative that we ensure Canadian oil can take the safest and most efficient route to market.

Tim McMillan
McMillan is Saskatchewan’s minister responsible for energy and resources.

This spring, Premier Wall went to Washington to promote Keystone XL and accused federal NDP leader Tom Mulcair of “betraying Canadian interests” by answering a question about the proposed pipeline in Washington. I responded with the following Leader-Post letter:

Keystone XL: Issues and Ideas (March 25, 2013)

Premier Brad Wall says Saskatchewan needs the Keystone XL pipeline because it would increase annual provincial revenues by $300 million. But the province does not control whether this international project will proceed. If the goal is to collect more resource revenue, Wall should focus on what he can control: the provincial royalty structure.

Energy and resources minister Tim McMillan explained the “up-to-$300-million” estimate in his Jan. 28 letter, “Province needs XL”. The pipeline would transport little, if any, Saskatchewan oil. However, the Saskatchewan Party government assumes it would raise western Canadian oil prices enough to boost the value of the province’s existing oil production by $2.5 billion, of which royalties would collect 12 per cent ($300 million).

Although Keystone XL’s projected effect on oil prices is open to question, it is true Saskatchewan’s royalties currently amount to only 12 per cent of oil sales. The province should strengthen its royalty regime to collect a better return, whether or not this pipeline is approved. If higher oil prices were to deliver a $2.5-billion windfall to companies extracting the province’s oil, the people of Saskatchewan should receive more than $300 million of the gain.

Erin Weir
Weir is an economist with the United Steelworkers union’s national office and was a candidate for Saskatchewan NDP leader.

Mulcair was in Saskatchewan last month and did not endorse Keystone XL, prompting another freak out by Wall. I had the following letter in last week’s Leader-Post and a similar one in the Saskatoon StarPhoenix:

Revenue Loopholes (September 23, 2013)

Murray Mandryk’s Sept. 13 column correctly observed that the Saskatchewan Party is “incredibly hawkish on Keystone XL.” How did a proposal to pipe bitumen from Alberta’s oilsands to American refineries become the litmus test of Saskatchewan patriotism?

In a Jan. 28 letter in this newspaper, provincial energy and resources minister Tim McMillan noted that West Texas Intermediate, the benchmark price for oil in western North America, had been $18 lower than Brent, a benchmark price for offshore oil.

He posited that building a pipeline from Western Canada to the U.S. Gulf Coast would eliminate that price difference, yielding up to $300 million of additional royalty revenue for Saskatchewan.

Since then, the gap between West Texas Intermediate and Brent has narrowed to $4 without Keystone XL. Even accepting McMillan’s assumptions, current prices mean that additional pipeline capacity to tidewater would be worth less than $70 million to Saskatchewan’s treasury.

Nevertheless, in the Sept. 10 press release that Mandryk references, McMillan demanded that New Democrats swear allegiance to Keystone XL. Ironically, the following headline was printed in that day’s Financial Post: “Rail, rival lines making Keystone XL redundant.”

McMillan could collect far more provincial revenue by closing loopholes in the royalty structure for which he has ministerial responsibility. For example, Saskatchewan currently charges a royalty of just 2.5 per cent for the first 38,000 barrels of oil extracted from each new horizontal well on Crown land. Are special incentives for horizontal drilling needed three decades after it became common practice?

Erin Weir
Weir is the United Steelworkers union’s Canadian economist and was a Saskatchewan NDP leadership candidate.

With horizontal wells accounting for most of Saskatchewan’s drilling, these incentives are probably the largest loophole in the province’s petroleum royalties. Another loophole set to expand is the special royalty regime for “enhanced oil recovery”: 1% of gross revenue until project payout and 20% of net revenue after that.

On September 26, The Leader-Post and StarPhoenix reported that carbon capture and storage could boost the annual value of Saskatchewan’s enhanced oil recovery (EOR) to $2 billion by 2025:

“We forecast EOR revenues (from CO2 injection) in excess of $2 billion by 2025,” Craig said, adding that government also receives increased tax and royalty revenue from the incremental oil production from EOR. For example, ICON estimates provincial royalties from EOR production at about $180 million a year and taxes at close to $100 million a year by 2025.

The forecast gross royalty rate of only 9% – $180 million out of $2 billion – implicitly assumes that projects will be effectively ring-fenced and that most will be subject to the post-payout rate. But as long as a producer can characterize additional EOR investment as part of an existing project, it will pay a royalty of only 1%.

I do not know whether carbon injection will generate $2 billion of enhanced oil recovery a decade from now. If it does, the people of Saskatchewan should collect substantially more than $180 million of royalties and $100 million of taxes.