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Promising Updates to Royalty Programs - Energy Industry at a Crossroad

HIGHLIGHTS

  • In early July the Alberta Department of Energy (Alberta Energy) announced two new royalty programs – the Emerging Resources Program and Enhanced Hydrocarbon Recovery Program– to stimulate oil & gas production
  • These programs will take effect on January 1, 2017 as part of its Modernized Royalty Framework (MRF)
  • Oil and gas producers can apply for early opt-­in to the MRF for wells that otherwise would not have been drilled
  • These steps are encouraging for those oil and gas entities that have the ability to participate in resource plays or enhanced recovery projects. However, they may not be sufficient to overcome the chilling effect on industry investment resulting from recent changes to the LLM program administered by the Alberta Energy Regulator (AER), and may do little to help junior players in the industry

Modernized Royalty Framework (MRF)

The Alberta government has made recent announcements intended to stimulate the oil and gas industry. Alberta Energy released two bulletins on July 11, 2016, announcing two new royalty programs for its MRF along with an early opt­-in process for new energy projects. While the news is certainly positive, investment uncertainty resulting from recent steps taken by the AER remains of concern for industry, particularly the juniors.

Following the recommendations made by the Alberta Royalty Review Advisory Panel in January of 2016, the formulas for the MRF were finalized on April 21, 2016. The MRF will incorporate the two new royalty programs to take effect on January 1, 2017.

Emerging Resources Program

According to the Alberta Energy website, the Emerging Resources Program (ERP) is intended to “encourage industry to open up oil and gas resources in higher­ risk and higher ­cost areas that have large resource potential.” This application-­based program provides a more accommodating royalty scheme in the hopes of achieving long-­term commerciality.

Like ordinary wells under the new MRF, eligible projects under the ERP will pay a flat royalty rate of 5% until their combined revenue equals their combined drilling and cost allowances, after which they will pay higher royalty rates that vary depending on the resource and market prices. However, an eligible well will be assigned a cost allowance 50-­100% greater than an ordinary well, providing a longer period for growth under the more lenient royalty rate. Projects with minimal existing development will see a greater increase to the applicable cost allowance under the ERP.

To become eligible, the proposed project must be at an early stage of development and be otherwise uncommercial at this point without the intervention of the ERP. The Department of Energy will conduct a technical and economic evaluation of each application and will assess the proposed project’s resource potential, timeframe for commerciality and net royalty benefit to Albertans.

Enhanced Hydrocarbon Recovery Program

The application-­based program Enhanced, Hydrocarbon Recovery Program (EHRP) will replace the existing Enhanced Oil Recovery Program and is intended to promote enhanced recovery methods that stimulate incremental hydrocarbon production.

The primary objective of the EHRP is to “provide appropriate royalty treatment for incremental hydrocarbon production to account for the higher costs associated with enhanced recovery methods.” Companies will pay a flat royalty of 5% on crude oil, natural gas and natural gas liquids produced from wells in an approved scheme for a limited benefit period, after which they will again become subject to standard royalty rates.

The EHRP will apply to two main components – both of which are methods of injecting materials into a reservoir to increase hydrocarbon production. The first component involves the injection of carbon dioxide, nitrogen, or other approved chemicals (tertiary recovery methods), while the second component involves the injection of water or gas (secondary recovery methods). The benefit periods approved under the program could be up to 90 months.

Applicants must establish that their enhanced recovery schemes are expected to increase hydrocarbon recovery at significantly greater costs to necessitate inclusion in the program. While the Department of Energy will conduct a technical and economic evaluation of the long term royalty benefits, applications must also receive technical approval from the Alberta Energy Regulator on or after January 1, 2017.

Early Opt-­in Program

In a separate news release, Alberta Energy announced that energy companies can apply to opt-in to the MRF for wells spud between July 13, 2016 and December 31, 2016. Otherwise, the MRF will come into effect January 1, 2017. This allows companies to make investments now that would otherwise be uneconomic under the current royalty framework. This optional application must provide a rationale explaining why the well would not otherwise be drilled unless early opt-­in is granted. According to the news release, companies will need to establish that their activity is “above and beyond what was already planned”. A well approved for early opt­-in to MRF will continue to pay existing royalties until early 2017, at which time royalties will be recalculated in accordance with MRF formulas.

Alberta Energy Regulator – Implications for Industry?

The ERP and EHRP (the MRF Programs) will likely be welcomed by those companies holding or acquiring interests in properties targeted by the MRF Programs, essentially resource plays and enhanced recovery projects. It seems unlikely that junior players in the oil and gas industry will see much benefit from the MRF Programs.

The recent changes to the AER’s LMR program doubling the deemed asset to liability ratio requirement to receive transfers of AER licensed wells and facilities may have a chilling effect on investment in the oil and gas industry in Alberta. While the orphan and inactive well situation in Alberta is indeed serious, these changes could have the opposite effect to that intended and lead to more bankruptcies and insolvencies and, thus, more orphan wells. Moreover, properties that might have been developed by juniors due to their lower cost structure may not be developed at all resulting in stranded reserves which benefit none of the stakeholders involved including the Province of Alberta.