Balancing Act: Inside The Alberta Government’s New Deal On Energy

The Notley Doctrine is taking shape: Stir – don’t shake – royalties; boost gas demand through petrochemical and power development; and get pipelines to tidewater by taking carbon out of the barrel. Will it work?

March 01, 2016

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Notley royalty deal
Illustration Michael Byers

Alberta Premier Rachel Notley is laying out her government’s highly ambitious energy strategy: Build the pipelines that previous governments failed to, transform power generation, minimize carbon output and create a Canadian plastics industry, all while being relatively laissez-faire about the oil sands. But she’s also hit the entire energy sector with carbon and corporation tax hikes. It’s looking like an integrated and co-ordinated plan, using power and petrochemical sectors to support gas production. Can she pull it off?

Notley didn’t kill the province’s golden goose. Drilling rigs won’t be trundling next door to Saskatchewan or over the southern border to avoid a cash-grab royalty regime. The oil patch’s sigh of relief was heard across the prairies. The government’s election promise was to review if Albertans are getting their fair share of royalties, and it’s been decided that yes, they are. The review panel said, “Overall, Alberta’s royalties are comparable with other jurisdictions,” and that the existing regime gives the province an “appropriate share of value.” Broadly, it was well-received by the industry. “[The] announcement has been the result of a fair and credible process, one Albertans can trust,” says Tim McMillan, president and CEO of the Canadian Association of Petroleum Producers (CAPP). “Our new royalty framework recognizes the reality of our economy today,” Premier Notley said at the time. The new rules maintain the status quo for oil sands producers and simplify royalty rates for conventional oil and gas wells. Dave Mowat, the head of ATB Financial who led the royalty review panel, says the review was focused less on rates and more on how to make the system work better.

With the review out of the way, the government will forge ahead with plans to diversify the province’s energy industry. Next on the Notley agenda is the downstream sector. Details of the boost to refining had yet to be announced when Alberta Oil went to press, but hard on the panel’s heels, Energy Minister Marg McCuaig-Boyd announced a program to lift petrochemical production and start a homegrown plastics industry.

Downstream producers had asked the province to lower royalties for hydrocarbons used by manufacturers in Alberta in order to lower costs for processors. Instead they got a new $500-million incentives program for new petrochemical plants – the first to launch will be in Alberta’s Industrial Heartland – a sprawling development northeast of Edmonton that is home to bitumen upgrading, refining and planned petrochemical plants. These incentives could spawn plastic, fertilizer, detergent and textile factories. The farther downsteam that petrochemical investment moves, the more jobs per unit of investment it creates. Chevron Phillips Chemical built the world’s largest ethylene cracker in Saudi Arabia for US$6 billion, employing 1,200 operational staff. The Saudis then asked Chevron to build a US$50 million conversion unit that produces plastics and will also employ 1,200 people, as producing and handling plastic products – cups, closures, pipes, drip irrigations, automotive parts – is more labor intensive.

The Notley incentive program operates under a bidding process that provides royalty credits to successful bidders as a way to cushion the high cost of construction in Alberta compared to the U.S. Gulf Coast. Petrochemical plant operators – which don’t pay royalties – are now allowed to sell their royalty credits to oil and gas producers. The government expects to create between $3 billion and $5 billion in new investment over the 10-year program, if the industry can compete against the Gulf downstream sector, which has built-in cost advantages. One estimate is that construction costs are 30 percent higher in Alberta, and the U.S. plants are closer to big markets and tidewater.

But for Alberta’s petrochemical industry, it could add up to a perfect storm. Falling labor costs and a low Canadian dollar help Alberta gain on Texas and Louisiana, and feedstocks are at an all-time low. Neil Shelly, executive director of Alberta’s Industrial Heartland Association says the review panel’s recommendation to promote natural gas and propane as feedstocks “hit the nail on the head.” And due to a similar policy introduced by the Lougheed government in the 1970s supporting ethane usage, Alberta is already Canada’s top producer of petrochemicals with four ethylene plants, employing 7,700 people.

The first final investment decision on building a petrochemical plant are expected from U.S. firm Williams Energy, which plans a $900-million facility in the Industrial Heartland that removes hydrogen from propane to produce propylene, and a facility to turn the propylene into plastic pellets operated by Goradia, a U.S. chemical investor. They will produce 525,000 metric tons per year of propylene and nearly as much plastic pellets as Canadian manufacturers import each year. David Chappell, president of Williams’ Canadian division, plans to apply for the government’s benefits, he told Bloomberg News. Manufacturers that use plastic pellets to make products such as yogurt containers and car bumpers are already interested in setting up in Alberta and buying from Goradia, instead of importing from the U.S., he says. “Williams is shovel-ready,” says Shelly. Western Canada is awash in cheap propane, flooding out of fields in the Montney and Duvernay formations to the point that, for several months last year, its prices went into negative territory.

In March, the government is expected to reveal the details of its carbon-cutting plan forged at the Paris climate summit last year, when it matched other nations’ pledges. Environment Minister Shannon Phillips said then the plan is a “long process” that will roll out over several months with details not revealed until the March provincial budget is announced. The devil may be in the details – which had some in the patch worried – mbut probably less so after Notley demonstrated pragmatism over ideology in the royalty review. Both CAPP and the Canadian Association of Oilwell Drillers (CAODC) have suggestions for the government’s carbon policies. Both want carbon tax money to be invested in clean technology for the oil industry. Last year, CAODC president Mark Scholz said that “every dollar raised through new carbon taxes should be made available to industry in order to reinvest into new technology to achieve emission reductions.” The group had also asked the review panel for a reduction in oil and gas royalties to compensate for the pain caused by the carbon tax and corporate tax hikes. The Premier, however, said some of the money will go instead into clean energy research and development, and the rest into public transit, support for small businesses and First Nations, and to help coal workers transition to another sector.

