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We must change: Alberta's peace overture to energy sector

The long-awaited competitiveness review of Alberta's oil and gas royalty rates offers a new tone, but the details are still obscure

AFTER three years of acrimony between the energy industry and the provincial government, Alberta's leaders still have a task on their hands to persuade oil and gas companies to keep investing.

The competitiveness review, released by the Alberta government in March, was supposed to do that job. The government promised it would restore the famed "Alberta advantage" – the province's reputation for low taxes, minimal government interference and business-friendly investment rules.

Ed Stelmach, Alberta's premier, suggested the review would also help Alberta adjust to changes in North America's energy sector more broadly. Alberta's conventional natural gas business, in particular, has been hit hard by the rise of shale gas and other unconventional output elsewhere in the continent, which has flattened prices and priced out the province's more expensive conventional gas business.

"The world has changed," Stelmach said at the launch of the review. "The realities of the energy sector have changed and Alberta must change, too, or risk losing its competitive edge in an industry that has given us so much and still holds so much incredible potential for our future." Standing beside him, the new energy minister, Ron Liepert, added that Alberta needed to "keep what's working, fix what's not, and eliminate whatever we no longer need".

What has not worked is a heavier royalty load on conventional gas producers in Alberta. Changes to the royalties – designed to give Alberta's citizens "their fair share" of the wealth beneath the ground – were introduced in 2007, and came into effect in 2009. In between, oil prices spiked and crashed, and Alberta's budget, which depends on oil and gas receipts for half of its income, went from surplus to deficit. Meanwhile, shale gas emerged to transform the energy outlook of North America.

In both, Alberta was a victim of global events outside its control. But now the royalty regime is to be adjusted to help the province's recovery. New natural gas and conventional oil wells will receive a basic 5% royalty rate to encourage drilling. The maximum royalty rate for conventional oil will fall from 50% to 40%; and for both conventional and unconventional gas the maximum royalty rate will drop from 50% to 36%. Royalties for bitumen production from the oil sands, which continue to attract sufficient investment, believes the government, will remain unchanged.

Those discounts could make a difference – but it is impossible to say, yet, because despite months of deliberation and repeated delays to the review's publication, the finer details of the new royalty regime still will not be available until the end of May. Even the basic 5% rate merely extends a discount that is already in place, an early backtracking from the more punitive rates proposed in 2007.

The delay of further details until May, meanwhile, leaves the "royalty curves" – when, and at what production and price levels, the taxes will be applied to output – an unknown quantity. In any case, natural gas prices are so low in Alberta now that the drop in the maximum royalty rate will not matter until the market recovers. But that is unlikely for exactly the same reasons that Alberta is throwing a bone to its conventional gas sector: the rise of unconventional reserves and production across North America, and the transformation of the gas outlook in the continent from one of scarcity to abundance.

Those fundamentals have undermined Alberta, where conventional output – in many cases now the domain of small developers – cannot compete against shale-gas production in the US or, gallingly for Albertans, in neighbouring British Columbia (BC) and Saskatchewan. Indeed, even with the proposed changes to the royalty regime, BC's low rates and investor-friendly government still make it a more attractive destination for developers. EnCana, Canada's leading gas producer, said after Alberta's announcement that it would have planned more wells in the province if the government had slashed royalties to match BC's. Instead, that investment will go to other producing regions.

The big firms such as EnCana might not much like the new regime, but they can easily shift money to other regions. By contrast, it is the small junior-capital firms in the conventional oil and gas sector that suffered most under the previous royalty changes. Indeed, the plan looked flawed from the start. Royalties on oil-sands production could always have been more safely imposed, with minimal political impact: the companies operating there have few other alternatives in the world and it was the boom centred on the bitumen business that most inflated Alberta's economy, to the disquiet of its citizens.

Stelmach's plan may have been a populist hit on big oil; but the collateral damage to the small firms that eke out incremental production from mature plays has been considerable – and increasingly unpopular. Many of these firms rely on farming-in to land already owned, meaning that on top of the previous 50% maximum royalty under the previous terms they would also pay royalties of up to 15% to landowners. An effective 65% royalty rate before costs – including, say, C$0.8m ($0.8m) or more for a basic vertical well, unrecoverable auction costs to acquire any land, raw materials and services costs that soared in recent years, and so on – decimated Alberta's burgeoning sector of junior firms. And as investors fled the province, so did their opportunities to raise capital.

Yet it is not just the fundamentals of natural gas output in North America that have changed for Stelmach's Alberta. So have the politics. During the boom, taxing wealthy energy companies more heavily was popular. But that was always short-sighted politicking. Those firms are also responsible for 30% of Alberta's economy and one in six of its workers is employed in the sector. Each well they drill, says the Canadian Association of Petroleum Producers (Capp), yields 138 jobs. The double-whammy of the recession and the royalty changes transformed what was a populist policy quickly into an unpopular one. Stelmach's ratings have plummeted. A new right-wing political party, the Wildrose Alliance, has emerged to challenge the ruling Conservative Party, apparently with support of some in the oil-and-gas industry.

Belatedly, Stelmach has recognised the problem. A reshuffling of his cabinet in January tried to neutralise some of the Wildrose Alliance's threat. Now it is trying to patch up relations with the oil and gas companies. Indeed, critics have already emerged to say that the government has bent over too far this time to assuage Alberta's oil interests.

Chris Severson-Baker, policy director at Pembina Institute, an environmental group, said Alberta's citizens had been excluded from the review: "We can't be sure that today's changes will allow Albertans to secure the best value from the development of their resource because they weren't consulted." The government reckons the changes will bump up income in 2011-12 by a mere C$168m, but cut net revenue by C$363m in 2012-13.

The industry gave cautious approval to the changes. Greg Stringham, vice-president of Capp, says the outcome of the competitiveness review makes "good steps" as Alberta tries to restore its image as an investor-friendly oil-and-gas province. The tone, as much as the content, of the review is encouraging, he says. But the companies will wait for more details in May before fully endorsing Stelmach's apparent change of heart.

Tone is important, especially in Alberta's tightly knit energy sector. The appointment of Liepert in January was welcome – not because of his energy expertise (he had none), but because Mel Knight, whom he replaced, had become deeply unpopular, especially in white-collar Calgary, the corporate home of Alberta's energy sector.

Reading from the same page

Liepert is now saying the kinds of things that executives want to hear. Although the details of the new royalty regime remain elusive for now, re-establishing good rapport between government in Edmonton and companies in Calgary will be vital for Alberta. This is true not just for the health of the province's conventional energy sector, which will remain under pressure, but also for its finances. Better co-operation will also be vital for Alberta's adaptation to new carbon-fighting measures stemming from the US. If it is to make progress on that front, Alberta will need both its industry and government reading from the same page: the alternative is stasis.

The province faces increasingly thorny problems: a struggling conventional gas business; competition from BC, Saskatchewan and the US for investment; tighter legislation on emissions; and, should an Asia-led global economic recovery lift demand for oil as many now expect, another surge of development in the oil sands, with repercussions for the province's job market, costs and inflation. Now is the time for its government and industry to be working in tandem not in opposition.

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