Executive Summary and Recommendations

Executive Summary and Recommendations

Executive Summary Our Collective Opportunity Alberta is losing its competitive edge. The United States, Alberta s number one customer for oil and gas exports, is quickly becoming its top competitor. The industry is challenged not only by price, but transportation to existing and new markets, and by rising costs. The collective opportunity, therefore, is to diversify the customer base and extract more value for Alberta s oil and gas resources. Overall, CAPP urges the royalty review panel and the government to re-establish Alberta as a place that attracts capital investment, to pursue market access, to recognize that cumulative costs work against competitiveness, and to support innovative technology for its ultimate and ongoing value to Albertans. The oil and natural gas industry is Alberta s number one economic driver and job creator. Industry employs approximately one in three Albertans, generates 42% of Alberta s GDP, and is responsible for 36% of provincial revenues, including royalties, corporate and personal taxes and fees. This includes the substantial benefits created in related sectors such as hospitality, transportation, food services, consultation, construction and real estate. Finding the right balance on royalties means the province can continue to develop its resources to improve the quality of life in Alberta. To this end, CAPP has identified 60 recommendations for the Panel to consider. Principles & Priorities Oil and natural gas royalties are part of a larger fiscal system that drives investment, creates jobs, generates government revenue and builds Alberta communities. The royalty review is an opportunity to re-establish Alberta s overall competitiveness and to pursue access to new markets. 1

The royalty structure must take into account the entire lifecycle of oil, natural gas and oil sands extraction projects including investment and cost-recovery, profit sharing, extended recovery of resources, shutdown, closure and reclamation in addition to all costs, taxes and fees paid by Alberta producers. Alberta s current royalty structure, put in place five years ago, has helped achieve these goals in a manner that is responsive to the evolving nature of the industry. That said, some changes are recommended to make the system more transparent, stable, effective and competitive. CAPP s recommendations are aligned with the royalty review principles that were set by the Alberta government: 1. Continue to encourage industry investment 2. Provide optimal returns to Albertans as owners of the resource 3. Support responsible development of the resource 4. Assessment of near-term diversification opportunities CAPP is supportive of the government s principles. In addition, we recommend any changes to the royalty system embrace these priorities: 1. Encourage Investment Alberta must be competitive. Alberta must be competitive with other jurisdictions to encourage investment to be made here. Investment in Alberta means prosperity for Albertans through job creation and maintenance of government revenues. In addition to government take, consideration needs to be given to capital recovery timelines, internal rates of return, stability and revenue risk. Predictability is needed for investment. Predictability around Alberta s royalty system is critical for investment in our province to proceed. Predictability restores investor confidence, attracting and maintaining capital. Cumulative costs impact competitiveness. Alberta s competitiveness, along with the associated jobs and investment, is affected by the cumulative costs borne by industry. Royalties are just one part of the bigger fiscal system that drives our province s success going forward. The current economic and policy climate has made it challenging for industry to have the confidence to invest in the provincial economy. To date, capital investment in the sector is down $29 billion or 40 per cent from 2014, a decline greater than all the capital invested in Canada s utility sector. Upstream oil and gas investment will likely not recover until these issues are resolved. While global commodity prices are well beyond the government s control, the royalty and climate panels are two initiatives that need to be resolved sooner rather than later. Certainty around Alberta s royalty system is critical for investment in our province to proceed, and is needed as soon as possible. With the myriad of changes to the Alberta royalty system since 2007, Alberta s status as a stable investment jurisdiction is at risk. Capital investment is highly mobile and flows to markets where investment returns are favourable and predictable. For this reason, it is critical the Alberta government work to provide certainty in both policy and regulation to attract investment and enable the province to compete on the world stage. 2

