OTTAWA — As Alberta’s once red-hot energy sector fizzles with the global economic downturn, the province is handing its oil and gas producers a break — but many say it’s not enough.
Last week, the provincial government announced temporary royalty breaks of up to C$1.5 billion for its beleaguered energy industry, offering low rates and drilling credits for new oil and gas wells to companies struggling with the collapse in commodity prices and tightened credit markets.
While energy companies say the incentives are a step in the right direction, the industry is skeptical of their ability to reverse a forecast 27% slump in drilling activity this year.
“The short-term stimulus does provide a lot more breathing room, and we know that the government can’t fix everything, but you can’t plan out a 10-year drilling program based on this,” said Greg Stringham, vice president of markets and fiscal policy at the Canadian Association of Petroleum Producers.
The adjustments came just two months after higher royalty rates — which were to rise even higher as energy prices climbed — had taken effect. Those rate changes prompted howls of anger when first announced in 2007. Energy companies complained the new rate plan would reduce Alberta’s competitiveness, and some bigger gas producers have already redirected investment outside the province.
With the temporary reversal, Alberta is hoping to stimulate its economy as the once-booming province faces heavy job losses and its first budget deficit in 15 years.
“This has nothing to do with splashing money around,” Alberta’s Energy Minister Mel Knight said. “What this has to do with is putting Albertans to work…The risk of doing nothing is simply too great.”
The one-year incentives start in April, capping royalty rates on new oil and gas wells at 5% and offering drilling credits to smaller producers.
Big Stimulus Tool
While Alberta’s vast oil sands grab the headlines, the province’s energy fortunes have been built on natural gas. But gas producers have had a bumpier ride in recent years than their oil-focused peers, and were still grappling with sharply lower crude and natural gas prices when the government announced its higher royalties.
The the so-called “juniors” — the countless small to mid-cap producers that populate Alberta’s energy sector — were hardest hit then, and are suffering the most now. Offering big rewards for higher risk, these often highly leveraged companies were left struggling to pay their bills as credit dried up and investors flocked to safer havens. The new incentives may attract new investment and get companies drilling once more.
“Companies will definitely respond and that’s going to affect tens of thousands of jobs. It’s a big stimulus tool,” said Gary Leach, executive director for industry group the Small Explorers and Producers Association of Canada.
One firm to benefit is Calgary-based Celtic Exploration Ltd., a gas-focused company whose operations are entirely in Alberta.
Celtic had already planned a C$150 million budget to do “way more drilling” than previous years, but the incentives may prompt the company to accelerate its schedule, chief executive David Wilson said.
“I think the government gets it now — they obviously didn’t before,” said Wilson, who reckons Alberta’s regulatory regime will again be more favorable than its neighboring provinces for certain producers.
But Celtic is in better shape than many junior producers, some of whom simply can’t afford to do any drilling even with the royalty breaks.
“Nobody could have predicted the severity of this downturn…[but] the government created a situation where the juniors were weakened ahead of this downturn” with the higher royalties, SEPAC’s Leach said.
Band Aid Solutions?
Heavyweight producers, meanwhile, may need more encouragement before directing spending back into Alberta. EnCana Corp., North America’s biggest gas producer, hasn’t yet decided if it will ramp up drilling schedules based on the new incentives, while Canadian Natural Resources Ltd. has already ruled out making any changes.
The new incentives help, “but you’re going to need longer-term measures,” said Canadian Natural’s president Steve Laut, noting that Alberta’s royalty system and low gas prices were equally to blame for the company’s cutbacks in the province.
The temporary “band aid” solutions suggest more changes and complications lie ahead for Alberta’s royalty structure, analysts say.
Alberta’s government has said it could extend the royalty breaks if necessary, but another complete overhaul is not in the cards. “The new royalty framework is doing exactly what it said it would do during lower commodity prices — providing lower royalty rates,” said Jason Chance, spokesman for the provincial energy department.
Copyright (c) 2009 Dow Jones & Company, Inc.