Alberta's energy royalties: an election explainer

Energy royalties have come up repeatedly in Alberta's provincial election campaign. There is a sense among some Albertans that we are not getting enough revenue from our natural resources.

Thatmay or may not be true. The problem is that the royalty regime in Alberta is ridiculouslycomplex, so complex that it's hard to know what theroyalty rates areor how they compare to other provinces and countries.

Some of thethings Alberta's royalty rates depend on are the price of oil, natural gas and other liquids, the production levels of an individual well, the age of a well, the depth of a well, the capital costsof an oilsands project, the value of the Canadian dollar, and the return on a Canadian government bond.

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So, in an attempt to clarify an issue many Albertans are wondering about, down the rabbit hole we go.

Oilsands royalties

The conversation about royalties tends to begin with the oilsands. Oilsands royalties are based on two things: whether the project has paid for its start-up capitalcosts and the price of oil.

It's very expensive to build an oilsands project.The provincial government encourages development in the oilsands by charging as little as oneper cent royalty rate during the start-up phase. That one per cent holds if the price of WTI (West Texas Intermediate) is below $55 per barrel and moves up from there.

There's a roughly 60/40 split between projects that have recovered their start-up costs and those that haven't.

If a project has paid off its start-up costs, the royalty rate can be ashigh as 40 percent of net revenue, meaning profits from oilsands production. The price of oil needs to be $120 before that royalty rate kicks in.

In practical terms, in the 2015-2016 fiscalyear, the provincial government forecasts that it will earn $1.3 billion in bitumen royalties. Working on the assumption of 2.3 million barrels per day of oilsands production, the government will be collecting $1.54 per barrel of oil this year, a 72 per cent drop from the last fiscal year.

Conventional oil royalties

Alberta is expected to produce575,000barrels a day of conventional crude this year, about 80 per cent of which is on crown land and pays a royalty to the government.The royalty rate paidfrom the production of thisoil is different for each well in the province. To repeat: every well pays a different royalty rate, depending on the production level of the well, the price, the ageand the depth.

According to a report done by the University of Calgary's School of Public Policy, nine per cent of Alberta's production comes from wells that produce lessthan sixbarrels of oil a day, which pay between zero and fiveper cent royalties.

Most of the royalties come from the provinces higher-producing wells the ones that produce more than 118 barrels per day, those wells pay a royalty rate of up to 40 per cent.

However, there's an exception for new horizontal and vertical wells that have a larger up-front cost. Those wells pay a royalty rate of up to five percent for up to fouryears depending on the depth of the well. The same report from the University of Calgary estimates approximately 118,000 barrels per day pay that maximum rate of fiveper cent.

As you can see, it is basically impossible to come up with a single number to accurately describe the royalty rate of Alberta's conventional oil wells, but let's look at the province's own forecast.

It expects to earn $594 million from conventional oil in this fiscal year, on crown production of 460,000 barrels per day of production, that averages out to a $3.53 per barrel.

That number was four times higher in the last fiscal year, when oil prices were nearly double where they are now.

Natural gas royalties

Natural gas royalties also depend on the price of gas, the production level and depth of the well. Royalties from natural gas productionare expected to drop by more than half this year fiscal year to $450 million,again because of lower prices.

That's based on production of 4.7 trillion cubic feet of natural gas produced each year, approximately 80 per cent of which is on crown land. A very rough estimate shows the province earning, on average, 11.3 cents cents per gigajoule of natural gas in the current fiscal year. The average price of natural gas in Alberta last month was $2.54 per gigajoule.

Why such a big drop in royalties?

You can see from the numbers above that royalties have dropped far more quickly thanthe price of either oil or natural gas. That's a result of Alberta's royalty review in 2006 and 2007. At that time oil and natural gas were reasonably buoyant and Albertans felt they weren't getting a fair share of the price increase.

So the province changed royalties to include a sliding scale, the higher the price, the higher the royalty.

"The downside of thatis that when prices crash, you're giving up a lot,"said Andrew Leach, energy economist at the University of Alberta.

Leach says the complexity of the royalty regime is caused by competing visions on what it's supposed to accomplish

"If you askten different Albertans what they want the royalty regime to do, one of them will say revenue, one will say jobs, one will say investment, one will say something else. So you have a royalty regime that tries to do all of those different things."

Leach welcomes more transparency in the system.

"We're getting the message that just asking whether the system is doing the job it's supposed to do, is not really in our interest. I don't think that's the right message to send to people."