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How a columnist scored big on eBay and impressed his 10-year-old Junior Achiever

by George Koch

Hear the boom-time calls for higher energy royalties? Oil and natural gas companies are accused of withholding the “fair share” that Albertans, through their provincial government, expect and deserve. Oilsands producers in particular are portrayed as contributing little to the province, despite obscene profits and ongoing subsidies.

The facts tell a different story. In fiscal 2006 the province hauled in $14 billion in resource-related revenues. That’s an astounding sum. Economists had previously estimated Alberta’s resource sector could generate just $3 billion to $4 billion per year on a sustained basis.

Rates are structured to cash in on high commodity prices. The natural gas royalty rises to 28%, straight off the producer’s top line. That can be equivalent to 50% or even 70% of profits. As for subsidies, tax credits to encourage certain types of drilling were a mere $113 million last year.

Now, royalties from oilsands do seem low. Until recently, they were low. Alberta’s “generic” royalty structure, approved in 1995, was designed to encourage the massive investments needed to build those monu­mental oilsands plants, which take years to construct and years more to recover their investment costs. Even a casual glance at oilsands investment, jobs or production suggests this approach was wildly successful.

Before cost recovery, an oilsands project pays only 1% of its gross revenue to the government. But this is temporary. After pay-out, its royalties shoot to 25% of net revenue (roughly, cash flow, or revenue minus direct costs). The low initial rate in fact hastens the day the government can apply the higher rate.

The trend is highly encouraging. Suncor Energy Inc.’s oilsands royalties went from $21 million in 2003 to $261 million the following year. In just the first quarter of 2006, Suncor paid $285 million in royalties. The province’s haul from one company in one quarter was more than the entire oilsands sector paid in any year prior to fiscal 2005.

The massive Syncrude project had been paying next to nothing as it underwent a multi-phase, multi-billion-dollar expansion. But this year its royalties shot from 65 cents per barrel of production to $6.68 per barrel – about $620 million per year. Canadian Natural Resources’

new Horizon project should generate $2 billion to $4 billion in annual cash flow beginning around 2012, meaning royalties of $500 million to $1 billion.

So far about 32 of 55 oilsands projects are past payout. Provincial oilsands royalties grew from $197 million in fiscal 2004 to $1.2 billion last year. They’re budgeted at $1.7 billion this year, but last year’s receipts were almost triple the budget. By 2020 they should be $5 billion to $7 billion per year. They’ll neatly replace the long-term decline of royalties from conventional production. These rates will have to be reduced over time to maximize recovery of this maturing resource. In the end, government revenues will be highest if we can maximize industry production and profitability. Remember, if there’s no production, there’s no tax or royalty revenue at all.

Still, some have wondered whether we might need to apply the brakes – gently – to our out-of-control boom. By, say, raising energy royalties. Wouldn’t slightly slower growth ease the labour shortage, pull back unaffordable housing prices and limit runaway industry costs? Not just left-leaning critics but even a prominent candidate for the provincial Progressive Conservative leadership have mused along these lines.

The risks would be enormous. Remember, most economic forecasts are wrong most of the time. Alberta’s boom may seem permanent, but the unexpected happens all the time. If commodity prices suddenly fell, any neo-Keynes­ian royalty policy would quickly go from applying the brakes to skidding off the road. You can’t manipulate an already cyclical industry.

And at bottom, you simply can’t hoard opportunity. From the 1950s through the mid-’90s, decades went by when nothing happened in the oilsands (Suncor’s plant nearly closed). Alberta seized a singular opportunity. Oil prices are high – right now. Investors worldwide are salivating to get in on the oilsands – right now. The U.S. is desperate for energy security – right now. Oilsands production is leaping and so are royalties. Rewriting royalties would be pointless – and profoundly self destructive.