In response to growing global economic crisis, lower commodity prices and decreased investment in Alberta's oil and gas sector, the Alberta Government introduced a new and optional transitional royalty rate program intended to provide relief from the effects of the Alberta Government's New Royalty Framework (NRF) which became effective on January 1, 2009. Aimed at conventional oil and gas producers, the transitional program is intended to free up capital and encourage the development of new drilling projects. However, due to its limited scope, the transitional program is unlikely to have a substantial effect on the majority of oil and gas producers operating in Alberta which were required to shift to the NRF on January 1, 2009. The transitional program will only apply to qualifying gas and some oil wells drilled after November 19, 2008 with the result that there is no relief for existing wells and no financial benefit to producers, under the transitional program for qualifying new wells, until likely 2010 when any qualifying new wells come into production.
On November 19, 2008, the Alberta Government announced that it would offer new transitional royalty rates for companies drilling new natural gas or new conventional oil wells at 1,000 to 3,500 metres in measured depth. The transitional rates are to be available to eligible companies as a one-time option that will apply to production from January 1, 2009 to December 31, 2013. To ensure all preparatory or drilling work planned to begin from the date of the announcement until the end of the year continues as scheduled, wells that were started between November 19, 2008 and December 31, 2008 were also eligible for the transitional rates. Following a five-year transition period, all companies that choose the transitional rates will switch to the NRF. The transitional rates will have no impact on oil sands projects which were required to shift to the NRF on January 1, 2009.
The NRF, which was announced in October 2007, raises royalty rates on conventional oil, natural gas and oil sands production. Under the NRF, conventional oil and natural gas royalties are based on a single sliding-rate formula with separate elements that account for price and production volume. Conventional oil royalty rates range from 0 - 50% and natural gas royalty rates range from 5 - 50%.
The transitional program does not technically impose a cap on royalty rates on conventional oil production but, practically speaking, the transitional rates are capped at about 38%. The transitional program will treat conventional natural gas production more favourably than conventional oil, capping royalties at 30%. For natural gas liquids, the current flat rate royalties of 30% for propane and butane and 40% for pentanes plus are not affected by the transitional program.
Companies electing to participate in the transitional program must choose to have the rates apply to the entire production from a particular well. As a result, the transitional rates will apply to any associated natural gas production from oil wells that are part of the transitional program in addition to the associated field condensate produced by natural gas wells.
Relative to what it would have collected under the NRF, the Alberta Government forecasts that as a result of the transitional program it will forfeit approximately $172 million in royalty revenue in 2009 and $1.8 billion over five years depending on the number of new wells paying transitional rates, production rates and commodity prices. However, royalty revenue losses as a result of the transitional program, particularly for 2009, are likely to be significantly lower due to the fact that the transitional rates apply to production from new wells which are not likely to start producing until next year and the fact that oil and gas commodity prices have been reduced to levels far below prices forecast in assumptions used in the models for the NRF and transitional program.
Since the NRF was announced, Alberta's energy sector has suffered from a marked decrease in investment as a steady stream of capital has continued to flow across Alberta's borders to British Columbia and Saskatchewan in response to the royalty hikes. Speaking to reporters at a press conference in Edmonton, Premier Stelmach explained that the transitional rates are designed to encourage the development of new drilling projects by helping to ensure that companies have access to the cash flow required to invest in new projects. However, due to its limited scope, the transitional program is unlikely to have a substantial effect on the majority of oil and gas producers operating in Alberta, which were required to switch to the NRF on January 1, 2009. The transitional program will only apply to a nominal number of wells drilled after November 19, 2009. As a result, it will offer no relief for existing wells and likely no immediate or significant financial benefit to producers until 2010 when qualifying new wells come into production. In addition, the transitional program does not affect any oil sands projects, which have already been required to shift to the NRF as of January 1, 2009.
In addition, the significant decrease in oil and gas commodity prices has adversely affected the economics of production rates of return and caused producers to reduce drilling activities.