The carbon price will take effect in January 2017 and cost $20 per metric ton before it’s boosted to $30 per metric ton the following year. It is accompanied by an overall oil sands emissions limit that will be set at 100 megatons, which leaves room for future oil sands growth, and exempts new upgrading. CAPP supports the government’s climate change plan – with some qualifications – saying that it will green up Alberta’s image and help get its oil to market. “As Premier Notley said, [the plan] will further enhance the reputation of our sector and improve our province’s environmental credibility as we seek to expand market access nationally and internationally,” CAPP’s McMillan says.

The NDP government has followed in the carbon-cutting footsteps of the previous Progressive Conservative government, which funded two massive carbon capture projects. Shell’s Quest and the Alberta Carbon Trunk Line cost Alberta tax payers $1.2 billion in subsidies. The carbon strategies differ, but the social license goal is the same. Things, of course, can always go wrong – Ontario’s soaring power prices warn of too much government meddling.

Before the October general election, oil sands pipelines were supported at a federal level by Prime Minister Stephen Harper, who pulled Canada out of the Kyoto protocol and aggressively championed pipelines. The industry promoted them using facts in what had already become a heated, emotional argument. The result was not a single pipeline built in more than 10 years, and Obama roundly rejecting Keystone XL for political reasons. In December, Notley called the U.S. decision “a kick in the teeth.” But her government has a different approach – she says “taking carbon out of the barrel” will get pipelines to tidewater. The strategy is short-term pain through a higher carbon tax, for a long-term gain in lower transport costs.

A policy that will have a more certain outcome of helping the oil and gas industry is the phase out of coal-fired power plants, which currently make up 55 percent of the province’s total power output, by 2030. The government is aiming for 30 percent generation through renewable energy, while achieving the rest from natural gas. CAPP estimates it will create about 1.5 billion cubic feet per day of new natural gas demand. Combined with support for petrochemical development, that is a double-whammy boost for gas producers.

Put it all together and it’s a wide-reaching plan – something that the federal government lacks. Only time will tell how effective it will be. Its success – or failure – will be measured in pipeline permits and final investment decisions.

Government, politicians, think tanks and industry give their reactions:

“We were pleased there were no surprises.”
— Mark Salkeld, president of the Petroleum Services Association of Canada

“The new royalty framework is principle-based and provides a foundation to build the predictability industry needs for future investment.”
— Tim McMillan, president of the Canadian Association of Petroleum Producers

“The report…falls short of our recommendation to reduce rates to incent drilling activity and offset higher provincial taxes.”
— Mark Sholtz, president of the Canadian Association of Oilwell Drilling Contractors

“What this government has done is cost Albertans thousands if not hundreds of thousands of jobs [and] billions of dollars of investment by having an unnecessary royalty regime review that at the end of the day has said what we’ve got now is pretty good.”
— Alberta Progressive Conservative leader Ric McIver

“It’s a 180-degree reversal from nine months ago. Notley was cornered both politically and economically.”
— Ted Morton, former Alberta finance minister and professor of political science at the University of Calgary

“We were right all along.”
— Wildrose Party leader Brian Jean

“We’re going to see the annual reports coming out, comparing us to other jurisdictions, so taxpayers will be able to measure our competitiveness. That’s a really positive result.”
— The Canadian Taxpayers Federation’s Alberta director Paige MacPherson

“Some people say the NDP have come face to face with reality. I say what happened can best be described as the government being captured by industry.”
— Gil McGowan, president of the Alberta Federation of Labour, who ran as an NDP candidate in the 2015 federal election

“The structure that is presented has all the right elements. It rewards innovation, it rewards cost- cutting.”
— Pat Carlson, CEO of Seven Generations Energy

“They had a chance to do a big tax grab here and resisted the urge, despite having quite a bit of pressure from some quarters.”
— Trevor McLeod, Canada West Foundation

Key takeaways from the Alberta government’s new resource royalty regime for 2017

  • For existing oil and gas wells, the royalty regime will remain the same for the next 10 years. But there will be a “modernized” framework for those drilled after Jan. 1, 2017. This framework will be calibrated to make sure that new wells give producers the same rate of return that they get from existing wells under the current royalty regime. The government won’t gain any extra revenue under this change
  • The system will no longer distinguish between the types of hydrocarbons found in a well, a “distortion” that previously put exploration at risk when companies found, for example, dry gas while exploring for oil
  • All drilling incentives with expirations in 2016 will be extended
  • Non-oil sands will see a new royalty regime – a simplified “revenue minus costs” system. This means that a flat rate of five percent will be levied until the cumulative revenues from the well equal that year’s average drilling and completion cost allowance. Then a higher rate will apply that tracks oil prices. These rates have yet to be worked out
  • The government says it will commit to “an unprecedented level of transparency” in the oil sands. It will publish a new capital cost index, and will also show all of the prices, production volumes and allowable costs that oil sands royalties will be based on
  • The government says it will also annually publish a detailed report showing the financial returns to Albertans. The report will assess job creation, production costs, investment and environmental performance
  • The government will “enhance value-added processing,” and develop a value-added natural gas strategy. It will also incentivize partial upgrading for bitumen

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