Musings: If at First You Don't Succeed, Try Alberta's Plan

Canadian drilling activity is flagging due not only to the recessionary impact on oil and gas demand, but also due to weak producers' cash flows and restricted access to investment capital to help fund new exploration and development programs. The traditional seasonal downturn at breakup this year was worse than at any time since before 2000. The Canadian land drilling rig count, as measured by Baker Hughes at June 26th, stands at 147 active rigs. This represents somewhere around 18% of the available rig fleet.

We have plotted the 2008 and 2009 rig counts along with the weekly high and low counts for the entire period of 2000-2009. So far, virtually all the weekly rig counts for 2009 have set decade lows, which is not surprising given the industry environment. As a result, when you look at the decade-low line on the chart you should note that the blue line going forward only reflects low rig counts through 2008, but given where drilling activity is centered at the moment, it is likely that many more weekly low counts will be established in coming months.

Last year, the Alberta government moved to alter its oil and gas royalty scheme with the aim of improving the attractiveness for exploring in the province. This new plan marks the fifth change in taxation of energy companies since 2007. Because of prior royalty changes, Alberta had seen its attractiveness as the prime location for oil and gas activity decline. The plan changes put in place last year were designed to stimulate Alberta's drilling activity, but no one expected the industry and economic changes that later unfolded. The Alberta government is now moving to extend its altered royalty scheme for a second year hoping to bolster industry activity and government revenues.


The Alberta royalty program consists of two programs - one for drilling and the second for production. The Drilling Royalty Credit provides a $200/meter royalty credit for new wells drilled based on total measured depth from April 1, 2009, through March 31, 2011. The new program extends the life of the royalty by one year from 2010 to 2011. The royalty is designed to assist small producers as it is determined on a sliding scale for each producer based on its 2008 oil and gas production in Alberta. The second program, the New Well Incentive Program, provides up to a maximum of a 5% royalty rate during the first year of production up to a maximum total production of 50,000 barrels of oil or 500 million cubic feet of gas.


While these programs are welcome, they will probably have only a marginal impact on oilfield activity for the balance of the summer. The new royalties should help the shallow natural gas market and smaller producers. The extension of the plan may help producers and service companies by providing operators more time to plan for drilling programs in seasonally restricted or winter access only areas. This means that wells that might have not been drilled because they couldn't be completed within the prior March 2010 deadline will now be drilled. This will be especially true for winter wells next year.

An additional aspect of the New Well Incentive Program is that the royalty increases linearly with rising gas prices, although at the present time prices seem to be struggling to sustain current levels. Should we see a rally in natural gas prices as the second half of 2009 unfolds, that would make it more attractive for producers to commence drilling under the new royalty scheme.

The newly extended incentives are designed to help producers recoup a percentage of their capital spending and the Drilling Royalty Credit helps. Producers, however, have to spend money in order to save money under the Alberta's royalty program. If producers were unconstrained by cash flow limitations or had ready access to capital financing or were enjoying high energy prices, these royalty programs would likely have a greater impact. Unfortunately, producers are finding their cash flow constrained, they have great difficulty securing outside capital and natural gas prices are low. To see how well these incentive programs are working, one only needs to understand that they have been in place for three months, yet drilling remains at decade lows suggesting that capital and cash flow challenges are overwhelming the government's improved incentives. Since Alberta gets 55% of its revenue from natural gas production taxes, low gas prices and high oilfield service costs are taking a serious toll on industry activity and government revenues.

The Alberta provincial government needs to re-examine its overall competitive position, a program that is underway and is targeted to be completed this fall. The province probably needs a simpler royalty scheme. There needs to be greater transparency and visibility in the province's incentive program. Without these characteristics, Alberta's ability to compete long-term for access to investment capital will be restricted. So far, the province appears to have been too focused on short-term stimulus efforts possibly driven by its budget revenue shortfall, currently estimated at $4.7 billion for 2009-2010.

Understanding that the oil and gas industry is a capital-intensive, long-term focused business that welcomes, and needs, stable government policies both on taxation and incentives is an important recognition. The Alberta Energy Department is performing its competitiveness review of conventional oil and gas, comparing the province's regulations, land practices and royalty schemes with others. This is a joint government-industry effort. Its results cannot come too soon as the recently released Fraser Institute Global Petroleum Survey ranks Alberta 130 out of 143 jurisdictions for its fiscal terms. Alberta continues to rank highly in terms of geopolitical security. With huge shale-gas and oil sands deposits in Alberta, the province needs to repair its economic incentives in order to attract the necessary capital to develop these resources.

G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.


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Lou | Jul. 13, 2009
Well this picture with the present price of natural gas and the abundance of the commodity found in the USA, I for one am skeptical of any robust activity in the near future.

The time extension offered just allowed some junior players to "wait and see" if rates drop further or prices fall...etc etc etc...(which I personally think may prove to be good business).

Janet | Jul. 10, 2009
Only when Premier Stelmach is no longer on the scene will Alberta regain the credibility it has lost due to his manoeuverings. This government obviously has no idea what they are doing or how to manage oil resources. They do not realize that resource companies budget for long term projects and do not have the ability to move money around monthly.

