A change of heart
Canadian producers claim some oil-sands projects may be under threat because of tax changes and tougher environmental regulations. WJ Simpson reports from Calgary
SO LONG accustomed to hands-off, laissez-faire government policies, Canada's petroleum industry has been shaken out of its comfort zone. This year, it has experienced a tightening of environmental regulations and the loss of a prized capital-cost tax credit. In addition, it is facing the prospect of higher royalties in Alberta.
Nothing caused more surprise or anxiety than plans to curb greenhouse gas emissions (GHGs) by the Canadian, Alberta and British Columbia governments – three of the staunchest foes of the Kyoto Protocol until pressure from their own voters forced a change of heart.
Canada and Alberta have introduced intensity-based emissions-reduction targets: polluters must reduce GHG emissions by 12% for each unit of oil or gas they produce. But both governments have avoided putting in place an absolute cap. This arrangement favours the producer because emissions can rise as production rises; in the case of an absolute cap, GHG cuts would increase with each incremental unit of production.
Under its newly elected premier, Ed Stelmach, Alberta – which accounts for 80% of Canada's oil and gas production – set the standard by imposing a 12% per-unit cut on GHGs from 1 July. The cuts will apply only to the province's 100 largest industrial facilities, which each release 100,000 tonnes a year or more of GHGs.
Those that fail to meet the quota will either pay C$15 a tonne ($13.55/t) into a fund to develop the technology needed to capture and store carbon dioxide, or buy carbon credits from Alberta companies that beat the 12% target.
High cost to companies
But Pierre Alvarez, president of the Canadian Association of Petroleum Producers (Capp), says that with such short notice "not all companies will meet the target". He claims the cost to companies will run to "hundreds of million of dollars".
The British Columbia government was next, pledging to lower GHGs by 33% from present levels by 2020. This was such an ambitious target that Capp will not comment until it obtains "clarification".
The Canadian government followed Alberta's softer line by announcing regulations in April requiring large polluters – mainly oil-sands producers and coal-fired power plants – to cut GHGs per unit of production progressively over the next 13 years to achieve a 20% reduction by 2020.
Companies unable to meet the standards will initially pay a maximum of C$15/t, rising to C$20/t in 2013. Payments will go into research and development, aimed at "significant, long-term" reductions in GHGs. Alternatively, companies could buy emissions credits from Canadian firms, along with a small number of international credits.
Credit for early action
Companies that took steps to lower their GHGs before 2006 will be rewarded with a limited one-off credit for early action, while operators of new facilities will be given a three-year grace period.
The federal government says the petroleum industry will be responsible for eliminating 60m t/y of the planned reduction of 150m t/y by 2020. However, Canada's environment minister, John Baird, admitted the objectives will not come close to meeting Kyoto targets for 2008-2012. These, he estimates, will not be achieved until 2025.
Canada's new targets drew a negative response from UN and European climate-change officials, who claimed Canada has abandoned its Kyoto commitments. However, Baird insisted Canada will participate in the next round of Kyoto negotiations, which are to cover the post-2012 period.
He also repeated the line that his government has maintained all along: that the previous, Liberal government made only token attempts to enact the Kyoto Protocol, with the result that Canada's GHG emissions had risen by 23% since signing the treaty, in 1997. Under the Conservative government plan, he said GHGs "could be going down, instead of up" within three years.
The cost of the federal measures will not be known until later this year when they have been harmonised with provincial plans. But Mark Friesen, an analyst at FirstEnergy Capital, estimates the new rules will result in an increase in oil-sands operating costs of less than C$1 per barrel of production. UBS Securities analyst Andrew Potter puts the figure at C$1.00-1.50/b.
Echoing the concern of industry leaders, Friesen adds that the target of a 20% absolute cut in emissions by 2020 from 2006 levels will force companies to reassess the economic feasibility of new projects. What governments are doing is shifting the economic balance by "burdening lower future cash flow against higher short-term construction costs", he says. "At some stage there is a tipping point."
EnCana's chief executive, Randy Eresman, says the greenhouse "tax" further erodes "very skinny" returns from high front-end costs in the oil sands and, if Alberta raises its royalties, "there will be a point where the industry starts shutting down new projects".
In March, the Canadian government decided to phase out an accelerated capital-cost allowance that is worth about C$300m a year to the oil-sands industry. The incentive, in place for a decade to stimulate oil-sands growth, was worth about C$1/b to producers, but the government has decided the oil sands "are now so healthy and vibrant that the tax break is no longer required."
Meanwhile, hanging over Alberta's upstream sector is the most comprehensive review ever undertaken of the province's royalty regime. There is a special emphasis on the oil sands, which benefit from a 1997 programme that charges just 1% of gross revenues until project costs have been paid off. Subsequently, this rises to 25% of net revenues.
With conventional oil and gas production in steady decline, the Alberta government forecasts its overall petroleum revenues will fall to C$7.8bn in fiscal year 2009-10 from a peak of C$14.35bn in 2005-06.
The government also predicts its returns from the oil sands will remain at C$1.2bn over the next 13 years, despite a tripling of output to 3m barrels a day, because of an agreement that allows producers to switch the base for their royalty valuation from upgraded synthetic crude to low-grade bitumen.
Conventional oil royalties are budgeted at C$2bn in 2009-10, 45% below a peak of C$3.8bn in 2005-06; natural gas returns, with production falling by 4.3% annually, will slide to C$4.6bn from C$8.4bn over the same period; and government land sales will decline by 50%, to C$1.2bn.
For a province that counts on the industry's net operating revenue to cover 20-25% of its spending, there is a sudden urgency to take corrective action. The previous government argued that higher royalties could be "destructive" in what is widely rated the most expensive hydrocarbons basin in the world. But finance minister Lyle Oberg has hinted that increases are unavoidable if his government is to meet its spending obligations over the next 15 years.