24 August 2007

Masters of our domain: Williams concedes on royalties

As Bond Papers noted on Thursday, part of the Hebron deal will involve a change to the provincial royalty regime local media are characterising as a concession.

The Telegram reported on Friday morning that the province will indeed lower the initial royalty to a flat 1% on gross from an escalating regime that maxed at 7.5% until the project recovered its initial development costs.

After that royalties jumped to a combined 305 in two separate tiers. After simple payout, provincial royalties were based on net profits which provided the companies with a rate of return allowance.

Under the royalty regime for Hebron, the province will collect 1% for as long as it takes the project to recover start-up costs.

The Telegram reports Dunderdale as saying that the royalty then would climb to 5% until the companies exhaust something called a "return allowance". This would represent a new royalty layer not included in previous agreements and also is a piece of information not previously released by the government. No further details were contained in the Telegram story.

Only after the return allowance for the 5% rate is exhausted would the province receive the higher royalty rate of 30%. Terra Nova is currently paying at the 30% level. White Rose will also hit that level within three years of production start up. Hibernia - a considerably more expensive project comparable in some ways to Hebron - is expected to hit the higher tier royalties around 2011, 14 years after production started.

Under the three existing royalty arrangements and the province's generic scheme, royalties are tied to production levels and time, as well as costs. However, the so-called super royalty for Hebron of 6.5% is actually contingent on oil prices being above US$50 per barrel for West Texas Intermediate at a point beyond simple payout and exhaustion of the 5% rate.

The royalty re-arrangement is correctly described as a gamble. It trades guaranteed royalty levels that don't depend on oil prices to exist.

Dunderdale told news media that the changed royalty regime is designed to provide the oil companies with front-end protection - i.e. reduced costs - against plummeting oil prices. Those same low oil prices the companies needed insurance against on the costly Hebron venture would also wipe out the super royalty under certain conditions.

The Telegram reported her comments this way:
"The rationale behind these changes was the companies needed some downside protection if the price of oil went very, very low," Natural Resources Minister Kathy Dunderdale said.

"So, that was the trade off for us — to give them protection if oil prices really plummeted, to get a gain if prices were high, above $50. So, we traded off some risk on the low end for significant gains on the other end."
It's important to note, though, that the lowered royalty scheme in the province's concession essentially provides the protections sought by the oil companies in the first round of talks when they sought tax concessions. Those concessions were rejected at the time by the province.

Premier Danny Williams said in April 2006 that those concessions would have wiped out the benefits of the equity position he was seeking.

In April 2006, Williams also criticised a reduction in the generic royalty regime, considered at one time under Premier Roger Grimes, even though that is essentially what he announced on Wednesday. Grimes considered an adjustment to the royalty regime - including lower initial royalties as Williams agreed to this week - at a time when oil was well below US$50 per barrel.

CBC reported Williams attitude in 2006:
"I've indicated publicly before, when Mr. Grimes offered the more favourable royalty regime, that I wasn't in favour of that," Williams said.

" We now have a situation where we have plus-$55 oil … so there's a lot of profit in the oil industry … and so we expect to get a good return," he said.
The Telegram story - headlined "Province concedes on early royalties" - has been picked up across the country. It appears in Cape Breton Post, and a CBC version is available internationally on the CBC website.

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