The news release on the government’s generic offshore royalty wasn’t exactly a model of clarity and accuracy.
The headline and first sentence referred to the announcement of a “framework.”
The first quote claimed that “establishing the enhanced generic offshore oil royalty regime” was an achievement for the current administration.
The problem is that none of it is true.
The federal and provincial governments need to sort out a royalty regime for the areas of the seabed outside the 200 mile exclusive economic zone.
Wylie Spicer of McInnes Cooper has pointed this out in a new paper from the University of Calgary public policy school..
SRBP pointed this out in 2009, at the time of a significant discovery that might have commercial potential.
SRBP pointed it out again earlier this year when the notorious scoff-law Paul Davis said he wanted to get a development going outside the 200 mile limit without having publicly addressed the issue of the new royalty regime. He had started talking about a new royalty regime, apparently, but was keeping it a secret.
Maybe now that someone from Calgary has pointed out this deficiency someone will notice the problem and do something about it.
Maybe it is something one of the political parties in the province would like to bring up during the provincial election.
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Natural Resources Canada news release:
“The Honourable Christian Paradis, Minister of Natural Resources, and Nathalie Normandeau, Quebec Deputy Premier, Minister of Natural Resources and Wildlife and Minister responsible for the Northern Plan, today announced that the Governments of Canada and Quebec have reached an important accord on the development of oil and gas resources in the Gulf of St. Lawrence.
"This is an important day that is the result of a great deal of hard work," said Minister Paradis. "Under a co-management framework, Quebec will derive significant financial benefits from resource-related activities. This accord is a concrete example of the two Governments collaborating to create jobs, energy security and economic opportunity in resource communities in the regions of Quebec and Canada. The Government of Canada will continue to work with Quebec to ensure the responsible and sustainable development of our natural resources."
"This is an historic day for Quebec. After more than 12 years — and thanks to the tremendous work of our two governments — we are very proud to announce that the Province of Quebec has an agreement that will give us 100 percent of the revenues from the development of our oil and gas in the Gulf. It's truly a great day for Quebec," said Minister Normandeau.
The Quebec government is undertaking a strategic environmental evaluation before allowing the development of oil and gas in the Gulf of St. Lawrence. The results of this evaluation will be known in 2012.
Since 2006, the Governments of Canada and Quebec have achieved several milestone collaborations. The accord is a key element in the continuation of that work.
The accord will be implemented by means of mirror legislation that will be tabled by the federal and provincial governments before the Parliament of Canada and the National Assembly of Quebec. The accord will be implemented in steps, and rigorous environmental assessments will be conducted before any oil and gas development begins.”
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A few things to note about the news that the White Rose extension field – called North Amethyst – pumped its first oil this week;
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Oil production in the first four months of fiscal 2009 is down about 23.5% - on average - compared to the same period in 2008.
But Hibernia payout and current oil prices mean that the offshore oil patch is on track to deliver about the same revenue to the provincial coffers in 2009 as it did last year.
That’s $2.5 billion for those who are keeping score.
Compare that to the $1.2 billion in oil revenues forecast in Budget 2009.
That also means the provincial budget will be on balance overall.
Of course, that also means the provincial government still has a couple of billion sitting in the bank doing nothing but collecting modest interest.
So why exactly is the provincial government still opposed to a setting up a sovereign wealth fund - like Norway or Alberta - to ensure the people of the province get the maximum benefit from their resources?
When you think about it, that makes it hysterically funny to see the federal Dippers trying to buy votes in the province by talking about “fairer” Equalization. Are they promising Alberta Equalization hand-outs too?
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While Danny William’s radio tirade/meltdown is rapidly eclipsing his own good news announcement nationally, there is interest in assessing the details of the Hibernia South Extension memorandum of understanding based on the official news release and news reports on the day of the announcement.
Caveats
As with Hebron, the final agreement may yield some details which were not readily apparent when the MOU was announced. As well, and as with Hebron, key portions of the deal are likely to be hidden from public view. With that said, we still have enough information to make some observations about the proposed development deal. In this first post, we will look at the royalty regime.