Alberta s competitiveness, along with the associated jobs and investment, is affected by the cumulative costs borne by industry. It is critical the province undertake budget, climate and royalty policy reforms that not just maintain, but enhance competitiveness and grow the economy. In Alberta s two most recent fiscal years, industry payments included royalties of more than $8 billion per year and corporate income tax of about $1 billion per year. In addition, municipal property taxes paid by the industry were $1.1 billion in 2014. These taxes increase by about $60 million (seven per cent) annually and are the industry s second-largest payment to governments, after royalties. The 20 per cent increase in corporate income tax rates introduced by the Alberta government in June 2015 is estimated to increase the industry s corporate income tax payable by $185 million annually, and has resulted in balance sheet impairments totaling $2.6 billion for CAPP member companies. Changes to the Alberta carbon levy will result in an incremental $600 million burden over two years. Forthcoming financial changes expected from the climate and royalty review panels have the potential to create additional financial burden on the industry. CAPP s submission makes recommendations on how to not only preserve, but also enhance economic competitiveness, and attract capital that creates jobs for Albertans and fuels the provincial economy. 2. Optimizing Returns to Albertans Market access is key. Tidewater access for Alberta production is the single greatest factor that will have the biggest impact in optimizing returns. By allowing producers to receive global prices for their products, market access will directly increase royalties paid to the government and encourage investment, job creation and prosperity across the province. 3

Consider comprehensive economic benefits. Optimizing returns means ensuring Albertans benefit from the development of the resource in all ways (e.g. royalties, provincial and municipal taxes, direct and indirect employment, across all areas of the province) and throughout the lifecycle of oil and gas development (e.g. exploration, production and mature phases). Expand the resource. Optimizing returns means encouraging investment to develop additional resources (i.e. growing the pie) as opposed to taking a larger share of the existing resource. The only way Alberta can get full value for its abundant oil and natural gas resources is to ensure the province is globally competitive and connected to more customers in new markets. Capturing the value of oil and gas first requires the resources be developed. That means royalty and other programs need to keep Alberta competitive with competing jurisdictions to attract capital investment. Once developed, the best way to capture value is to sell the products, at the best price, to the most customers. Alberta faces significantly increased competition for investment dollars, primarily a result of growing hydrocarbon production in North America. In 2014, Alberta s share of upstream oil and gas industry capital investment was 17 per cent, down from 35 per cent in 1994. Given the presence of large deposits of unconventional resources coupled with the technological expertise to develop them, the future focus of petroleum industry activity in Alberta is anticipated to occur in three main areas: tight oil, deep/shale gas and oil sands. Producers looking to develop tight oil prospects will find opportunities with similar geological potential in Saskatchewan, North Dakota, Montana and Texas. 4

In the case of deep/shale gas prospects, producers interested in developing these opportunities can look to British Columbia and prolific shale gas plays located in the United States such as the Marcellus and Utica shale deposits in Pennsylvania and Ohio. Relative to resource opportunities such as Alberta s oil sands deposits, investors will have the option of investing in large scale offshore opportunities such as the North Sea and Mexico, and perhaps most similar in terms of resource characteristics to the oil sands, the ultra-heavy crude oil deposits found in the Orinoco Belt in Venezuela. CAPP s submission makes recommendations on how to ensure Alberta can compete with other jurisdictions, create jobs and strengthen the provincial economy. 3. Responsible Development Manage growth thoughtfully. The pace of investment is influenced by a number of factors. Royalty and tax programs are best suited for ensuring a competitive and equitable distribution of costs and benefits, while the sequencing of development is best managed through the current robust land management system, informed by well-developed land use planning thresholds, as opposed to the tax and royalty system. The market distributes wealth. Oil and gas investment has led to higher real wages within the sector and across the entire economy, relative to other provinces. All Albertans in all regions and sectors benefit from continued oil and gas development. Climate policy matters. The upstream oil and gas sector recognizes the importance of mitigating climate impacts, and will continue to work with the province to achieve meaningful results, informed by its recommendations and commitments made to the Alberta Climate Change Advisory Panel. Responsible development is a core tenant of industry practice. CAPP members recognize the importance of responsible stewardship in the development of Alberta s natural resources. Responsible development requires consideration for the environmental and social impacts of development, in addition to equity in the distribution of the economic benefits of resource development across the province. 4. Innovation and Diversification By encouraging innovation, Alberta will be a leader. Innovation and technological advancement is key to maintaining and expanding energy supplies in a responsible manner, while addressing societal and environmental needs. Innovation unlocks energy resources, identifies energy development efficiency opportunities, improves environmental performance, and helps to address the cost structure challenge. The key is to remove barriers to R&D investment in the industry through programmatic and cost allowance changes. Partnerships add value. Industry has a long history of collaboration with government and within the sector to advance innovation and technology commercialization. Examples include the Alberta Oil Sands Technology and Research Authority, the Canada s Oil Sands Innovation Alliance, and the Alberta Innovates Energy and Environment Solutions. Enhancing the collaborative partnership approach between industry and government going forward will add value. Diversify within your strengths, where economics and opportunities permit. The evolution of the oil and gas industry is one of diversification. While market fundamentals currently do not support refining and upgrading economics, opportunities exist to add value and achieve climate policy objectives through cogeneration and natural gas electricity fuel switching. There may also 5