Jack W Reeve | Jul. 10, 2009
Visionless. It's a term I use to describe the general perspective from which politicians plan and implement their policies, especially with regard to the energy business. Stelmach's regime and their stultifying idiocy currently are trying to unravel the damages wrought by their visionless greed and stumbling short term myopia, while trying to shore up public perception and positive opinion. As they do so, they continue to dine on the flesh of the very goose which used to lay golden egg after golden egg. Like most politicians, Ed and his ilk are but visionless power-mongers surrounded by sycophantic hangers-on.

Don | Jul. 10, 2009
I too have been tracking the Western Canada rig count and it is easy to see that the average annual rig count declined 25% in 2007. This was primarily due to "The New Royalty Framework." Companies simply stopped drilling in Alberta as a resut of this huge miscalculated grab and was a colossal mistake by the Alberta government thinking they were the only game in town.

Projects in Alberta were simply no longer as attractive as other global opportunities after weighing all other risk factors. This was simply a disaster for the Alberta oil & gas producers and for many thousands of Albertans who make their living and are supported by this industry. I dare say, not one person in Alberta is not touched by this.

With gas prices as low as they are and are likely to be low for at least another year the industry is in ruin and no band-aid solution is going to fix it. Get ready for another slow winter!

Blaine Maller | Jul. 9, 2009
The latest tweak to the royalty and drilling incentive program is simply an extension of the 1 year program for one more year. Nothing else has changed and the New Royalty Framework (NRF) has not been rolled back in any way, shape or form.

The entire production base pre-Nov 19, 2008 is fully taxable as per the NRF and is not subject to any credits or incentives. Going forward as gas prices increase the royalty paid on this production is still the major cash grab it was and this does nothing to help those in need of royalty relief which could result in an immediate effect to their cash flow. So it is good for those who will take advantage of it, but that is very few companies.

The only way to improve the immediate cash flow situation for small oil and gas is to cancel the NRF. This would increase the cash flow available now and going forward as prices improve. It would allow companies to re-do their reserves; add oil and gas reserves back onto the books and increase the asset value of their properties which would have shored up the balance sheets, share values and may have got the banks off their butts. It may even have helped them to raise money. Not to be.

These small steps backward do nothing to compensate for the main cause of the problem and that is the NRF. This is not going to result in any major increase in activity in Alberta and may have just cemented the fact, in many minds, that this government still doesn't get it and enough is enough.

Many companies have already moved their focus to BC and Saskatchewan and internationally, many will totally leave here now and the rush will be on in those Provinces; they are more competitive jurisdictions and we don't need another long drawn out chin wag with the government as CAPP and SEPAC continue to do and accomplish nothing. The government has totally misunderstood the entire industry and how it operates with respect to risk and reward, the costs, the compliance, the regulations and environmental costs, the demands of the capital markets, the potential profits and potential liabilities for the companies involved. And the service sector gets crushed in the process.

They do not understand the damage they have done to their own reputations as credible, reliable, stable Ministers of the Crown. They have no more credibility in the eyes of a growing number of influential people from all sectors of the economy. So when the Premier says wait for gas prices to increase and things will improve rig activity wise, he is wrong again. Ten (10%) of the rig fleet is working. Oil is already very economic to drill and produce in other Provinces at $ 70 US. Why has activity not picked up in Alberta on the oil side? Because their cash flow has been severely reduced by the royalty increases on oil. The returns are greater and the costs per Bbl are less in BC and Saskatchewan and the red tape is significantly less. There is only so much money to go around in these days of reduced budgets and major restrictions on access to capital so they have to get the best return possible for the investors. And that is anywhere but Alberta.

Going forward, the NRF will see the lion's share of any potential revenue increases go to the government. Many companies are shutting in to avoid royalties all together and some are pinching back production to get a lower royalty rate and that just cuts into the volume of oil and gas that is on production and that the government relies upon for some 33% of its revenue. That revenue is taking a major hit and they may finally be looking at the inflow of cash from their NRF and it is not good. It is significantly less than they have forecast. The underestimate of the deficit is going to blow people away and will be the last straw for those that are clinging to the hope this government will somehow do the right thing and get it straight.

Hemant Ahir | Jul. 9, 2009
I think the impact that the Alberta Premier has made on oil and gas production and exploration is what will cause the eventual collapse of Alberta's economy.

Gene Mall | Jul. 8, 2009
I am glad to see that the government is trying to salvage something; here in the states all they want to do is tax and tax and tax. If Washington would open up the outer shelf we could produce more oil and in turn the government would reap greater revenue. The world over is drilling where they can and what are we doing? Nothing.

Bigern | Jul. 8, 2009
Ed and the rest of his provincial puppets are at the Calgary Stampede this week sporting their 10 gallon hat with their 1 gallon brains and actually had the nerve to make a public announcement "There will be no tax hikes while I am in power".

