Alberta’s resource royalties

Just on the heels of posting a $9 billion surplus for the last fiscal year, largely on the strength of resource royalties, comes this fascinating article in The Globe, which echoes comments about low royalty rates that the Edmonton-based Parkland Institute has been making for years:

Alberta eyes greater share of oil wealth

Considers changes to royalty system

Alberta is quietly studying how it could boost its take from the oil sands, as the gap widens between the province’s royalty income and the industry’s revenue.

There has been a growing chorus of calls to rewrite the decade-old rules for the oil sands and boost royalty rates, which critics say amounts to a massive subsidy of an industry enjoying huge profits.

So far, the provincial Conservative party has rejected those demands for a radical overhaul of the fiscal regime, put in place in the mid-1990s with the aim of spurring investment by lowering royalties. Premier Ralph Klein loudly proclaimed earlier this month that the province is not engaging in a wide-ranging royalty review.

Behind the scenes, however, Alberta is examining small, but crucial, changes to the royalty system that could shift tens of millions of dollars, perhaps hundreds of millions, from industry profits to the province’s coffers each year.

It might seem paradoxical that Alberta is concerned about losing out on royalties at a time when oil is selling for more than $70 (U.S.) a barrel, and the province is awash in energy revenues. Although the oil sands account for a quarter of Alberta’s production of oil and gas, they make up just over a tenth of its total income from non-renewable resources, a reflection of the extremely low royalty rates much of the sector is currently paying.

In addition, most oil sands projects do not pay royalties on expensive crude oil; instead, they pay the levy on much cheaper bitumen, which this winter sold for less than $40 a barrel.

That discrepancy has caught the eye of the Alberta government, which is now trying to determine why bitumen is selling at such a steep discount — and whether it needs to intervene to increase its revenue from the oil sands.

… In the early years of an oil sands project, Alberta skims only a small part of the value of a barrel of bitumen. In a model based on oil costing $42 (U.S.) a barrel, Scotia Capital projects a Canadian selling price of just over $54 (Canadian), for an integrated mining project with an upgrader facility. The vast majority of the proceeds goes to private industry. Even so, the steep fixed costs of those projects means that those profits translate into an annual return on capital of just over 17 per cent — enough to justify an investment, but lower than other opportunities in the global energy sector.

A barrel of bitumen that sells for $54.23 brings the Alberta government only 25 cents.

Missing from the text is a chart showing that, of the $54.23, $16.59 represented operating costs, $1.85 excavation and other costs, $2.10 ongoing capital costs, and a whopping $33.43 operating margin (profits). Ching, ching.

How it works . . .

A decade ago, Alberta scrapped a welter of special deals with oil sands projects in favour of a generic royalty regime. Here are the basics of that structure:

Projects pay 1 per cent of gross revenues in their early years, until they have earned profits equal to their capital costs, an event called payout.

At payout, the royalty rate rises to 25 per cent of net revenues, for an eight- to tenfold increase.

Unlike the royalty structure for conventional production, oil sands projects do not pay a higher rate as prices rise.

Project operators can choose to pay royalties on either raw bitumen or upgraded synthetic crude. If royalties are paid on bitumen, an operator cannot include the capital expense of upgrading, which means the payout point will arrive sooner.

New capital investment can delay payout for a project, but only if it is deemed to be part of the existing operations.

The terms apply to all new projects. The two operators in business in 1996, Suncor Energy Inc. and Syncrude Canada Ltd., will be able to move to the generic regime toward the end of this decade.

By the numbers . . .

1

The royalty percentage rate applied to gross revenues in the early years of an oil sands project

10

The maximum factor by which royalties rise after a project exhausts capital-spending credits

40

The top royalty percentage rate paid by conventional oil producers

2020

Year by which oil sands investment would reach $25-billion, according to 1995 projections

2003

Year that goal was reached

$14.9-billion

Oil sands sector revenue in 2004

$700-million

Oil sands royalties paid, 2004