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Some Good News for Canada’s Oil Producers

By Chad Fraser on February 17, 2016

“You campaign in poetry. You govern in prose.”

That phrase, famously uttered by New York governor Mario Cuomo in 1985, has particular resonance in the oil-rich province of Alberta these days.

For the province’s left-leaning New Democratic Party (NDP), the “poetry” part came during last spring’s provincial election. On the campaign trail, it went after the 44-year-old Progressive Conservative (PC) government on two key fronts: what the NDP saw as weak climate change policies and the PCs refusal to review royalty rates—what the province charges companies for the right to extract crude.

There was no question about where the NDP stood on the latter point. Here’s what its platform said: “The PCs have refused to implement realistic oil royalties that the people who own the resources—all of us—deserve.”

It was tough talk in a province where the energy sector generated C$111.7 billion of revenue in 2014, with 60% of that coming from the oil sands. In all, money collected from oil sands royalties paid more than 10% of the province’s operating costs in the 2014-15 fiscal year.

In a result no one saw coming, the May 5, 2015, vote catapulted the NDP to power for the first time in Alberta’s history. The party captured 54 seats in the 87-seat legislature, up from just four before the election call. The Conservatives fell to 10 seats from 70.

A Royal Pain

The problem? For the NDP, the “prose” part—or the messy business of running the province—came at a time when the Alberta oil industry was in freefall.

The numbers are grim: the Canadian Association of Petroleum Producers estimates that 100,000 jobs directly and indirectly related to energy have been lost since oil prices started to nosedive in mid-2014. Industry capital spending dropped from C$81 billion in 2014 to around C$45 billion last year.

That pushed up the provincial unemployment rate to 7.4% in January from 4.4% in November 2014. Alberta’s economy also contracted by about 1.3% in 2015, according to RBC, and the bank only expects it to eke out 0.9% growth this year, compared to 2.2% for Canada as a whole.

Even so, the NDP went ahead with plans to hike corporate tax rates to 12% from 10%, impose stricter limits on carbon emissions in the oil sands and bring in an economy-wide carbon tax, starting in 2017.

But royalties were the issue that caused the most anxiety in Calgary’s glass towers—and the NDP’s earlier stand on the file did nothing to quell these fears. The government created a four-member panel to look into the matter last August.

Before we go further, here’s a quick look at how Alberta’s oil sands royalty regime works. First, it’s important to note that the province, not the federal government, owns 81% of Alberta’s mineral rights.

Right now, royalty rates range from 1% to 9% of an oil sands producer’s gross revenue, depending on the price of crude, until a project has recouped its start-up costs. Once that hurdle is cleared, royalties are derived from net revenue in a range from 25% to 40%, again depending on the price of oil.

The NDP Changes Course

Thankfully, the NDP took the opportunity to show that it has a pragmatic streak when it comes to the province’s golden goose.

When the report was released on Jan. 29, it recommended few changes. Oil sands rates were left at current levels, while other oil and gas projects will shift to a similar model as the oil sands, with a 5% royalty applying until a project recoups its costs, and a higher rate thereafter.

Premier Rachel Notley accepted the findings, going as far as to say that due to the oil-price plunge, “times have changed,” and now was not the right time for a “money grab.”

The oil patch, too, was largely onside, apart from concern about the uncertainty the review process caused. “Today’s announcement has been the result of a fair and credible process, one Albertans can trust,” said Tim McMillan, president of the Canadian Association of Petroleum Producers.

It’s not the first time the NDP has taken a co-operative approach with the energy sector.

As my colleague Ari Charney noted in December, the government’s climate change strategy, drafted after consultations with oil producers like Canadian Natural Resources, Shell Canada, Cenovus Energy and Dividend Champion Suncor Energy (TSX: SU, NYSE: SU), caps carbon emissions from the oil sands at 100 megatonnes a year, up from 70 now.

That leaves some room for growth, with estimates that the cap would allow an additional 1 million barrels per day of oil sands production, up from 2.3 million in 2014. The heads of all four companies were on stage when Notley made the announcement.

From Payments to Pipelines

Notley’s climate change plan also gave Ontario premier Kathleen Wynne some cover to tentatively back the Energy East pipeline proposed by Dividend Champion TransCanada Corp. (TSX: TRP, NYSE: TRP). Energy East would stretch 2,860 miles from Alberta and Saskatchewan to refineries in New Brunswick. Along the way, it would traverse Manitoba, Ontario and Quebec.

However, the 1.1-million-barrel-a-day line still faces strong opposition, including from a group of Montreal-area mayors who aggressively came out against the project on January 20.

To be sure, Energy East still has a long way to go, and it will be Canada’s independent National Energy Board that will have the final say. One thing working in TransCanada’s favor is the fact that most of the line already exists: it uses 1,865 miles of gas line the company will convert to carry oil. Only 995 miles will be new pipe.

If TransCanada gets the thumbs-up, it plans to have Energy East up and running by 2020.


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