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Wednesday, September 26, 2007

High-Cost - Low Margin Oils Sands Projects Can't Handle Higher Royalites - Is that Necessarily a Bad Thing?

The Experts are getting engaged in the recommendations of the Alberta Royalty Review. Wood Mackenzie issued a news release yesterday projecting some $26B on reduced value in oil sands projects could happen if the Alberta Royalty Review recommendations were adopted. Wood Mackenzie are well respected consultants in area of Energy and Life Sciences. They consult to Alberta Energy and as a result their expertise was used by the Royalty Review Panel as well.

Two different news stories and headlines based on the Wood Mackenzie release are telling and is enough to make one wonder just who you can trust to report on this stuff. A Reuters story in the Edmonton Journal today uses essentially the same headline as the Wood Mackenzie release predicting doom and gloom over a potential for $26B of lost value in the oil sands if the Alberta Royalty Review recommendations are implemented. The Globe and Mail headline based on the same news release says: “Report finds Alberta still a bargain, even with higher royalties.”
The Globe says Wood Mackenzie finds that even with the royalty hike "...Alberta would remain one of the cheaper places to do business in the world even with more money going to the government."

Both stories are "correct-ish" but let’s look at little deeper at some facts and some context. Wood Mackenzie actually says “…higher royalties will have the biggest impact on high-cost, low-margin projects.” They calculate the Net Present Value of current and planned projects would fall by $26B based on $50 per barrel oil. The Wood Mackenzie news release it self notes that “We predict the worst affected projects would be the most marginal, or those with a start up date furthers into the future, with an average of 30% of value transferred for underdeveloped projects.”

I would like to know some more of the assumptions behind the consultant’s conclusion beyond oil at $50. What interest’ currency exchange and inflation rates did they use? Was this the same assumptions used for open pit and in situ projects and what project assumptions on environment and reclamation costs were applied in the calculations? Did they differentiate between the Fort McMurray, Cold Lane and Peace River sites…they are all quite different realities.

Not all projects are created equal and some will become more marginal as circumstances change – including economic rents, environmental requirements and new technologies are all a natural consequence of the larger concept of the marketplace. An oil sands extraction project is a very long term patient investment. If your project is so marginal at the start that a royalty increment of 8% on your NET PROFITS is untenable – the same could (and should?) be said for the project anyway.

Albertans are strained and arguable unable to cope with the economic, infrastructure and social demands caused by the current oil sands production of 1.2 mbls/day. We are being told we need to triple the production within the next 8 to 10 years. What planning is in place and being done by industry and government to catch up and be ready for the consequence of 3-5million barrels of production?

Wood Mackenzie says only marginal projects may not be economic at $50 oil but that clearly means not all projects are in jeopardy. I can live with that and I am sure Alberta will survive. After all the demand for energy is not going down and the oil sands are not going away.