be an opportunity to extract some low value bitumen components as feedstock for conversion to potentially higher margin economic products as a means to diversify Alberta s economy. Horizontal drilling, hydraulic fracturing and pad drilling technologies are examples of innovations that have been adopted widely by the unconventional oil and gas industry and are credited with vastly expanding the reserve potential of the Alberta oil and gas basin. Industry has invested in a number of areas to add value to Alberta s oil sands and to increase the diversity of the economy. The industry supports value-added investments when the actual value created is greater than the cost required to create them. Oil sands innovations such as bitumen upgrading have enabled the substantial growth in Alberta s oil sands. Continued innovation through research focused on improved resource recovery, lower costs and reduced environmental impacts will be required to ensure the competitiveness of this resource. Industry-government partnerships are key to unlocking the innovative potential of new technologies in the upstream oil and gas sector, and this activity needs to continue because it shows Alberta leadership in responsible resource development. An oil and gas focused R&D authority is recommended to enhance innovation and commercialization of conventional extraction technologies and environmental performance. CAPP s submission makes recommendations for responsible resource development, research and development investment and diversification opportunities. Conclusion Oil and natural gas royalties are part of a larger fiscal system that drives investment, jobs, economic success, societal well-being, prosperity and quality of life. Investment in Alberta means prosperity for Albertans through job creation and maintenance of government revenues. Certainty around Alberta s royalty system is critical for investment in our province to proceed, and is needed as soon as possible. Alberta s competitiveness, along with the associated jobs and investment, is affected by the cumulative costs borne by industry. It is critical the province undertake budget, climate and royalty policy reforms that not just maintain, but enhance competitiveness and grow the economy. Innovation and technological advancement is key to maintaining and expanding energy supplies in a responsible manner, while addressing societal and environmental needs. Innovation unlocks energy resources, identifies energy development efficiency opportunities, improves environmental performance and supports diversification. The key to maximizing and diversifying the value of oil and gas for Albertans is to ensure the province is globally competitive and connected to more customers in new markets. 6

Summary of Recommendations 1. Continue to Encourage Industry Investment 1.1. Competitiveness Applying a comprehensive approach to evaluating competitiveness, based on metrics that consider payments to government, internal rate of return, fiscal stability and revenue risk across jurisdictions with similar resources. Positioning Alberta favourably through a competitive capital recovery regime, relative to jurisdictions with similar resources and similar fiscal systems, economic advancement and jurisdictional risks. 1.2. Predictable, Clear, Evidence-Based and Relevant Over the Long Term Conventional Oil and Gas Introducing a minimum three years notice period prior to any government imposed changes to the conventional royalty system, in order to recognize the significant upfront capital costs required to develop conventional oil and gas. Ensuring any proposed conventional oil and gas royalty changes would only apply on a prospective basis. Publishing an annual report of the performance of the royalty system benchmarked against the principles underlying the panel s royalty review and, where possible, drawing from existing provincial datasets. This approach would provide the transparency and public confidence needed to assure the continued relevance of the royalty system and preclude the need to preset timelines for both specific program expirations and more general royalty system reviews. Oil Sands Regulatory Maintenance Process CAPP recommends developing an ongoing joint Alberta Energy/industry process designed to ensure that scheduled and regular maintenance of the oil sands royalty regulations and associated business rules is occurring. The transparency of such a process would be enhanced when facilitated by senior Alberta Energy and oil sands industry representatives. Such a process would assist in ensuring that the oil sands royalty regulations and associated business rules continue to uphold the underlying principles of the generic oil sands royalty regime, by contributing to a durable fiscal regime. Regularly scheduled communication by Alberta Energy with the oil sands industry and a timeline for action will ensure issues identified in the process will see resolution within a specific time frame. 1.3. A Comprehensive Approach to Cost Competitiveness CAPP recommends adopting an overarching approach that enhances the economic competitiveness of Alberta s upstream oil and natural gas sector, recognizing the full spectrum of costs faced by industry and the cumulative compliance burden across all policies and regulations. Climate Policy Competitiveness CAPP recommends that any climate policy costs introduced by government be offset through a corresponding reduction in royalties collected. Municipal Competitiveness CAPP recommends that municipal economic competitiveness be prioritized as an overarching objective of the Municipal Government Act review, and any incremental municipal competitiveness costs not addressed by the province in that review be offset through the royalty system. 7