General
Overall, this agreement represents a transformation from Williams Mod 1 to Williams Mod 2 in the government’s approach to offshore oil development.
Williams Mod 1 (pre-2o06) was essentially a variation pre-1984 provincial government thinking and emphasised:
Williams Mod 2 (post- 2006) places the greatest emphasis on additional government revenue through the most obvious source: enhanced royalties. This is especially clear in the Simms encounter where the Premier states:
The reason we’re caught up in the oil, it’s not the oil, it’s the black gold that’s out there, it’s not the petroleum, it’s not the oil and gas, it’s the revenue that it brings to us, so that we can deal with problems in the fishery, so that we can take care of the Abitibi workers, so that we can build new hospitals and new long terms care facilities, so that we can build new schools, so that we can lead the country in poverty reduction, and it goes on and on and on. Surely you – presumably – run a municipality. You must know the importance of revenue, and where that revenue comes from – if it comes from business, whatever form of business it is, or if it comes from residential real estate, it goes into your coffers now so you can do all the wonderful things that need to be done. [Emphasis added]
Government-induced infrastructure has been effectively abandoned as evident in both Hebron and Hibernia South and the equity portion has also been capped artificially at 10%. In Hibernia South, the second GBS or other production facility has been discarded for the most economical production method (slant drilling from the original GBS and tie-backs to the original GBS).
This effectively adopts the philosophy that guided resource development after 1985 and is best seen in the 1990 Hibernia agreement and in the subsequent developments at White Rose and Terra Nova.
As much as Danny Williams may like to complain about those who offer alternative views to his own, this basic approach has been noted before – including in this corner – as an alternative to Williams Mod 1.
The easiest, most efficient means of enhancing government revenue is through adjustments to the royalty regime. Revenue is needed to meet the demands for program spending and infrastructure development today. Regular readers of Bond Papers will recognise the refrain.
Hibernia Southern Extension Royalty Regime
The base for the three-part royalty is the existing Hibernia royalty regime as concluded in 1990 and modified in 2000.
This sets the rate after simple payout (achieved a few months early) at 30% Tier 1 royalty with a further 12.5% Tier 2 royalty triggered by profitability.
This is the royalty rate – 42.5% - that produces the bulk of the cash.
The royalty regime for the southern extension is cut into three parts. There is no explanation as to why the rate is structured this way. The backgrounder provided with the news release does not explain the structure clearly.
Part I: For the 50 million barrels or so that will be drilled directly from the Hibernia gravity base structure, there is the 42.5% that already exists in the Hibernia royalty regime established in 1990 and modified in 2000.
There is no price trigger for this since the original royalty regime did not tie provincial government revenues to oil prices directly.
Part II: For the portion of the project that is under the original production License 1001 (PL 1001), the basis is the original Hibernia royalty regime (maximum 42.5%, not tied to price).
In addition there is a further 7.5% royalty when prices for West Texas Intermediate (WTI) are above US$50. Above WTI at US$70 there is an additional 5%.
There is a cap on the royalty however:
Should supplementary royalty payout be achieved under the terms of the original Hibernia contract be achieved, the top rate will be 50 per cent.
It would appear that once the project has triggered the Tier 1 and Tier 2 royalties (42.5%), only an additional 7.5% is available beyond that irrespective of price.
Part III: There is a similar 50% cap in the new areas, i.e. the ones covered by PL 1005 and Exploration License 1093 (EL 1093). The cap is achieved by reducing the incremental royalty tied to price (WTI at US$50) from 7.5% to 2.5%.
Observations
Overall, this represents a complex arrangement that modifies the existing royalty regime slightly. The complexity may be due in part to the highly diversified interests in the three licenses, especially EL1093.
In many pricing scenarios, then, the maximum available royalty from what is described here as Part II of the regime would appear to be the same as under the existing Hibernia regime, i.e. 42.5%.
On the face of it, the Part II and Part III royalty structures offer an identical outcome. Additional information would be needed to explain how the structure works and why it is in place.
