Petro-Canada's Letter to Alberta Premier Regarding Royalty Review Recommendations
CALGARY, ALBERTA--(Marketwire - Oct. 3, 2007) -
October 3, 2007
Dear Premier Stelmach:
Petro-Canada is pleased to offer you our views on the royalty report. We have a broad perspective to share because of our upstream and downstream operations around the world. We also have a significant presence in Alberta, as reflected in the $294 million we paid in royalties to the Government of Alberta last year.
A decision on Alberta's future royalty structure is critical to the future of our province. We acknowledge that at higher oil and natural gas prices, it is reasonable for Albertans to expect higher revenues from royalties. However, it is also important to get the right balance between royalty rates and economic activity, as both influence the total value received by Albertans.
In our opinion, the royalty report contains material flaws in its analysis. If the report were enacted as is, we believe investing in Alberta would be severely impaired given prices today and those reasonably expected in the future. The result would be less total returns to Albertans in both the short and long term.
As evidence, below I provide you with four main points which describe these flaws.
1. Albertans have been receiving their fair share of price increases with revenues from both the existing royalty structure and from higher lease sales.
Over the past seven years of rising oil and gas prices, royalties on conventional production increased 128%, consistent with a 133% increase in industry revenue over the same period. The upside of higher prices is also shared with Albertans through revenue from lease sales. In the 2005-2006 fiscal year, the Government of Alberta received a record $3.5 billion from competitive bidding for oil and gas leases. This income was ignored in the report. These lease sale amounts represent far more than the $2 billion the report suggests the province was short-changed. If royalty rates rise significantly, companies will bid less for leases and reduce activity, ultimately lowering Government revenues.
2. Judging the competitiveness of Alberta's oil and gas industry based upon royalty rates ignores the higher costs, smaller finds and lower well rates in this mature basin.
The report ignores the fact that investors make business decisions based upon return on investment, not on royalty rates. According to a 2007 Global Upstream Performance Review done by John S. Herold Inc., based on returns for the past five years, Canada is already the least favourable region in which to invest. This is evidenced by the fact that rig utilization is only 40% in Alberta, compared with nearly 100% in the United States. The United States is singled out in the report as a key comparator for Alberta. Increases to royalty rates will significantly worsen this situation.
3. The report's conclusion that 82% of natural gas wells will pay lower royalty rates is misleading. At today's prices (year-to-date AECO-C of $7.10 per thousand cubic feet - Mcf), almost all wells will pay higher royalties.
The report uses a natural gas price of $4/Mcf as a reference point for this statement. That price level will not support exploration investment. Average finding and development costs in Alberta are close to $4/Mcfe, with operating costs adding another $1/Mcfe. Royalties and taxes are on top of that. Based on these costs, a natural gas price of more than $8/Mcf is required in Alberta to justify new investment today. Natural gas prices would need to be more than $2/Mcf higher for investment to occur if the report is enacted. In particular, the proposed royalty rates and recommendation to eliminate incentives to drill deep gas would make many of these prospects uneconomic. Of the 40 trillion cubic feet of remaining established natural gas reserves in Alberta, deep gas prospects represent a sizable 25%.
4. The report's introduction of a non-deductible severance tax for oil sands projects ignores the higher cost and risk of these mega-projects.
The proposed severance tax, which is non-deductible and geared only to the oil price (equivalent to adding between 2% to 15% to the base royalty rate), is not appropriate for oil sands investments. It does not reflect the downside of oil sands projects - which are amongst the most capital intensive and challenging energy projects in the world. For example, a typical integrated oil sands mining project (i.e. mining and upgrading of 100,000 barrels per day) now costs in the $10 billion to $11 billion range - more than twice the $4 billion to $5 billion range claimed in the report. The severance tax would make in situ projects (the recovery method for 80% of Alberta's oil sands resource) simply uneconomic. Oil prices, which year-to-date have averaged $80/barrel (Edmonton Par) would need to be more than $100/barrel on a sustained basis for in situ oil sands investments to make sense with the proposed changes.
We recognize you have received a variety of input from industry, the panel and the Auditor General. This reinforces our view that we need to take our time and get this right.
So we offer the following recommendations:
- only increase royalty rates at oil and gas prices above today's levels;
- royalties on the conventional side should take into account the unique aspects of Alberta's mature basin and the resultant returns for investors;
- retain the net-profit structure for oil sands projects; and
- phase in royalty changes so investors and producers have time to adjust.
I believe a win-win royalty solution that benefits all Albertans is attainable. I am available to discuss these points with you and your colleagues.
Ron Brenneman, President and Chief Executive Officer
cc - Hon. Ron Stevens
cc - Hon. Mel Knight
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