Reboot Alberta

Tuesday, October 16, 2007

Oil Sands Project Cost Double and CAPP Accuses the Royalty Review Panel of Using "Incorrect Costs!"

I have done a quick read of the CAPP Technical Review Executive Summary of the “Our Fair Share” Royalty Review Report. CAPP is a very professional and respected organization with expertise available in it and to it to do such a Technical Review of the “Our Fair Share” report. I, on the other hand, am just a layman, and have not yet read the full report. However, I do find some representations in the Executive Summary curious.

I don’t know on what basis they say “Flawed Data” and that “The Panel did not take into consideration all of the data made available to them through the review process.” How could they know that, even if it were true? How do they know what was available to the Review Panel and what was not considered? We need a bit more evidence of this allegation, and it may be provided I the body o f the Review. I will definitely be looking for it.

The Panel based their recommendations on “severely understated industry costs.” The accusation is they (the Panel) used as range of between $4 – 6 Billion for a typical oil sands project. CAPP claims, and rightfully so, that such projects are ending up costing between $10 – 11 Billion. However CAPP omits the fact that all of those costs are totally recoverable by the industry during the 1% royalty rate until full project recoupment. In fact this 1% royalty rate until all project productions costs are recovered means less rigour is put on management to review and reconsider a project when costs are doubling as would be the case in a normal business model.

At record oil prices many projects have fully recovered these excessive project cost overruns in as little as 4 years. In any event, it is Albertans who are actually paying for these extreme project cost overages by virtue of our deferred royalties. So why is industry taking issue with this a saying the Panel is making a mistake of using “incorrect costs?”

I am inclined to have such projects that will do not meet presented budget targets in the original EUB process for approval go back to the EUB to show why their original project budget was so inaccurate. It is Albertans, after all, who are paying for these additional costs because of the 1% royalty rate until all such project costs are recovered. Albertans get no say in how much a company decides to pay or overpay in the end, once the proponents have an EUB project approval. That makes little sense.

Why don’t we require such projects to do a study and hold a further hearing to satisfy the EUB on what the cumulative impacts and secondary consequences are from such cost overruns? What do they do to the availability and increased costs of trades, supplies, equipment and materials? What impact will such excessive project overruns have on the costs of other necessary projects like schools, roads and hospitals who have to compete on price with energy companies?

Perhaps a project that is so inaccurately budgeted should have to justify the additional costs and perhaps even have to adjust the timing of the project so they don’t skew the labour and construction costs for other sectors. The astonishing cost escalation of the 23rd Street Overpass in Edmonton to some $250M in less than a year is a case in point on how this behaviour affects other sectors. Property taxes will also have to go up in Edmonton to pay for this inflated overpass project costs. This is because of the increases caused by competition with energy projects for everything from labour, to supplies, equipment and materials.

So the energy projects can blithely pay whatever they wish so long as oil prices stay high and Albertans eventually pay such additional project costs by our deferred royalty regime. The taxpayer gets it in the ear again by increased taxes or borrowing costs for much needed public infrastructure or the local government end up deferring those other very necessary projects hoping prices will come down.

And in the face of this the Technical Review accuses the Panel of using “Incorrect Costs?” Ironic isn’t it!

8 comments:

  1. Anonymous7:42 pm

    No comment on the federal throne speech! It states that Canada will NOT meet its Kyoto targets and that they are looking into other types of agreements. Is your so-called leader a man of principle (will he vote against such a statement) or is he so weak and scared that he won't show up?

    Maybe the NDP or the Greens will be the new option.

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  2. Anonymous8:41 pm

    That's a very typically nonsensical approach. The projects are very marginal. The primary reason companies invest is that the resource itself is easy to find and it has a long life.

    As costs rise, it erodes the return on capital. Everybody shares in this. Tristone is very accurate (and unbiased) in their description.

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  3. So maybe some projects are not commercialy viable in any event and show not be encouraged or even allowed.

    Why are we not focused our drilling more on SGAD oil sands projects instead? All those drilling costs are set off against the sweetheart 1% royalties.

    And why don't we look at investing in CO2 sequestration/injection to get more out of the wells we currently have instead of drilling more deeper marginal wells?

    We improve output productivity from old wells, we dont' mess up more surface with roads and stream crossings, habitat fragmentation etc. We solve some GHG issues and help at least slow down global warming the same time.

    Lets not do the same old same old. Where is the imagination in this sector? We should start legislating improved productivity from existing wells for environmental purposes alone.