The provincial government revenue figure offered in the announcement - $10 billion – is apparently derived almost entirely by applying the existing Hibernia Royalty Regime to an environment in which oil prices are considerably above the average price that existing during the initial phase of the project.
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Money Update: Premier Danny Williams told CBC’s David Cochrane today that the estimate of $10 billion of provincial revenue from Hibernia South is based on an estimated average oil price of $83 over the next decade.
There is something suspicious about the government calculation though since Williams claimed on Tuesday that five times as much oil left in Hibernia as in Hibernia South would net the province only slightly less cash than Hibernia proper even though both projects use essentially the same royalty regime:
We expect a further $13 billion from the remaining main field production and this extension adds an estimated $10 billion more in revenue for the province…
In July 2006 when Danny Williams accused ExxonMobil of denying the provincial government access to the books for the Hibernia project there was a lot more to the story either than what he said or than just his fit of pique at the failure of talks to develop Hebron.
Williams put it in another context altogether at the time, claiming the company had reneged on a commitment to “audit process to validate statements by the company that the Hibernia project was not meeting the owners’ expectations.”
As it turns out, the reality – revealed almost three years later by the province’s auditor general in his annual report for 2007 (year ending 31 March 2008) - is that the provincial government was and is behind in its own audits of offshore oils project reports:
… At October 2008 [sic], there were 87 annual royalty and eligible project cost submissions made by project
owners for which the Department has not started any audit work. No royalty or eligible project cost audits have been conducted on the Terra Nova or White Rose projects since production started in 2002 and 2005 respectively.
On top of that the department’s audit manual was approved in 2000 but hasn’t been updated in the intervening seven years.
Each of the 15 companies operating offshore are required to file monthly and yearly operating reports with the provincial government. They must also file an audited financial report annually on project costs. All these are used to calculate royalties paid to the provincial government’s royalties and benefits division of the natural resources department.
The majority of the outstanding audits, shown in the chart at left taken from the auditor general’s report, are for the period after 2003.
In early 2006 - the year Williams made his accusations against ExxonMobil and the year before the one audited by Noseworthy – then natural resources minister Ed Byrne told a House of Assembly committee that his department was experiencing staff problems in the division of his department responsible for the royalty and cost audits.
MR. E. BYRNE: Difficult not only to attract, difficult to maintain. A lot of this, too, is part and parcel of the energy policy review that is ongoing and the dedicated resources we put to that. Within the Department of Natural Resources, the energy division is most challenged, more than any other division within the department, on not only recruiting but maintaining.
We had senior petroleum auditors who left for double the salary. We recently had an ADM who took a job in Calgary. I do not know what his salary was or what he was offered. He was making a competitive salary here, but it was a significant offer. Those are issues that the deputy and government struggle with everyday. Anyway, that is part and parcel of the change in direction there.
Within the local oil patch the migration of senior, experienced public servants to the private sector caused a great deal of chatter.
The problem hasn’t gone away. Last May, natural resources minister Kathy Dunderdale told the House of Assembly’s Resources Committee that there had been a number of vacancies in the audit division and that the department was hiring outside contractors to take up the slack. She said the audits were “Behind, big time.”
The department’s deputy minister - Chris Kieley - told the committee:
For those three projects [Hibernia, Terra Nova and White Rose], and with the increased activity, every year we are doing audits but, because of the turnover in staff, because of the resources that were assigned to that particular piece in previous years, the audits were behind; so, this past year and the year before we have made a particular effort to get those audits up to date and we have used outside assistance through auditing firms to help us do some of those audits. So, we have a combination now of outside accounting firms helping us get the audits up to date and we have our own staff working on the audits as well. We are working on a number of different audits now with all our projects at this point.
Kieley also insisted in May that
“[w]e are within the timelines prescribed by legislation (inaudible) the Hibernia royalty contract, but we are behind and we are putting extra effort into this whole piece to get caught up. When I say behind, we have not lost any ability to audit these. What we are saying is that we would like to get them up to a closer time frame.”
