29 August 2007

Hebron Basic Royalty: a second view

On the heels of Bond Papers' preliminary assessment of the Hebron royalty regimes, here's a look at the same issue using different oil price assumptions. please refer to the earlier post for more detail on the scenario, assumptions and caveats to be applied.

The initial assessment assumed total annual production averaging 50 million barrels per year, based on the provincial government's estimate that Hebron would produce at least 150,000 barrels per day on average. It also assumed first oil would be achieved in 2017.

As well, the initial assessment used an assumed average price for heavy crude oil at US$45 per barrel, on average for the period.

To get a more refined look, this version uses constant 2005 US dollars and takes price projections from the United States Energy Information Agency (EIA). The EIA issued its annual energy outlook in February 2007 for the year 2007 with projections to 2030.

EIA projected prices for West Texas Intermediate (WTI) delivered at Cushing Oklahoma, however, heavy oil sells at a discount compared to WTI. That discount varies over time, based on market action and has been known to run at 40% to 50% less than WTI. For the purposes of this second look, the average price per barrel for heavy crude is taken at an average of US$38 per barrel, on average over the 10 year period 2017 to 2026. That assumes a discount for heavy oil of 25%. The EIA prices ranged from US$31.88 to US$37.13.

The provincial generic royalty regime produces two years of production at 1% of gross revenue , two at 2.5%, two at 5% and four at 7.5%. The Williams basic royalty, as presented in the provincial government news release of August 22, 2007 sets the basic royalty at a constant 1% for the period before simple payout.

As can be seen, the generic royalty regime's steady progression produces significantly more royalty revenue for the provincial treasury annually than does the flat rate approach during the assumed 10 period before the project attains simple payout.

Cumulatively, the generic royalty would produce $893 million in royalty versus $190 million over the 10 year period.

There are several points to bear in mind:

1. Since there is insufficient information available publicly from the provincial government on the proposed royalty regime after simple payout, there is no way to assess whether or not there are gains after simple payout to offset the revenue foregone in the initial phase.

2. When assessing the impact of Tier 3 so-called super-royalty, it will be important to confirm whether the figure of US$50 per barrel for WTI will be expressed in any final agreement as being constant dollars (adjusted for inflation given a base year) or nominal dollars.

To illustrate the importance of this distinction, note that the EIA forecast shows WTI going above US$50 constant 2005 dollars in 2028 and then only by 17 cents. Revenue from Hebron will be actually lower than this, given the impact of the heavy oil discount.

3. Given the royalty that appears to flow in the period before simple payout, there is some doubt as to the accuracy of the $16 billion revenue figure used by the provincial government or exactly what revenues it contains in addition to royalties.