Alberta Angles for Bigger Share of Oil Receipts as Futures Soar

CALGARY Sep 27, 2007 (Dow Jones Newswires)

Alberta, once a refuge from the world's resource nationalists, could soon join them.

Last week's long-awaited review of the province's oil and gas royalty system proposes a new tax, linked to rising oil prices, and higher royalty rates. These and other measures, if implemented, would put an extra 20%, or C$2 billion ($2 billion), a year in Alberta's treasury coffers.

The review comes after an extensive investigation into whether Albertans were getting their fair share of the profits from their province's vast resources. They aren't, the panel entrusted with the task concluded, and they haven't for quite some time.

"I don't know how you define fair share, personally. I wouldn't have used those words," Tim Hearn, chief executive of Imperial Oil Ltd. (IMO), said. "I could argue that this is the worst time to make changes." Imperial is a subsidiary of Exxon Mobil Corp. (XOM).

Two days after the recommendations were released, oil futures hit an all-time high, nearing $84 a barrel on the New York Mercantile Exchange. While falling U.S. crude inventories and threatening storms in the Gulf of Mexico, not Alberta's revenue grab, spurred prices higher that day, oil's broader bull run has been underpinned by the perception of tightening global supplies. These supply worries came to the fore after countries such as Russia and Venezuela, the oil industry's hope for massive new reserves, restricted access to their resources and forcibly raised their stakes in lucrative projects. While Canada's shift isn't as radical, it underscores the temptation oil prices present to countries known for their stable fiscal regimes.

Calgary's oil industry reacted with dismay. Analysts and producers began to refer to "Albertastan" and accused the province of downplaying the oil sands' operating costs. The reserves here may be second only in size to Saudi Arabia, but the sludgy raw material, bitumen, is difficult and expensive to extract, and needs further processing before it can even flow through a pipeline, let alone be handled by refineries. And although no one is predicting a full-scale exodus from the region, the changes will likely hinder investment, slowing growth in oil production and possibly leaving Alberta's government less, not more, in tax receipts.

This could have ramifications for the U.S., which gets much of its crude from Canada. Many U.S. refineries are making upgrades to process the poorer-quality crude, betting that it will stay much cheaper than other blends. If there's less crude expected on come on stream, that may not be the case.

Equities Take A Beating

The stocks of oil sands producers have already taken a hit, losing more than C$8 billion in market capitalization the day after the review was released, even though there is no knowing which, if any, of these recommendations will become policy when the provincial government discloses its decision next month. And many companies are steeling themselves for another hammering on the stock market should the review be implemented in full.

This could wipe $26 billion off the value of existing and future oil sands projects, with valuations for undeveloped projects slumping by an average of 30%, according to estimates from Edinburgh-based consultancy Wood Mackenzie. Alberta is copying other oil-rich regions in trying to extract more "economic rent from its natural resources" while commodity prices are high, Derek Butter, head of corporate analysis, said in a statement.

The new tax takes 1% of gross revenues when the front-month crude-oil futures contract in New York is at C$40 a barrel. The levy, separate from existing royalties, rises to a maximum of 9% when prices hit C$120 a barrel.

Alberta isn't the only province hiking taxes in Canada, whose system of government is highly decentralized. Only last month, Newfoundland and Labrador Premier Danny Williams - dubbed "Danny Chavez" - succeeded in imposing such a "super-royalty" linked to oil prices on the Hebron offshore oil project. This Chevron Corp.-led (CVX) venture halted talks with the provincial government for more than a year because the companies didn't want to pay the tax.

Under President Hugo Chavez, Venezuela has strengthened its grip on oil resources, most recently telling foreign oil companies they must cede some ownership and operational control of the Orinoco heavy oil properties to the state oil company. In response, ExxonMobil and ConocoPhillips (COP) abandoned their projects.

The Canadian Association of Petroleum Producers, an industry group, said the new and increased levies were unrealistic.

It assumes the level of investment in the oil sands will stay the same despite the changes, said CAPP president Pierre Alvarez.

"Companies look at these projects over 25 years," he said. "When project economics lower to unsustainable levels, then they'll just pull out."

The problem with the review is that it looks at royalties in isolation and ignores factors that already are chipping away at the oil sands' profitability, Alvarez said. These include the elimination of various tax credits, climate change obligations, soaring project costs and the Canadian dollar strengthening against its U.S. counterpart.

"These facts got disregarded, swept aside on $80-a barrel-oil and the opinion that a high tide raises all boats," he said. "It's not as though everything else has stayed the same while the price of oil went up."

Oil sands capital costs have been climbing rapidly: The consortium behind the massive Fort Hills development estimates first phase of the 140,000-barrel-a-day development will cost C$14.1 billion. This translates into a rate of return that even project leader Petro-Canada (PCZ) describes as "skinny." Already, more than one development has been put on hold as bigger and bigger projects compete for scarce materials and a shrinking labor pool, lifting costs higher still.

Mission Accomplished

The existing royalty structure, established to kick-start oil sands production when crude-oil prices were around $20 a barrel, sets a base 1% rate of gross revenues until capital and operating costs are recovered, after which the rate jumps to 25%. The review recommends raising this net royalty rate to 33%, with the new tax becoming effective once projects start producing oil. This should increase Alberta's take from oil sands revenues to 64% from 47% at present.

Panel chairman Bill Hunter argues that the current system has accomplished its goal of attracting investment to the oil sands, and noted that the review had taken project cost inflation into account by maintaining the 1% base rate, allowing Alberta to keep its competitive edge versus other regions. And the prospect of decades of stable bitumen output with a ready market south of the border will likely keep producers in the province.

In fact, Petro-Canada and mining firm Teck Cominco Ltd. (TCK) both took extra 5% stakes in Fort Hills last week. Petro-Canada spokesman Peter Symons said the timing of the deal, just two days after the review's release, was coincidental and "signals our further confidence in the partnership and the asset that we have."

Several companies operating in Canada have said the oil sands could pay higher royalties, but warned against overburdening the industry.

Many analysts and oil executives expect most of the review will be adopted, forcing project delays and even cancellations as companies re-evaluate.

By slowing production growth, the government shrinks its royalty base and consequently its potential revenues - the opposite of what it hopes to achieve, said Stephen Calderwood, a Calgary-based analyst at Raymond James. The changes to the royalty rate is bad enough but introducing a new tax is "probably overkill," Calderwood added.

Copyright (c) 2007 Dow Jones & Company, Inc.