Auditor General John Noseworthy noted in his report that the Hibernia audits completed had revealed $8.66 million owed to the provincial government. In her testimony to the resource committee, natural resources minister Kathy Dunderdale insisted, however, that “there has been nothing earth-shattering that we have come across to this point.” The completed audits done in May 2008 are almost identical to the ones listed as finished by the auditor general in his report.
Noseworthy also noted that the department had committed to completing all outstanding audits by 2010. At the same time, though noted that even the 2008 schedule was off, largely due to staffing problems within the natural resources department.
In 2008, the work plan was amended to move 2400 hours of work scheduled for White Rose to 2009 as a result of audit work done for Hebron. As of October 2008 – half way through the fiscal year - an external contract for an auditor had not be let for 2008.
The 2008 audit plan was based on 1400 hours for four staff positions supposed to be filled by the start of the fiscal year. By October 2008, one position was still vacant. Another was filled in July and only two of the original four planned were in place in April 2008. Associate deputy minister Pierre Tobin gave the resource committee a different version at the committee hearings in May. Rather than disclose that two audit positions were vacant, he left the committee with the impression the division was “almost fully staffed”:
That would be, in the past year, a number of auditors, but those positions have since been filled for the most part. There would also have been a couple of development officers and a couple of economists. We are almost fully staffed, particularly in the royalty audit section. We are down one person out of upwards to a dozen, I guess; we are doing really well there. [Emphasis added]
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The crew that put together's CBC's usually fine "Reality Check" can be forgiven if they missed a few points by a country mile in a summary of the Family Feud.
Forgiveness is easy since the issues involved are complex and - at least on the provincial side since 2003 - there has never been a clear statement of what was going on. Regular Bond Papers readers will be familiar with that. For others, just flip back to the archives for 2005 and the story is laid out there.
Let's see if we can sort through some of the high points here.
With its fragile economy, Newfoundland and Labrador has always depended on money from the federal government. When they struck oil off the coast, the federal government concluded it would not have to continue shelling out as much money to the provincial treasury. N.L.'s oil would save Ottawa money.
Not really.
Newfoundland and Labrador is no different from most provinces in the country, at least as far as Equalization goes. Since 1957 - when the current Equalization program started - the provincial government has received that particular form of federal transfer. So have all the others, at various times, except Ontario. Quebec remains one of the biggest recipients of Equalization cash, if not on a per capita basis than on a total basis. Economic "fragility" has nothing to do with receiving Equalization.
In the dispute over jurisdiction over the offshore, there was never much of a dispute as far as Equalization fundamentally works.
Had Brian Peckford's view prevailed in 1983/1984, Equalization would have worked just as it always has. As soon as the province's own source revenues went beyond the national average, the Equalization transfers would have stopped.
Period.
That didn't work out. Both the Supreme Court of Newfoundland (as it then was called) and in the Supreme Court of Canada, both courts found that jurisdiction over the offshore rested solely with the Government of Canada. All the royalties went with it.
In the 1985 Atlantic Accord, the Brian Mulroney and Brian Peckford governments worked out a joint management deal. Under that agreement - the one that is most important for Newfoundland and Labrador - the provincial government sets and collects royalties as if the oil and gas were on land.
And here's the big thing: the provincial government keeps every single penny. It always has and always will, as long as the 1985 Accord is in force.
As far as Equalization is concerned, both governments agreed that Equalization would work as it always had. When a provincial government makes more money on its own than the national average, the Equalization cash stops.
But...they agreed that for a limited period of time, the provincial government would get a special transfer, based on Equalization that would offset the drop in Equalization that came as oil revenues grew. Not only was the extra cash limited in time, it would also decline such that 12 years after the first oil, there'd be no extra payment.
If the province didn't qualify for Equalization at that point, then that's all there was. If it still fell under the average, then it would get whatever Equalization it was entitled to under the program at the time.
The CBC reality check leaves a huge gap as far as that goes, making it seem as though the whole thing came down to an argument between Danny Williams and Paul Martin and then Danny and Stephen Harper.