First of all, the damage is already done; you have scared people away. Oil companies, drilling contractors, workers and investors, they're gone. You can only sit and hope for so long. Maybe next time a high ranking oilfield official says, "Dont do it, you will be sorry," our government will listen. If there is no profit to be made why do it!

Everyone is getting their FAIR SHARE now, layoffs in every sector in Alberta.

Scott Smith | Jul. 8, 2009
As an Albertan, it's good to see that the government is hopefully going to scrap the disastrous royalty program they rammed down the throat of the industry a few months ago. Maybe we can get back to work drilling this year and turn things around.

Daniel Boone | Jul. 8, 2009
The problem with Alberta Oil and Gas Exploration is the same as in the U.S of America. Oil and Gas Companies budget large amounts of money with huge risk (unlike any other business) and will wait a long time for an eventual return on investment then long term profits. There is not another business like it. Consider trying to make long term forecasts with wild swings in product prices and a Government that changes the rules (Taxation/Regulation etc.) all the time?

Robert | Jul. 8, 2009
As a person that works in the oilpatch in Alberta, the Royalty program did not make a whole lot of sense to me. The economy dropped off when that was announced. To me if it would have been left alone then the government would have been better off as the people would be spending money on new cars and recreation as well as traveling, which would boost all aspects of Alberta's economy. ED dropped the ball as far as I can tell...but I am just a little person trying to make a living in a slow working environment.

Brian Hummel | Jul. 8, 2009
It just goes to show how a political leader with a hidden vindictive agenda to make oil companies tow the line, has severely harmed the goose that lays golden eggs. It is unfortunate for Albertans to once be leaders in the oil patch are now underlings looking for new places to spend money elsewhere in other provinces. Can government squeeze this industry out while trying to make their budgets increase with higher capital costs plus paying the high dollar pensions for retiring civil workers(sic). I hope after this fiasco that we will have some major pension cuts in the civil workforce as we will not be able to afford them. It is about time for a wakeup call to Eddie's ballooning debt scheme to stop.

Mike S | Jul. 8, 2009
USA pay attention -- a program to encourage energy production. How novel.

Carl | Jul. 8, 2009
I think the impact that the Alberta Premier has made on oil and gas production and exploration is what will cause the eventual collapse of Alberta's economy. It is already slow to begin with and people are looking for a leg up but instead the guy who has no worry about loosing money out of his deep pockets stomps his foot on the people of Alberta and gives an extension on the Royalty review. He should have shut the program down and maybe waited until there was activity in the province; now he has ensured that there won't be any activity. The next election can't come soon enough.

Alan McDonald | Jul. 8, 2009
This is sort of like closing the barn door after the animals are out, which also falls on too little, too late. The Alberta government made a mess of a system that was chugging along sort of fine, considering the global economy.

Saskatchewan and British Columbia have been able to enjoy the spoils of a poorly managed government and one that would not listen to industry experts as they drew up their first plans to start the mess that we are in today. I know too many people from the drilling industry that left Canada to work where they could most of the year, rather than a spatter of work here and there.

Does the government not realize that people cannot simply work 1 or 2 months a year but rather need to feed their families all year round? That is the gap that has been left with the decisions made by the Alberta government and one that many Albertans will have to live with just because of the government not being able to think and make good decisions.

Tony Lacey | Jul. 8, 2009
Scrap the present royalty program and come up with a long term program that will stimulate long term jobs. Oil companies want to know what's in store for the future 5, 10 years down the road. The province has done well in the past with low unemployment and high rig activity so quit crying about dimes and let's get back to making dollars! I've worked in the industry for 20 years and this is the first time I've ever been out of work for 4 months.

We paid off a huge debt once so the province must have been making money. Why did we get greedy? It's the oil companies' investment. Quit complaining about who's making money and start worrying about everything we are loosing. High rig activity generates plenty of revenue.

DAN ROBINSON | Jul. 7, 2009
I have worked in the Western Canadian oilpatch and mostly in Alberta for the last 30 years. We have gone through the bad times before but this seems to be a little different. The government came in at the worst possible time and tried to be heavy handed with the oil companies by taking away their profit margin and increasing the taxes; the economy tanked and the oil companies left in droves to try and make money elsewhere.

This move by the government was due mostly by pressure from the people in the cities who did not understand what drives the province's economy. By taking too big of a bite from the hand that feeds them they have caused a snowball effect. The oil patch drives the province; now the hotels are empty,the service industry has laid off most of their workers, the dealerships are not selling vehicles, people are not buying houses. There are no jobs for this skilled work force and they are running out of money.

When it does turn around the drilling contractors and service companies are going to be facing a big problem with not enough people to properly run the rigs and equipment that will be left. Now Alberta, which used to be swimming in cash, is running out of money and then the government will do the only thing left to do -- raise taxes. They have created a problem that is going to take a long time to fix, and one that I also think will be the end of the present people in power now.

Herman | Jul. 7, 2009
I think that the government should try a different approach, rather than taxing the oil companies. They should just continue on with the drilling tax cuts they had in place to produce more jobs in the U.S. It would surely help unemployment rates drop.


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