New Alberta royalty legislation was intended to increase Alberta’s annual income by some C$1.8 billion. However, due to its unintended consequence of reduced drilling activity, along with cost escalation, lower E&P action will likely erase any royalty gains and, instead, may cause an energy recession, reports energy-research firm Ziff Energy Group.

Going forward, “the decreased activity will reduce future gas production, on which provincial royalties are levied. What this means is that the new proposed royalty policy for gas is intensifying the recession in the conventional energy industry,” says Paul Ziff, chief executive for the Calgary- and Houston-based firm.

“This unintended consequence was not predicted by the Alberta government, although it was forecast by the gas producers.”

Unless the proposed royalty program is revised, conventional gas activity will decline sharply, creating a “made in Alberta” recession in 2008, not including oil sands. The increase in provincial net revenues of C$1.8 billion in 2009 is “a house of cards ready to tumble,” he says.

The conventional energy industry in Alberta is mainly gas. Since 1998, gas drilling has surpassed oil drilling. In 2007, there were more than two gas wells for each oil well. Drilling for gas, not oil, drives Alberta’s massive service industry, he says.

Gas is selling for only half of the price of oil, based on its respective energy content. The low gas price, higher drilling and operating costs, and the new royalties on gas production are “coming at a lousy time,” says Ziff. Areas most affected are deep gas plays in western and northwestern Alberta, and shallow and coalbed-methane plays in central and southeast Alberta.

Labor, influenced by the surging oil-sands developments, and the strong Canadian dollar, which has cut into the Canadian gas price, are causing wide­spread cost escalation.

Comparing producers’ return to costs, royalties and taxes since 2006, Ziff says the price of gas in Alberta is not high enough to justify new gas exploration. Therefore, royalty rates and escalating costs are contributing to a sharp drop in current and future gas-drilling activity and a drop in employment for related service sectors.

In fact, a number of Canadian oil and gas companies, such as EnCana Corp., Canadian Natural Resources Ltd. and Talisman Energy Inc., have announced large 2008 spending cutbacks in Alberta, and are shifting spending outside Alberta. Others are doing the same, but without announcements as they “don’t want to upset the political apple cart,” says Ziff.

Some 80% of companies active in Alberta have reduced their planned conventional spending since the new royalty announcement was made.

In December 2007, Canadian Natural Resources conducted layoffs. In February, Apache followed suit. Hundreds of Alberta companies that provide drillers with needed services such as steel, mud, site-clearing, catering and lodging services, have also had layoffs, says Ziff.

Examples include Calfrac, Halliburton, BJ Services, Savanna and Schlumberger, which are moving some of their underutilized high-quality equipment south of Canada. Other service companies, such as Trican and Nabors, are sending to Russia some equipment previously used in Alberta.

“We believe more Alberta layoffs are in the wings. The impact has been felt with large layoffs in the service industry across Alberta. It is likely to get much worse during the spring and summer of 2008, affecting rural Alberta, as well as major cities such as Calgary, Edmonton, Red Deer, Medicine Hat and Grande Prairie,” he says.

Ziff says the Alberta government and a royalty-review panel relied on dated and erroneous information and incomplete cost models when forming the new royalty rules.

Following the announcement of the new royalty plan in October, conventional energy spending has dropped sharply.

However, spending in Saskatchewan and British Colum­bia is booming, he says. Also, U.S. gas drilling continues to increase, as costs and royalties are lower, even though the price is similar. Industry experts have projected the number of Texas gas wells will increase to a decade-high in 2008.

Comments