Nothing could be further from the truth, to use an overworked phrase.
During negotiations on the Hibernia project, the provincial government realized the formula wouldn't work out as intended. Rather than leave the provincial government with some extra cash, the 1985 deal would actually function just like there was no offset clause. For every dollar of new cash in from oil, the Equalization system would drop Newfoundland's entitlement by 97 cents, net.
The first efforts to raise this issue - by Clyde Wells and energy minister Rex Gibbons in 1990 - were rebuffed by the Mulroney Conservatives. They didn't pussy foot around. John Crosbie accused the provincial government of biting the hand that fed it and of wanting to eat its cake and "vomit it up" as well.
It wasn't until the Liberal victory in 1993 that the first efforts were made to address the problem. Prime Jean Chretien and finance minister Paul Martin amended the Equalization formula to give the provincial government an option of shielding up to 30% of its oil revenue from Equalization calculations. That option wasn't time limited and for the 12 years in which the 1985 deal allowed for offsets the provincial government could always have the chance to pick the option that gave the most cash. It only picked the wrong option once.
The Equalization issue remained a cause celebre, especially for those who had been involved in the original negotiations. It resurfaced in the a 2003 provincial government royal commission study which introduced the idea of a clawback into the vocabulary. The presentation in the commission reported grossly distorted the reality and the history involved. Some charts that purported to show the financial issues bordered on fraud.
Danny Williams took up the issue in 2004 with the Martin administration and fought a pitched battle - largely in public - over the issue. He gave a taste of his anti-Ottawa rhetoric in a 2001 speech to Nova Scotia Tories. Little in the way of formal correspondence appears to have been exchanged throughout the early part of 2004. Up to the fall of 2004 - when detailed discussions started - the provincial government offered three different versions of what it was looking for. None matched the final agreement.
The CBC "Reality Check" describes the 2005 agreement this way:
The agreement was that the calculation of equalization payments to Newfoundland and Labrador would not include oil revenue. As the saying goes, oil revenues would not be clawed back. Martin agreed and then-opposition leader Harper also agreed.
Simply put, that's dead wrong.
The 2005 deal provided for another type of transfer to Newfoundland and Labrador from Ottawa on top of the 1985 offset payment. The Equalization program was not changed in any way. Until the substantive changes to Equalization under Stephen Harper 100% of oil revenues was included to calculate Equalization entitlements. That's exactly what Danny Williams stated as provincial government policy in January 2006, incidentally. The Harper changes hid 50% of all non-renewable resource revenues from Equalization (oil and mining) and imposed a cap on total transfers.
As for the revenues being "clawed back", one of the key terms of the 2005 deal is that the whole thing operates based on the Equalization formula that is in place at any given time. Oil revenues are treated like gas taxes, income tax, sales tax, motor vehicle registration and any other type of provincial own-source revenue, just like they have been as long as Equalization has been around.
What the federal Conservatives proposed in 2004 and 2006 as a part of their campaign platform - not just in a letter to Danny Williams - was to let all provinces hide their revenues from oil, gas and other non-renewable resources from the Equalization calculations. The offer didn't apply just to one province. Had it been implemented, it would have applied to all.
That was clear enough until the Harper government produced its budget 18 months ago. What was clear on budget day became a bit murky a few days later when Wade Locke of Memorial University of Newfoundland began to take a hard look at the numbers.
Again, that's pretty much dead wrong.
It became clear shortly after Harper took office in 2006 that the 100% exclusion idea from the 2004 and 2006 campaigns would be abandoned in favour of something else. There was nothing murky about it at all. So plain was the problem that at least one local newspaper reported on a fracas at the Provincial Conservative convention in October 2006 supposedly involving the Premier's brother and the Conservative party's national president. That's when the Family Feud started.
As for the 2007 budget bills which amended both the 1985 and 2005 agreements between Ottawa and St. John's, there's a serious question as to whether the provincial government actually consented to the amendments as required under the 1985 Atlantic Accord.
