Call for bids

On April 7, 2016, the Canada-Newfoundland and Labrador Offshore Petroleum Board announced two Calls for Bids for 2016 (the 2016 Bid Round). Call for Bids NL16-CFB01 comprises 13 parcels and a total of 2,949,252 hectares in the Eastern Newfoundland Region, and Call for Bids NL16-CFB02 comprises three parcels and a total of 354,552 hectares in the Jeanne d’Arc Region.

The deadline for the 2016 Bid Round is November 9, 2016, and as in previous rounds, the sole bid selection criteria will be the size of the work commitment that is bid.

This follows the successful conclusion of last year’s Call for Bids NL15-01EN (the 2015 Bid Round). The 2015 Bid Round resulted in companies bidding over CA$1 billion in work commitments in respect of 11 parcels totalling 2,581,655 hectares. This represented a strong result, particularly in the context of current low commodity prices.

Royalty regime

Immediately prior to the closing of the 2015 Bid Round, the government of Newfoundland and Labrador announced significant changes to its offshore oil royalty regime (the New Regime). The New Regime was to apply on a go-forward basis from November 2015 to new production licenses issued, whether pursuant to exploration and significant discovery licences existing at that time or new exploration and significant discovery licences issued in the future. Existing production licenses remain subject to the previous regime, implemented in 2010. At the time of writing, however, no legislation or new regulations have been issued to implement the New Regime, and at present, it is not clear when the New Regime will come into force.

Notwithstanding uncertainty as to the date and specifics of implementation, the New Regime as announced in 2015 is to be based on an “R Factor”, which is calculated as a ratio of revenue over allowed costs, and comprises two different royalty rates.“Basic Royalty” is payable on gross revenue starting at first production and ranges from 1-7.5%, depending on a project’s R Factor. Upon a project achieving payout, the Basic Royalty is replaced with “Net Royalty”, which is payable on net revenue and ranges from 10-50%. Basic Royalty and Net Royalty are calculated as follows:

Click here to view table.

The New Regime as proposed will represent a significant change in approach when implemented, as it is intended to be a “generic” royalty applicable to all new production, whereas our experience to date in this region has been that royalties have been heavily negotiated on a project-by-project basis. Although the “generic” New Regime is intended to provide a consistent and clear royalty environmental for producers in this basin, we would not rule out negotiated exceptions in certain circumstances.

United Nations Convention on the Law of the Sea (UNCLOS)

As offshore bid rounds move beyond Canada’s 200-mile exclusive economic zone, it remains to be seen how Canada will meet its commitments as set out in Article 82 of the United Nations Convention on the Law of the Sea (UNCLOS). To address these obligations, current offshore bid documents contain a proviso indicating that, “additional terms and conditions may be applied through legislation, regulations, amendments to licences or otherwise” to any licenses granted thereunder.

UNCLOS sets out a 200-mile offshore exclusive economic zone for coastal states, and Article 82 requires coastal states exploiting natural resources beyond their 200-mile zone to pay royalties on production to developing countries. Canada was one of the original coastal state signatories to UNCLOS, which it ratified on November 7, 2003. Certain parcels comprising the 2016 Bid Round are outside the 200-mile zone and therefore production from these parcels could be subject to an Article 82 royalty.

To date however, the International Seabed Authority (the ISA), which administers UNCLOS, has neither collected nor distributed any Article 82 royalties, and is still in the process of developing a regulatory framework in this regard. Further, no commercial production has yet occurred on Canada’s continental shelf outside the 200-mile zone. As such, Canada has neither collected nor remitted Article 82 royalties, nor have the federal or provincial governments implemented a royalty framework to address what Article 82 royalties would amount to in practice. However, Statoil ASA and Husky Energy Inc. have made discoveries in the Flemish Pass basin that are expected to yield significant production to which Article 82 would appear to pertain; this may require a reaction from Canada.

It remains to be seen how Canada will meet its obligations, particularly as the current royalty regimes in offshore Canada are incompatible with UNCLOS. Currently, royalties are collected by and on behalf of the provinces, not by the federal government (which is obliged to collect Article 82 royalties and make remittances to the ISA). There has been no indication from the federal and provincial governments to date regarding: (1) resolution of these apparent inconsistencies; (2) which level of government will be responsible for paying the Article 82 royalty; (3) and whether additional royalties will be imposed on producers in offshore Newfoundland and Labrador in order to offset the cost incurred by Canada in respect of the Article 82 royalty.