Royalty discount not enough to prevent investment from fleeing Alberta

The Alberta government this week announced that it is postponing royalty rate hikes on some types of new oil and gas wells in hope of attracting new drilling projects. The change is an acknowledgement that the higher royalties scheduled to take effect in 2009 are putting the province at a competitive disadvantage. Unfortunately, the change falls far short of the reforms necessary to encourage petroleum industry investment, production, and employment in the present economic environment.

Industry executives have maintained for some time that Alberta's new, more costly royalty framework would reduce drilling in the province and drive production elsewhere. This was documented in the Fraser Institute's 2008 Global Petroleum Survey, which found that managers of petroleum exploration and development companies regarded Alberta as posing significant barriers to upstream oil and gas investment. Consequently, the province ranked far worse in relative attractiveness for investment compared to 2007.

Beginning Jan. 1, the new royalty framework will increase the payments due on most oil and gas production. Last week, however, Premier Ed Stelmach announced a royalty discount potentially totaling $1.8 billion for new oil and natural gas wells (within 1,000 and 3,500 metres in depth) drilled from now through the end of 2013.

But these "transitional royalties" won't actually have much immediate impact because the winter drilling schedules already have been set, including investments shifted to Saskatchewan and British Columbia. And, because the royalty reductions apply only to new wells, the benefits won't accrue until after production of successful wells commences, or well into 2009, in most cases.

Consequently, the partial royalty retreat is a case of too little, too late. The royalty discount won't apply to 80% of all wells in Alberta, and higher rates on existing wells and new shallower wells will still take effect on Jan. 1. In fact, taking into account the impact of the special discounts, the government still expects to collect an additional $1.8 billion in royalties next year and an additional $2.1 billion in 2010 as a result of the new royalty framework. Those are dollars that will be unavailable for investment in new oil and gas projects and for creating additional jobs in the province.

If the government were truly interested in bolstering investment and employment, it should simply suspend imposition of the royalty rate hikes. The failure to do so indicates that the government does not fully appreciate the extent of the economic damage that the new royalty framework will inflict and leaves the impression it is simply more interested in filling its coffers.