Blaw 628 - Alberta Oil Sands Royalty Regime

BLAW 628

Alberta Oil Sands Royalty Regime

By

Ashutosh Garga

Submitted to: Prof. Stan Rutwind

December 3, 2009

TABLE OF CONTENTS

EXECUTIVE SUMMARY 3

General Background of the Alberta Oil Sands Regime 4

Origins of the Alberta Oil Sands Royalty Regime 4

Generic Oil Sands Royalty Regime 6

Current Alberta Oil Sands Royalty Regime 7

Key Considerations for Implementing a Royalty Regime 8

CONCLUSION 13

REFERENCES 14

EXECUTIVE SUMMARY

On October 25, 2007, the Alberta government announced its new policy on the oil and gas royalty structure in Alberta. The new policy represents the first major overhaul of the provincial royalty regime in over thirty years. A comprehensive review of the royalty system was necessary due to a significant increase in oil prices and the perception that Albertans were not receiving their fair share from energy development. From 1998 to 2005, oil sands production exceeded forecasted expectations. There was an 80% increase in total conventional oil and natural gas wells, a 74% increase in overall expenditures on oil and natural gas, and finally, a 300% increase in investment in the oil sands. Furthermore, royalty rates and associated formulas were not keeping pace with changes in the resource base, world energy markets, and conditions in other energy-rich jurisdictions. Clearly, the onus was on the government to re-balance the royalty and tax system to ensure a fair share is collected both currently and as future circumstances change. With some exceptions, the province of Alberta forecasts a 20% increase in royalty revenues due to anticipated increases in royalty rates. The announcement has been mired with disappointment by industry and scepticism regarding government estimates of the size of increased royalty revenues. The purpose of this paper is to provide a general background and origins of the Alberta oil sands royalty regime, discuss the generic and current royalty regimes, and recommend key considerations in implementing a royalty regime that is fair and equitable for both Albertans and the oil and gas industry.

General Background of the Alberta Oil Sands Regime

The Alberta government does not currently own, operate, or participate in oil sands projects even though the provincial Crown still retains title to the vast majority of oil sands resources. Instead of direct participation, the Crown operates under a royalty system, whereby it leases the rights to produce oil sands to private entities, and collects rent from the production of the resource. This rental system is commonly known as the Alberta Oil Sands Royalty Regime and is designed to maximize and capture a fair share of the value of mineral and energy resources for the benefit of Albertans. The Crown's share is paid by way of a royalty credit against other oil sands gas production and the bitumen producer's share is paid via an advance from the Crown in the way of a royalty credit, with recovery coming from increased future bitumen royalties after payout of the project. The total value of the settlement is estimated to be $85 million.

Origins of the Alberta Oil Sands Royalty Regime

The origins of the oil sand regime are quite astounding. In an effort to accelerate oil sands expansion beyond 1 million barrels per day by 2020, the Alberta government established the oil sands royalty regime in 1997. Extremely low royalties (25%) were effective in overcoming barriers related to high capital costs and encourage the large investments needed to develop the oil sands. Since 1997, capital investments in oil sands projects have increased more than 400%, oil production has increased 130%, and the price of bitumen has increased 256%. The production goal of 1 million barrels of oil per day from the oil sands was surpassed sixteen years ahead of schedule in 2004. During the 1960s, the complex extraction process and subsequent upgrading of bitumen into a marketable product was not well understood. Eventually, the first large scale commercial oil sands project was launched by the Great Canadian Oil Sands plant, owned by a syndicate of companies who later became oil sands giant Suncor. To encourage innovation and private investments in oil sands projects in the face of these early challenges, the Alberta government imposed a royalty regime in which the Crown shared the inherent risks by accepting a minimum royalty until these projects began to realize profits. Minimum royalty rates on gross revenue ranged from 1% to 5%. Royalty on net revenues ranged from 25% to 50%. Specific development, operating and capital costs were permitted and some gas royalties were waived. However, as more projects prospered, royalty terms for significant oil sands projects were negotiated on a project-by-project basis and specified in individual Crown agreements. This project-by-project royalty approach was relatively manageable in the formative years of the oil sands sector due to few commercially viable operations. Furthermore, this flexible royalty arrangement proved useful in accommodating the unique requirements of each project, addressing project-specific concerns, and providing the foundation for building institutional knowledge and experience that formed the basis of current oil sands legislation. As oil sands development progressed, research and technological innovations contributed to increased returns on investment and reduced operating and production costs. Inevitably, additional companies became involved in oil sands development and world oil prices and global market forces governed their investment decisions. A different royalty regime was needed to address the different circumstances and needs of a growing oil sands sector as this individualized royalty arrangements clearly began to outgrow its utility. Maintaining the status quo resulted in an inconsistent royalty system in which potential investors lacked a transparent and predictable royalty structure on which existing oil sands companies were unsure about the type of royalty structure new investments