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  4. To answer the question:

    "I don’t know on what basis they say “Flawed Data” and that “The Panel did not take into consideration all of the data made available to them through the review process.” How could they know that, even if it were true? How do they know what was available to the Review Panel and what was not considered? We need a bit more evidence of this allegation, and it may be provided I the body o f the Review. I will definitely be looking for it."

    Answer: in short CAPP knows because they showed the Royalty Panel on May 22nd in Calgary the following presentation:

    http://www.capp.ca/raw.asp?x=1&e=PDF&dt=NTV&dn=121781

    So yeah, you definitely will be looking at it.

    After that inauspicous start, you make some decent points on this post.

    Oilsands development has turned into a theatre on fire with a crowd of people leaving through one door.

    The existing project approval process should have been more vigorous in terms of delaying project approvals until operators could produce studies to show they could construct the projects without undue inflation to the provincial economy. ($250 billion for a bridge in Edmonton? Cripes, and you are complaining about oilpatch cost control!)

    Complaining about not getting the royalties soon enough (4 years is too long??) sounds pretty silly though. You'll see them for another 46 years or so without putting up a dime of risk capital. I'm sure a citizen of PEI or Cape Breton or North Dakota would consider such a thought to be that of a "typical greedy Albertan".

    We built a computer model with both the old the new royalty scheme in in. It is a full Monte Carlo simulation; does 1000 runs under varying combinations of commodity prices, operating costs, capital costs, etc. We use methods like Black Scholes within the model to cover optionality benefits/disincentives within the model. I was pretty shocked that using historic volatility and trends for the previous factors that for a low rate and reserve gas well, you know the ones that are supposed to benefit from the new royalty scheme, have a reduction in net present value of 80%. I can assure you that in the new royalty regime that there will almost none of those drilled anymore. In a day or two will have the results of dozens of investment situations and I'm expecting the results to only get worse....... this is really bad; we are taking bets as per % of drilling reductions that would result; most people are at 75% reduction in wells drilled. Will take a couple of years for people to figure it out though, most people use deterministic approaches to economics. It is way worse than the deterministic economic values everyone else is using.

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  5. Anonymous9:31 am

    Ian
    The original blog posting had the wrong cost for the 23rd Avenue overpass.
    It is $250 MILLION, not BILLION.
    What did you think of Pedro Van Meurs' piece in The Edmonton Journal today?
    He argues that CAPP's position means Albertans won't see a penny of returns on big oil sands project for 20 years.

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  6. Hello Satya. Yeah, I guessed that.

    Opinions can vary, but facts should not.

    We must be careful with our facts, right? In quick perusals of Cambridge posts I'm seeing many issues with facts.

    For example, are you going to put up a piece correcting the history of the NEP, for example?

    I read van Meurs piece. Complex topic. Have thoughts. Will post to my blog, maybe tonight. Sometimes these things have to roll around in my head to gel.

    Ken was saying projects are so profitable that we were missing out on royalties for four years. So I used four years. It was what he wrote and understood and is telling as to what he thinks. My comments stand as per what people of other less fortunate jurisdictions would think of Ken's attitude stands.

    Now the Parkland institute wants 90% or 100%.

    There is a word for it all - greed.

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  7. Anonymous5:15 am

    Satya:

    I assume you are filing in for Ken. I would suggest to you that if the bitumen tax is adopted, there is a likelihood that Albertans will never see a penny of return on big oil sands projects ever because they will likely not proceed. If you bothered to read the van Meurs reports posted on the Alberta Energy web site, you would know that one of the objectives of the bitume tax is discourage what van Meurs perceives as high cost oil sands projects. An elegant theoritical construct, but so is supply side economics. I'm from Missouri, show me where it has worked. Alaska?...they are having to overhaul van Meurs PPT because it has not met its original objectives (check out the PPT implementation report from August 3, 2007). You should also check out the history of windfall profit taxes (WPT). I suggest you read a Congressional Research Service report by Salavatore Lazzari.

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  8. Anonymous11:29 am

    It is becoming funnier by the minute. Dr van Meurs appears to breaking ranks. Not only is he taking a run at the industry, he is taking a run at the Premier, Alberta Energy (who he worked for as a consultant for a number of months) and even the Panel itself. Hunter, Chrapko, Spanglet and van Meurs. Just like the keystone cops, I'm afraid. That's what happens when you try to defend a report based on very poor foundations. It comes back to bite you in the ass eventuallly. And now the Parkland Institute wants to nationalize the oil and gas industry in Alberta. Will this comedy of errors from the anti-capitalists ever end.

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