Alberta royalty calculus can’t ignore reality of the oil market

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Alberta Premier Rachel Notley's pledge to tinker with the province's oil and gas royalties is what most struck fear deep into the hearts of the business set.

Conditions in the energy sector were grim when her New Democrats took power last spring, promising to make sure that Albertans got their fair share of spoils from the province's massive resources. Since then, they have become much grimmer as crude oil crashed below $30 (U.S.) a barrel, a price at which most projects lose money.

Plus, the last attempt to reform royalties is still fresh in the collective memory. In the past decade, the government of former Progressive Conservative premier Ed Stelmach rejigged rates in hopes of achieving what it saw as a fairer split. But the moves were enacted as markets tumbled and oil executives threatened early and often to spend nary another dime in the province. Eventually, the government backtracked.

One positive kernel in the current downturn is that it has shown the need for the economic rents that are charged for the privilege of producing hydrocarbons to be responsive to fast-changing macroeconomic conditions.

The Notley government is widely expected to announce the results of its royalty review panel's months of work on Friday, and its messaging has been consistent – that any changes to the fiscal regime will not be another head-on blow for an energy sector on its heels.

Let's face it, the NDP has its biggest chance to gain – or lose – credibility with the powerful and wary industry just when it can ill afford a major distraction. That is, when it's wrestling with its worst financial crisis in decades.

The main budgetary problem is the steep drop in non-renewable-resource revenue. It has tumbled to 6.3 per cent of total revenue in the 2015-16 budget from 18 per cent in the previous fiscal year. Meanwhile, a spate of industry layoffs is taking its toll on overall economic activity.

Royalty rates should not be set expecting oil and gas prices to keep pushing ever higher, but they should also not be structured just for a slump. The panel, led by ATB Financial chief executive officer Dave Mowat, has also been clear about how the system must respond to shifts in technology and markets. And there have been scads.

One of the starkest stats is how the sector's focus has completely changed in a decade. In 2005, royalties from cheaply produced natural gas and its byproducts totalled $6.4-billion – more than three-quarters of the royalty take. Bitumen from the oil sands accounted for just $718-million. In the 2014-15 budget, bitumen royalties were $5-billion, and natural gas royalties were $989-million. This year, bitumen royalties are projected at just $1.5-billion.

At its core, the exercise should be about striking a balance between providing decent return for the citizens and encouraging economic activity and keeping competitive with other jurisdictions. Ideally, there will be levers in each category, so that Albertans don't get short-changed, or large chunks an industry stop being viable or false economies aren't created to prop up bad businesses.

It's tough to imagine price sensitivity not being a key part of the calculus, especially after the past 18 months of upheaval. The current system has a sliding scale, but only to a point. Before capital costs are paid out at oil sands projects, producers pay 1 per cent of gross revenues when U.S. benchmark oil prices dip to $55 (Canadian) a barrel. Postpayout, the rate is 25 per cent of net revenue. But there are no smaller percentage when oil prices fall, as they have, below that level.

There has been co-ordination between the royalty review and the government's recent climate framework, such as with economic assumptions. In addition, the climate and royalty panels made sure that all costs of production were taken into account when assessing the best rates, rather than looking at each exclusively.

What is not known yet is how the royalty system will help achieve the Premier's goal of providing incentives to process more of the bitumen that gets produced in Alberta as a way to create jobs.

Alberta historian David Finch points out that Alberta royalties have been reviewed and changed in every decade since the 1930s. Sometimes rates went up, sometimes down.

This time around, given the tough financial straits the industry finds itself in, and the NDP's aim to avoid scaring away investment, it's unlikely that the government will immediately demand a much bigger slice of the pie.