The recent recommendations from Alberta’s royalty review panel put me in mind of the old joke. Here’s the abridged version:
Alberta spares oilsands companies in new royalty regime according to revenues, not oil prices
The Alberta government’s $3 million royalty review, which in fact had the energy industry tied in knots for months, turned out to be an expensive lesson.
A reporter gets assigned to investigate tales of a fantastically gifted pig who resides on the farm outside the city. So he drives to the farmhouse on a warm summer’s day and knocks around the door. Door opens, and there stands a handsome, three-legged pig, who proceeds to take the reporter’s hat and coat, shows him to the living room, and serves him a glass of lemonade.
The farmer joins the reporter and the interview proceeds, the reporter dutifully taking notes around the life of Wilbur (this is the pig): How the farmer realized Wilbur’s smarts at an early age; how he educated the porcine prodigy around the arts, history and the nuances of household service; how Wilbur helps the children with homework; and so on. Even while, Wilbur does his thing – preparing coffee and sandwiches, collecting the bathroom (and doing them), even playing the piano a bit for the human duo’s entertainment.
As the interview approaches its conclusion, the reporter asks his final, perhaps most delicate question: “How,” he asks, “did Wilbur come to lose one of his legs?”
“Oh well, you know,” answers the farmer matter-of-factly, “you don’t eat a pig like this all at once.”
Rimshot.
OK, so nobody was laughing either following the Alberta royalty review panel found its long-awaited conclusions, which basically recommended the province not eat any more from the pig, but no doubt many in the oilpatch were breathing a sigh of relief.
Just to recount, the panel was appointed months ago through the NDP government of Premier Rachel Notley. Notley’s invective from the existing royalty regime during last year’s provincial election – to the effect that Albertans were getting scammed – had some within the oil industry fearing the worst.
Well, the worst (or the best, for the way you look at it) didn’t happen. Those who understand the ins-and-outs of royalty schemes will no doubt their very own more detailed views, however the important takeaway would be that the panel’s recommendations were pretty middle-of-the-road, and won’t likely wind up changing greatly.
Should investors care? Well, sure. Under Alberta’s royalty regime, the government collects 60 to 70 per cent of any oil revenue remaining after operating and capital costs. Whether that’s fair or not – well, you decide. But in contrast to other oil-producing jurisdictions, it’s more or less competitive. (Saskatchewan, though, takes a smaller share.)
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Another point is that the panel’s recommended royalty structure will reward low-cost operators (who’ll keep a bigger slice of the action) and punishes high-cost operators (who will tight on remaining after operating costs to talk about). As the oilpatch focuses on costs and activly works to improve efficiencies, that sort of structure seems to seem sensible.
So, overall, it might have been much worse for Alberta energy producers. The panel’s recommendations suggest that the NDP government will accept reason even in the face of ideology, a minimum of occasionally, and also the industry might expect some degree of policy stability moving forward, a minimum of with regards to royalties.
Lord knows it has enough changes to consider in other areas. Nobody yet knows what the impact of the province’s new carbon tax plan is going to be. Too, the brand new federal government’s method of pipeline approvals, environmental reviews and also the role of the National Energy Board comprises another unknown on the regulatory level.
But the reality is that this doesn’t matter greatly towards the short-term prospects of Canadian energy companies or their investors. To mix my animal metaphors, likely to elephant within the room – in other words, an elephant not in the room, but a large number of miles away.
Last week, energy stocks rose, with S&P/TSX capped energy index up a lot more than eight percent. It’s impossible to tell just how much that rise revolved around Alberta royalties, but probably not a lot. Since oil prices rose a lot more than 10 % – from below US$30 for West Texas Intermediate to north of US$33 – what’s really determining the price of Canadian energy stocks is, well, energy prices.
And those are now being determined far away from Canada. Russia states that OPEC has proposed a five-per-cent production cut in partnership with non-OPEC producers. A study from Saudi Arabian television on Sunday suggests that the Saudis are available to dealing with other producers to support the marketplace.
Who knows when the resulting speculation will be borne out. Maybe OPEC has already established enough time selling from the cheaper. Or maybe it is simply seeing how far it may talk up oil prices without actually cutting production.
Either way, what this points out, sort of by contrast, is the lack of pricing power for Canadian oil producers. Better export infrastructure – i.e. more pipelines – would help, as Canadian product currently sells at a discount to global prices in part since it is expensive to get free from the nation. But given background and the federal government’s signals, that path is way from clear.
At least the royalty review panel has removed a potential irritant. When oil prices recover, the possible lack of uncertainty might encourage, or at least not discourage, re-investment within the oilpatch, which should enable Canadian producers to understand the advantages of rising prices sooner.
But for most investors now, and costs still within the basement, there are bigger items to be worried about in Canadian energy – and to hope for.
