Oil companies should "calm down" and "take a deep breath," Alberta Premier Ed Stelmach said after energy giant EnCana Corp. (TSX:ECA) revealed it will cut capital spending in Alberta by $1 billion next year if the province raises oil and gas royalties as much as proposed by a government panel.
"We're analysing all of the recommendations," Stelmach said. "We need the time to review. Whatever is being said is not going to sway me from the total review and again, finding that balance."
"If adopted in full, the royalty changes will negatively impact EnCana's future investments and operations in Alberta and will have a widespread impact on economic activity across the province," the company said in response to last week's report from the Alberta royalty review panel.
EnCana, North America's largest natural gas producer and a growing oilsands operator, said it had been planning to spend $2.5-$3 billion on Alberta-based drilling and development in 2008.
The Calgary-based company said it will "reallocate capital to investments outside Alberta" if the government adopts the panel's so-called "fair share" proposal for a 20-per-cent increase in the province's overall resource revenue take.
"Many of Alberta's new and emerging resource plays will simply not be economically viable," said EnCana CEO Randy Eresman.
"These new plays would have formed the foundation for the future of Alberta's natural gas production."
Warning that this would cause a continuing production decline, Eresman added: "We are open to changes to Alberta's royalties - changes that reflect the economic realities of volatile commodity prices, higher costs and the appropriate risks and rewards of long-term capital investments."
But the proposed changes "will have immediate and long-term impacts on working Albertans," EnCana cautioned, saying the investment cutback would ripple through the whole provincial economy. "We would greatly regret seeing these job opportunities evaporate."
The head of the Canadian Association of Petroleum Producers (CAPP) said this is the time of year that companies have to make spending decisions.
"Every company in town is working through those royalty reviews. They're in the middle of capital budgets which happen this time of the year and go to the boards in October," said CAPP president Pierre Alvarez.
"So you've got to understand what the implications of a decision might be, so EnCana's the first and clearly the most public but I know everyone is looking at what the implications would be to that company, if the implementation goes ahead," he added.
Kyle Preston, an oil and gas analyst with Salman Partners, observed that EnCana made a significant cut to its drilling program in the past year and he wouldn't have been surprised if another reduction was coming anyway in 2008, considering current low natural gas prices.
"Even with that new royalty regime, they would be economic at a certain price," Preston said.
"So it's not just the royalties that are causing them to cut their budget - it's a combination of the royalties and the low gas prices."
More than 80 per cent of EnCana's output is natural gas, but the company has also struck a heavy-oil deal with U.S. giant ConocoPhillips to expand its northern Alberta oilsands operations.
In late 2006, EnCana announced it would cut overall spending by six per cent to US$5.9 billion in 2007, reflecting a plan to temper growth in its natural gas and oil production because of weaker gas prices and inflationary pressures that had raised operating costs in the industry.
However, EnCana spokesman Alan Boras said low natural gas prices were not a factor in EnCana's declaration, as the company has hedged half of its production for the year at about US$8.50 per thousand cubic feet, well above current prices.
And Boras balked at a characterization of EnCana's statement as a threat.
"We had an obligation to inform our employees and our contractors and suppliers that the results of the royalty panel's recommendations could have a dramatic impact on what our investment levels look like as we go forward," he said.
"We are not opposed to royalty changes," Boras added. "We understand they happen from time to time but we just want to encourage a broad debate and understanding of what the potential impacts are."
The controversial report by the royalty review panel said Albertans have been shortchanged by the oilpatch for years.
It said oilsands projects should pay roughly 36 per cent, though with a continuing royalty holiday for new projects to encourage the multibillion-dollar commitments involved in the northern oilsands.
High-production oil and natural gas wells should also pay higher royalties, the panel said, although a large number of low-production wells would pay less.
Alvarez said the report by the government-appointed panel of business and energy experts promises an "unrealistic" future.
"The basic assumption is that the size of the 'pie' will not change," Alvarez said. "Past experience, in this country and around the world, just doesn't support the panel's view."
He said recommendations of increased royalties across all sectors and a new "severance tax" levied against all oilsands producers would lead to a significant cooling off in the Canadian energy industry.
Alvarez also said some facts in the report were simply wrong.
CAPP says at forecast prices, all natural gas wells will end up paying higher royalties compared to the report's claim that 82 per cent of wells will pay less under its suggestions.
The association also says the report's take on cost pressures facing the oilpatch "are simply not up to date," especially with new oilsands projects that are now averaging around $11 billion each.
"They do not adequately reflect the costs of some of these big projects," said Alvarez. "There's an assertion that many of these costs are because of local activity levels, but it's got nothing to do with that.
"It's the price of steel, the price of equipment - heavy vessels, compressors - around the world."
A report from an international energy research company warned Alberta would reduce the commercial value of its oilsands projects by US$26 billion if it were to adopt the recommendations.
The report by Wood Mackenzie said current and planned oilsands projects with a startup date furthest into the future would be most affected.
"Alberta is following in the footsteps of many other oil-producing regions in its desire to extract a greater share of the economic rent from its natural resources during the current period of high commodity prices," spokesman Derek Butter said in a release.
"However, the higher than expected level of new taxation will cause concern among oilsands industry players already struggling to cope with spiralling costs."
Applying the oilsands severance tax to revenue before project costs have been recovered would be particularly damaging, he said.
The Canadian Association of Oilwell Drilling Contractors issued a news release saying it, too, refuted the royalty review panel's recommendations.
"The royalty review panel is wrong to believe that there is a surplus $1 billion that can be taken out of the natural gas business in Alberta," said the release. "Their naivete will undermine the confidence of energy investors in Alberta's natural gas industry."
The association said it had advised the royalty review panel that during 2006, 373 drilling rigs worked on average in Alberta, employing an average of 9,400 rig workers.
By May 22, 2007, there were just 61 rigs running in all of Alberta, said the association.
The Canadian Association of Geophysical Contractors (CAGC) also weighed in against the proposal to increase royalties paid by the energy industry in Alberta, saying it would jeopardize investment and jobs.
"We share the investment community's assessment that this report is draconian," Mike Doyle, president of the CAGC, said in a release. "After a year of federal tax increases, trust taxation, sinking natural gas prices and layoffs in the oil-service business, the implementation of this report risks further job losses, lengthening and deepening the current downturn."
The CAGC represents seismic services in the Canadian oil and gas industry.
"The people of Alberta whose 'fair share' this report professes to defend are our employees, their friends and families," Doyle said.
"Removing $2 billion from the industry that employs so many Albertans and placing it in government coffers, as this report proposes to do, is an odd way to help people. It is Albertans' hard work and investor capital, not some government program, that created Alberta's prosperity."
Yet despite warnings from key executives that royalty changes would choke off future investment, major international energy companies continue to pay handsomely to enter the sector.
Last month, the Abu Dhabi National Energy Co. unveiled a friendly, $5-billion bid for Calgary's PrimeWest Energy Trust (TSX:PWI.UN) and said it has plans to boost Canadian investment to $20 billion in the next five years.
Chief executive Peter Barker-Homek said stable fiscal terms were important for any investor, but didn't seem too spooked by the report.
"I'm familiar with the committee's findings, I know that there's a great debate brewing in Canada," he said.
Barker-Homek said he was "certain that the policy-makers within Canada will come to terms that will foster inward investment and the continuation of a robust industry that has fuelled much of Canada's growth."