2. Provide Optimal Returns to Albertans as Owners of the Resource 2.1. Market Access CAPP recommends the province work with other provinces and the federal government to increase access to tidewater for Alberta production in order to serve global markets. This approach will enable the province to access world prices for its oil and gas products, leading to increased investment and job creation, and correspondingly, higher royalties to fund provincial infrastructure and services. 2.2. Conventional Oil and Gas Base Royalty (Alberta Royalty Framework, ARF) and Mature Oilfields Adding a Depth Factor Adjustment for Oil Wells CAPP recommends introducing a depth factor adjustment to new oil wells in the Alberta Royalty Framework, similar in approach to the existing measured depth adjustments for gas wells. This approach would have the following benefits: Harmonize the treatment of oil and gas in the ARF for consistency, and simplify the royalty framework. Encourage drilling of deeper and longer oil wells to enable investment in emerging plays in the basin, in recognition of the higher costs associated with deeper drilling. Encourage more innovative and efficient drilling techniques, leading to reduced environmental footprints. Natural Gas Liquids Sliding Scale Royalty CAPP recommends applying a sliding scale royalty to plant liquids to be consistent with the risk reward nature of the ARF as it relates to oil and natural gas and to discourage inefficient product handling that may occur in order to avoid paying penal fixed royalty rates in times of depressed commodity prices. Gas Cost Allowance CAPP recommends continuation of the Gas Cost Allowance program, but suggests further collaboration with industry to work toward simplification of the overall program. Mature Oilfields CAPP recommends promoting re-stimulation of existing producing zones by freezing royalties for a number of producing months following a successful re-stimulation. This approach would encourage innovation, attract investment and minimize land disturbance. Maning the Enhanced Oil Recovery Royalty Regulation (EORRR) program a permanent feature of Alberta s royalty framework. Working with industry to explore innovative fiscal mechanisms to foster technologies to develop and extract oil from mature fields, including new and enhanced waterflood projects. Mature High Water Oil Ratio Wells: CAPP recommends adding a modifier to the rate component in ARF that recognizes water production for high Water-Oil-Ratio (WOR) wells due to the added costs incurred from handling high levels of water produced with oil well production (e.g. WORs in excess or equal to 20m3/m3). Abandonment and Reclamation Liability Risk CAPP recommends working with industry to explore innovative financing mechanisms to address potential abandonment and reclamation liabilities confronting Alberta s upstream oil and gas industry. Alberta Petroleum Marketing Commission (APMC) and Par Pricing CAPP recommends moving to a cash payment approach for Crown oil royalties in Alberta, as opposed to the current in-kind approach. This approach would ensure that equitable par prices are applied to base royalty calculations to determine Crown volume, ultimately reducing cost and risk to the province. 8

