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Yedlin: Alberta Tories learn royalty lessons the hard way
http://www.calgaryherald.com/business/energy-resources/Yedlin+Alberta+Tories+learn+royalty+lessons+hard/2673391/story.html
Tories work to mend fences on royalties

There’s an adage in the business world oft quoted to those whose tendencies lean toward being on the greedy side: pigs get fat and hogs get slaughtered.

In announcing changes to the existing royalty framework under the guise of the competitiveness review, the Alberta government effectively acknowledged the new royalty framework — that was meant to net upwards of $1.4 billion in additional royalties for government coffers — was an abject failure. Greed trumped what was best for the province — factors such as real returns on investment and capital mobility were ignored or disregarded and the consequence was the massive decline in oilpatch activity.

This time, the government appears to have listened, with the great irony being that there was no difference in the material submitted by the energy sector to those involved in the competitiveness review than was presented during the Royalty Review Panel.

This is obviously a positive step forward, said John Dielwart, chief executive of ARC Resources. It’s a recognition that Alberta had lost its competitiveness, which came at a cost of thousands of jobs in the province. To support drilling at the front end with a five per cent royalty is a major step forward because it better reflects the evolution of the basin.

Ultimately, what Thursday’s announcement means is the primary challenge for the industry has gone back to being a focus on the geology and use of technology to exploit the resource, instead of being handicapped upfront with a royalty structure that acted as a disincentive to investment. It’s now about being a competitive operator.

“I give them an A for consultation, tone and spirit of this process. This time, it was based on looking at factors such as what are the real rates of returns and what drives capital spending,” said Michael Tims, chairman of investment firm Peters & Co. “I do think it’s a big improvement. I think they found a good balance between the government representing the people who own the resource and the industry that creates value from it.”

And while industry was lauding Thursday’s apparent recognition that one of the key ingredients for a healthy energy sector is the establishment of a partnership between industry and government, there was nothing resembling a mea culpa by Premier Ed Stelmach, whose decision to tinker with the royalties is what caused so much economic pain in the first place.

Stelmach publicly took no responsibility for the investment dollars that have flown out of the province, saying instead that industry circumstances had changed and that much of the pain was due to the difficult economic conditions around the globe.

Even more astonishing is that Stelmach took credit for things going well in the oilsands — that it was because of the new framework that activity was robust in that segment of the oilpatch.

There’s a word for that — spin. It is indisputable that the royalty framework in place since 1996 was a better structure for encouraging oilsands investment. A competitiveness paper published by University of Calgary professor Jack Mintz last month made the point that the original structure was the best at extracting what Mintz defined as the true economic rent from the resource, which is ultimately the intent of a royalty system.

The fact things are going well in the oilsands has more to do with the need to keep up investments in projects of size through the business cycle, costs that have come down and oil prices that have risen.

And lest anyone get too excited that what was announced on Thursday is going to fix drilling levels overnight, it won’t.

But it will make things better. Land prices are bound to go up because the value of that land, especially for conventional oil plays, has been enhanced. The challenge, however, remains natural gas.

It would be folly to believe the natural gas business is headed for rosy times. Commodity prices remain soft and the cost of production is high. Cracking this nut will require technological advances that help to reduce these costs. The fact the government is now bearing some of that cost in the form of the five per cent royalty is incentive for companies to try new ways of exploiting that resource.

Could the government have done more for the natural gas producers? Sure. They could have extended the time frame and production threshold of the five per cent royalty beyond the one-year or 500-million-cubic-feet limits.

The important piece in all this, however, is that a positive relationship between the energy sector and government appears to be in its nascent stages. The energy business is global, capital flows to where it earns the best returns and its success is based on a sharing of risk between government and industry. The Alberta government has learned an expensive lesson at the expense of its electorate. One hopes Thursday’s announcement is a signal that the temptation for the government to get its fair share, whatever that really means, has permanently vanished.

Had they not tinkered with the royalties in the first place, none of this would have been necessary.