The story about Equalization is a long one and the Family Feud - a.k.a the ABC campaign - has a complex history. There's no shame in missing some points. It's just so unusual that CBC's "Reality Check" was so widely off base.
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If crude oil averages US$87 per barrel through the current fiscal year (ending 31 March 2009) and the government performs exactly as budgeted in every other respect too, the provincial government will wind up with a deficit of more than $794 million this year.
That's right.
Almost eight hundred million dollars in the hole.
It's not a state secret.
Your humble e-scribbler did not have to go through any contortions - mental or otherwise - to figure it out.
The figures are there, in black and white, in the provincial government's current budget. Hidden in plain sight, you might say.
But no, some of you are saying, the provincial government is forecasting a surplus of a half a billion dollars. The media reported it in April and they've kept saying it so it must be true.
Yes, the did and they have.
But that isn't the official budget of the provincial government approved in the House of Assembly any more than all the talk by politicians about surpluses the past few years was accurate either.
That forecast was done separately by the department of finance and repeated by the finance minister countless times. It is based - evidently - on the hope that oil would actually spend most of the year well north of US$87. They were hoping on oil revenues being almost double the $1.7 billion used to make up the budget. An extra $1.3 billion would wipe out the forecast deficit and leave another $500 million or so besides.
The recent drop in oil prices below US$100 could throw that hope out the window, coming as it does a little less than half way through the fiscal year. Oil would have to drop quite a bit further than its current price in the mid nineties to wipe the anticipated surplus out entirely, but don't count on there being too much cash left in the till next April.
There are a couple of reasons for that beyond the drop in revenues compared to the Atlantic City dice roll projections.
For starters, if revenues are already up by about $800 million or so, government might be able to bring in something close to a balanced budget. Any less than that and something's gotta give to stay in the black.
The other thing is that - contrary to the popular view - government hasn't actually produced a real surplus in three years. Again, eyes are rolling, but all you have to do to see the truth is look at the government's annual financial statements.
Last year, for example, the government spent every nickel it originally budgeted, every penny of the $1.5 billion surplus and on top of that had to borrow another $88 million just to make ends meet.
Just to make it really plain, that table above is taken from a Bond Papers post last June that lays the whole thing out in a picture.
This administration, like pretty well all the ones before, likes to spend public cash. If there isn't enough coming in, hitting up the banks is just as good as money earned in other ways.
As the Auditor General pointed out in his report earlier this year, the provincial government has consistently boosted public spending based on the mountains of oil cash flowing.
They've built the province's spending on some pretty shaky ground, namely highly volatile commodity prices.
At the same time, very little attention has been paid to paying down the large amount of debt - the accumulated deficits - that now runs upwards of $8.5 billion and is expected to climb higher this year.
That's the table at right, with the figures taken from the finance department's budget document, The Estimates.
For those of you whose mind has not just boggled into the "off" position, this has some pretty significant implications for what is going on in the province.
The province's finance minister told reporters today that salary expectations from groups like the nurses are based on high oil prices.
No, they aren't.
High public expectations for new spending and public sector union salary demands are based on the government hype about its own financial plans and its own cash flows. The people of the province believed all the stuff about surpluses and happy days finally being here. They believed because that is what they were told by politicians.
People have even been lulled into believing that the Hebron project - all $28 supposed billion of it - is coming right along any day now.
The reality is starkly different.
Oil revenues will decline over the next decade because of dwindling production and prices that are returning to something approaching the norm. The three existing fields will be well on the way to shutting down by the time Hebron gets into production.
Rather than adding to current cash flows - as most people likely believe - Hebron will simply take up some of the slack from that dwindling production. If construction starts on Hebron in 2012, the cash from its oil won't hit provincial coffers until about a decade from now.
The reality is that the next decade is going to be considerably more difficult than people imagined; difficult that is for the provincial government. They have made a rod to beat their own backs by creating a climate of expectations that simply can't be met with likely revenues. At the same time - through the energy corporation and the equity stakes - they've committed to a steady stream of new government borrowing over and above what it may cost to sustain the existing spending levels after the oil money drops off.
