Introduction

On March 11, 2010 the Government of Alberta announced a reduction in the royalties payable by producers of petroleum and natural gas wells on Crown lands. The effect of this announcement is to substantially reverse the “Alberta Royalty Framework” (ARF) which was introduced in October of 2007 to ensure that the Province received its “fair share” of the benefits of energy development. The ARF altered the royalty structure to boost the Crown’s take by 20%, which the Government predicted at the time would translate into an extra $1.9 billion a year.

Under the ARF, conventional royalty rates for both oil and gas under the ARF ranged as high as 50%. Not surprisingly, the increased royalties rates caused tremendous consternation in the Canadian oil and gas industry. The introduction of the ARF also turned out to be very ill-timed. Gas producers were suffering from low commodity prices; and gas prices continue to stagnate. The price of oil hit an all-time high in early 2008 but then dropped like a stone before stabilizing in the $70 to $80 range. As a result of all of these factors, exploration and development expenditures declined and the increased royalty rates never translated into the forecasted $1.9 billion or anything like it. On the contrary, many companies voted with their feet by moving their exploration focus to Saskatchewan and British Columbia, both of which had markedly less aggressive Crown royalty regimes.

In November, 2008 the Government introduced “transitional” royalty rates for new gas and conventional oil wells. While not technically imposing a cap on the ARF rates, the transitional program had the effect of capping rates on conventional oil at around 38% and on gas at around 30% for companies electing to participate in the program. In an article published in Energy@Gowlings at the time, John Iredale and Chiara Woods predicted that the transitional program was unlikely to have a substantial effect on the majority of oil and gas producers operating in Alberta. This prediction turned out to be correct.

These transitional royalty rates were shortly followed in March 2009 by the Province’s three-point incentive program. Among the highlights of this program was a 5% royalty rate for the first year of production for new oil and gas wells. However, this program was announced as a temporary measure and did little to persuade the industry to become more active in Alberta.

Features of the New Royalty Reduction Program

The new royalty reduction program is in essence a return to the pre-ARF royalty scheme or an entrenchment of the transitional royalty rates on a permanent basis. Key features of the new regime are as follows:

  1. The temporary incentive policy limiting royalties on new natural gas and conventional oil wells to 5% during the first year of production has been made permanent.
  2. The maximum royalty rate for conventional oil at higher price levels will be reduced from 50% to 40%.
  3. The maximum royalty rate for conventional and unconventional natural gas at higher price levels will be reduced from 50 to 36%.
  4. All royalty curves will be finalized and announced by May 31, 2010.
  5. The transitional royalty framework introduced in November, 2008 will continue until the original announced expiration date of December 31, 2013. Effective January 1, 2011, no new wells will be allowed to select the transitional royalty rates. Wells that have already selected the transitional royalty rates will have the option of staying with those rates or switching to the new rates.

“Competitiveness Review”

The royalty reduction program was part of a “competitiveness review” which the Province announced at the same time, as detailed in a publication titled “Energizing Investment: A Framework to Improve Alberta’s Natural Gas and Conventional Oil Competitiveness”. In addition to the changes to the royalty scheme, the Framework proposes to:

  1. explore ways to recognize and account for the higher costs of new and advanced technologies needed to develop mature fields;
  2. ensure that the development of technologies for enhanced oil and gas recovery remains a priority in the Government’s research strategies; and
  3. create a more streamlined, efficient and effective regulatory system.  

Fiscal and Economic Impacts

The Government predicts that the lowered royalties rates will be offset by increases in land sales, personal and corporate taxes, and jobs, and that there will be a positive net impact on government revenues through 2011/2012. A net decline in government revenues of $363 million is forecast in 2012/2013, when revenues generated by increased activity will only partially offset declines in royalty revenues.

Industry Response

In contrast to the very negative reaction to the ARF in 2007 and the decidedly unenthusiastic response to the transitional program in 2008 and the three-point program in 2009, the oil and gas industry’s response to the new Framework has been positive, with some predicting that more companies will now seriously look at redirecting their exploration activities back into Alberta.

Some industry spokespersons have cautioned that the devil is in the details, and that since gas prices in particular are a long way from the prices which would attach the maximum rates under the new Framework, the shape of the curves still to be worked out by the Government will be absolutely critical.

One point of particular note is that some shale gas developers have indicated that they will now be investing in Alberta because of the lowered royalties rates. Shale gas has become a booming part of the energy sector that has largely bypassed Alberta to date.

Conclusion

The Government’s stated goal was to increase Alberta’s competitiveness while realizing the full economic benefits of Alberta’s oil and gas resources by taking stock of new circumstances and market realities. It is still to be seen whether the revised Framework will have the desired effect of fairly distributing the benefits and costs arising from the development of resources between government and industry.