18 June 2009

Lack of royalty regime hampers further oil development

Not surprisingly, some people attending the NOIA conference in St. John’s are wondering what is next on the horizon.

As CBC reports, there is much talk of developing smaller fields in the Jeanne d’Arc basin.


There is also the recent announcement by StatoilHydro of a significant oil find at its Mizzen property, farther offshore than the three existing projects and Hibernia South and Hebron both under development.

Regardless of its size, Mizzen poses a number of challenges, not the least of which is the cost and technical issues of developing a field – even one of upwards of three billion barrels of oil – in deep water.

There are at least two others.

One is the impact of the United Nations Convention on the Law of the Sea (UNCLOS). Mizzen is well outside the 200 mile exclusive economic zone but may not lie outside the definition of the continental shelf.   If this is the case, the coastal state – namely Canada – would be required to set aside a portion of the revenue (maximum seven percent) from any development for distribution to the other states which are party to the convention.

Article 82

2. The payments and contributions shall be made annually with respect to all production at a site after the first five years of production at that site. For the sixth year, the rate of payment or contribution shall be 1 per cent of the value or volume of production at the site. The rate shall increase by 1 per cent for each subsequent year until the twelfth year and shall remain at 7 per cent thereafter. Production does not include resources used in connection with exploitation.

That’s potentially a significant cost to both Newfoundland and Labrador and to the companies.

That links to the other problem, namely the absence of an oil or gas royalty regime in the province.  Hibernia, Terra Nova, White Rose and Hebron all have royalty regimes.

The 2007 energy plan wiped out the existing generic oil regime. While the plan promised to replace it and issue a new gas regime, neither has emerged in the intervening years. There is no sign of either coming in the near future.

Even the development of smaller fields on the Jeanne d’Arc basin not associated with the existing projects is affected by the lack of a royalty regime.  The Hibernia South agreement is proposed using the Hibernia royalty regime developed in 1990 and amended in 2000, with some minor amendments.  Other projects would not have that as a basis, nor would it have the Terra Nova, the generic regime used at White Rose or the amended generic regime used for Hebron.

As Danny Williams said in 2005, oil companies don’t like risk.  Really though it isn’t that they dislike risk as much as they prefer predictability.  Even a volatile political climate is manageable, but when it comes to money, the companies like to have a good picture of what their costs will look like over time. That’s where an established royalty regime comes in handy.

In the meantime, some exploration will continue.  Seismic is pretty straightforward.  But when it comes to drilling holes and maybe looking at production, the lack of a predictable financial regime tends to make oil companies skittish.

The situation today is much the same as it was three or four years ago.  There are more exploration and development prospects for Big Oil than there is available capital.  They will put their money where they can figure out the financials.  Anything they can’t calculate  at all will go to the bottom of the pile in favour something somewhere else, even in a part of the world where the politicians in charge change with the sound of gunfire.

Now that Hebron and Hibernia South are pretty much done, the provincial government should turn its attention to restoring stability in the offshore financial regimes.

Above all else, that is what will determine the location of the next project or if there is a project at all.