There's nothing overly complicated about the whole business. The information is readily available to anyone who cares to look.
Understanding what is going on today and what looks very likely to happen?
Well, that's as easy as A-B-C.
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The Telegram front page today carries a story on the provincial government's revenue estimates for the Hebron project in three scenarios. The scenarios use oil at an assumed average price over the life of the project at US$50, US$87 and US$113 (constant 2008 dollars). The story is also available online.
Given that oil prices haven't averaged anything near US$87 or US$113 over the past 25 or 30 years, that US$50 a barrel estimate in constant dollars is probably a little closer to the likely performance of oil prices sometime after 2018. In that scenario, the provincial government estimates revenues at $6.8 billion, including $5.4 billion from the revised royalty regime.
That royalty regime keeps royalties at a constant 1% up to simple payout and then provides for an additional 6.5% in any month after simple payout in which prices average above US$50 for West Texas Intermediate at Cushing, Oklahoma.
To see the impact of oil prices on the revenue projections using the revamped royalty regime, all you have to do is lop one measly dollar off the assumed average price. At US$49 - a 2% drop from the government's assumed average price - the province's royalty take drops by at least $1.25 billion. That's 23% less. Factor in the loss from the changed royalty regime, which government estimates at $105 million at the average price of US$50 a barrel and the loss climbs.
The provincial estimates see the 4.9% equity position generating $800 million for the energy corporations oil subsidiary at the US$50 price assumption. This appears to be based on total costs for the company of $600 million over the life of the project (construction to decommissioning).
Based on the provincial government's own estimates of costs for acquisition and the construction phase, that would assume the OilCo's share of all production and decommissioning phase costs at $200 million. That works out to a total projected cost of $4.0 billion for ongoing operations of the rig, exploration, delineation and production drilling after first oil and whatever share of decommissioning costs the oil company will bear. It would also have to include any fees and charges for handling the sale of crude which represents the OilCo share of production.
Low-balled costs? Could be. Bond Papers' preliminary estimate of lifecycle costs for OilCo came in at about twice the amount apparently used in the provincial government calculations. Bond Papers used a figure of $10 billion as the cost of operations expenditures and production phase drilling, and decommissioning costs, including the $250 million for a liability guarantee.
Fixing an accurate estimate of the costs after first oil would help refine the calculations. That may be difficult, though, since the acquisition agreement between the provincial government and the oil companies hasn't been released to the public. It might become somewhat easier when and if a development application is filed with the offshore regulatory board. That application would include a forecast of drilling activity for the production phase.
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Related:
The provincial government and the White Rose partners revealed some further detail of the White Rose expansion project on Monday.
Some observations/questions:
1. The bulk of the financial return to the provincial treasury is from the old generic royalty regime established in 1996.
2. There is no real discussion of the "equity ownership" and what it means.
With the exception of a few general references, there is no discussion at all of what is entailed in the "equity". There is no discussion of acquisition costs or other liabilities associated with it, nor is there any discussion of what - if any - management rights accrue to the energy corporation our of this stake.
There is a reference to a processing fee on "its", i.e. the energy corporation's, oil but no indication of what that means in general terms.
3. What is the "processing fee" for?
Under the agreement, the province’s energy corporation will pay a ‘processing fee’ of $3.50 a barrel on its oil.
This is essentially a fee to ensure processing capacity on the Sea Rose FPSO.
The floating production, storage and offloading vessel for the project has the capacity to handle production from the field at the approved rates. It can store and process at established rates. There is no obvious reason for the provincial government to pay a set fee per barrel to ensure capacity exists.
If this fee is one applied to all operators, then this is an operating cost, not a cost related to acquisition of an equity interest, it has been presented.
If it is an operating cost, it certainly isn't clear if the fee represents the total energy corporation share of operations or if it is a specific amount related to a certain aspect of operations. A "processing fee" of this type is sometimes applied on leased FPSOs where the vessel owner is actually reimbursed a lease rate and an additional amount for processing from the company renting the platform.
The fee may be related to a process of "deeming" what part of production belongs to the provincial government, even though the production is co-mingled with the total production. That appears to be the case, given the implication of the next sentence in the backgrounder: "To get the crude to market, there are a number of marketing arrangements already in place with existing facilities, and the province’s energy corporation will be able to tap into those."
Essentially, the energy corporation would receive the value of a quantity of oil less operating, capital and any other costs rather than receive a specific quantity of oil that it could then take to a refinery and market directly. The quantity of oil would be "deemed" or established based on a set of accounting rules.
There's nothing unusual or necessarily problematic about such an arrangement; it would just mean that the energy corporation could not necessarily load up a series of tankers and move the crude to a refinery of its choice.
So what is the fee really all about and what other fees and charges are being applied to the energy corporation?
3. There is no indication publicly of what the energy corporation will pay as part of ongoing operations expenditure or what share it will bear, if any, of phase-out or emergency response costs.
4. Will energy corp pay its portion of the provincial oil royalty on its assets? How will that be handled?
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"The proponents have chosen to proceed with this development, even though the fiscal and other terms haven’t been finalized.
"What we will have to ensure, as we continue our discussions around these satellite field developments, is that the province receives a fair return."
With regards to criticism of modifications to the basic royalty, it is important to note that the change is the difference between 2.5% and 1% -- not between 7.5% and 1% as reported by Mr. Coyne -- in addition, we still maintain the 5%, and in some cases 7.5%, level of royalty once costs are recovered.For those familiar with the provincial generic royalty regime, this would create some confusion since the situation described by the Premier is not how the existing generic royalty regime works.
Crown corporations and agencies involved in oil and gas resource activities in the offshore area shall be subject to all taxes, royalties and levies.As a result of the Hebron memorandum of understanding, the Government of Canada will collect revenues from the provincial government's share of overall revenues which it ordinarily would not collect. These come in the form of federal corporate taxes, for example.
With regards to criticism of modifications to the basic royalty, it is important to note that the change is the difference between 2.5% and 1% -- not between 7.5% and 1% as reported by Mr. Coyne -- in addition, we still maintain the 5%, and in some cases 7.5%, level of royalty once costs are recovered. As well, the province will still receive the monetary benefits of being a 4.9% owner of this project during these early years.The government Hebron news release stated that the only changes to the province's generic royalty regime were to add a Tier 3 royalty (the so-called super-royalty) and to reduce the basic royalty to a flat 1% until the project attained simple payout. It made no reference to the basic royalty level after simple payout. Presumably, Tier and 2 would continue as currently stated in the generic regime.
"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.
"It was a significant move," Mr. Williams said in an interview. "They looked to us to do something. We said we will take our [offer to purchase a 4.9% stake] from $100-million up to $110-million, and then we also took our 7% super royalty ask ... to 6.5%, and we tweaked the timing of payment, and that is basically the deal."The Premier made similar comments during the news conference, as indicated in CTV Newsnet , but made no mention of the change to the province's royalty regime covering the pre-payout phase.
The new super royalty for the province is an additional 6.5 per cent of net revenue at higher oil prices (>US$50 WTI/bbl) after net royalty payout;As the Hibernia royalty regime indicates "Net Royalty consists of a two tier profit sensitive royalty which becomes effective when Net Royalty Payout occurs." Net royalty payout is the "point in time when the costs related to a particular project are recovered plus a specified return allowance on those costs." A similar concept exists in the province's basic offshore royalty regime.
A fiscal capacity cap to ensure that Equalization payments do not unfairly bring a receiving province’s overall fiscal capacity to a level higher than that of any non-receiving province.Many people in Newfoundland and Labrador - your humble e-scribbler included - took this to mean that the existing offset agreements, both of which are tied to Equalization and are limited in duration, would still operate until such time as Newfoundland and Labrador exceeded the national per capita fiscal capacity as determined by whatever Equalization formula is in effect.
"The worst betrayal of all was the barefaced failure to tell the truth on the issue of equalization and the Atlantic accord," he told Liberal MP Geoff Regan's nomination meeting.