Emerging Resources and Technology Initiative (ERTI) Horizontal Oil and Gas CAPP recommends combining the Horizontal Gas NWRR (New Well Royalty Rate) and Horizontal Oil NWRR programs. Key considerations include: Combining all products into a single treatment. Apply a value based program, similar to the Natural Gas Deep Drilling Program, which is price sensitive due to the fact that in periods of higher prices, the allowance is used up faster. Shale Gas NWRR CAPP recommends extending the Shale Gas NWRR beyond its current expiry date. Key considerations include: Confirm that the program applies to all products (gas, NGL and oil) in both oil and gas wells. Deep Oil &Gas CAPP recommends confirming the Natural Gas Deep Drilling Program (NGDDP) as a permanent feature of the royalty framework. CAPP recommends creating an amalgamated deep oil and gas drilling program that combines the current NGDDP with a proposed deep oil drilling program in order to stimulate incremental development of deep, unconventional oil opportunities, in addition to existing deep gas opportunities, based on a measured depth and production months approach. 2.3. Oil Sands Generic Oil Sands Royalty (OSR) Regime CAPP recommends retaining the current OSR Revenue minus Costs (R-C) sliding scale royalty structure as it recognizes the significant upfront investment capital required in oil sands projects, through a pre-payout and postpayout royalty regime. Further, Replacing the oil price marker from WTI/$CDN to a more representative Alberta bitumen based crude marker (e.g. WCS (Western Canadian Select Blend)) price received from the production of oil sands. The generic oil sands royalty regime continues to provide certainty to industry and that any changes made to the overall generic oil sands royalty regime be made on a go-forward basis. Allowable Costs Providing additional flexibility for the recognition of research and innovation costs. Continuing to recognize all levies, charges, carbon taxes and/or any other costs related to federal and provincial assessments for greenhouse gases as allowed costs. Providing a mechanism for the recognition of otherwise eligible abandonment and reclamation costs that have been incurred for post-production projects. Increasing the current general timing rules for the eligibility of costs incurred prior to the OSR effective date of a new project or project amendment approval. (Prior Net Cumulative Balance or PNCB rules). Providing additional flexibility for the recognition of shared personnel and services costs. Recognizing the principle-based costs that are currently not recognized as Allowed Costs, including but not limited to Canada-Alberta Joint Oil Sands Environmental Monitoring, AER Oil Sands Administration Fees, collaborative research and development membership fees like COSIA, PTAC and Phoenix, community support and development payments to First Nations in support of associated oil sands development. 9

Project Bitumen Valuation Methodology (BVM) CAPP recommends the BVM methodology used for the oil sands royalty valuation of non-arms-length bitumen dispositions be principle-based, transparent and based upon relevant Alberta bitumen markets, and the methodology use an appropriate Alberta-based bitumen pricing marker, and include quality adjustments for Total Acid Number (TAN) and Sulphur, in addition to the individual project s product density. Further: The Floor Price provision included within the methodology be removed. All relevant costs to enable transporting bitumen be recognized in the methodology. The bitumen royalty valuation be neutral regardless of whether the bitumen is disposed of in arms-length transactions or non-arms-length transactions, or the destination of the bitumen. The BVM methodology should not influence the decision by a project owner whether to build affiliated value-added processing facilities. 3. Support Responsible Development of the Resource 3.1. Robust Regulatory Framework CAPP recommends continuing to maintain a robust, world-leading regulatory framework to guide oil and gas development in Alberta, and to develop and publish a set of goals and performance metrics to increase transparency, demonstrating the performance of the system to Albertans and other stakeholders. 3.2. Managing Resource Development CAPP recommends continuing to manage resource development through the existing robust land management system, informed by well-developed land use planning thresholds, as opposed to the tax and royalty system. 3.3. Wage Distribution Across the Economy CAPP recommends not utilizing the royalty system to achieve wage and income distribution objectives, but rather, continuing to enable industry to optimize income and employment growth across all economic sectors in the province. 3.4. Employment Distribution Across the Province CAPP recommends encouraging industry investment across all types of production at all stages of development (e.g. exploration, production and mature phases) in a manner that is responsive to price and production and recognizes the varied nature of the benefits derived from the industry. This approach ensures Albertans across the province have the greatest opportunity to benefit from oil and gas development through direct and indirect employment opportunities and provincial and municipal tax revenues, in addition to royalties. 3.5. Municipal Relationships CAPP recommends creating a municipal-industry partnership funding program that encourages and rewards collaboration between industry and municipalities in the provision of mutually demanded infrastructure, such as roads, bridges and water and wastewater facilities. 3.6. Climate Policy CAPP recommends adopting the recommendations of CAPP s climate policy report, submitted to the Alberta Climate Change Advisory Panel in October 2015. 10

4. Encourage Diversification Opportunities such as Value-Added Processing, Innovation or Other Forms of Investment in Alberta 4.1. Encouraging R&D and Innovation in Alberta s Oil and Gas Industry Scientific Research and Experimental Development (SR&ED) Program Removing the annual SR&ED expenditure limit in Alberta, similar to the approach taken in other jurisdictions. Allowing corporate partners of a partnership to claim their respective share of the Alberta SR&ED tax allowances. Innovative Energy Technologies Program (IETP) That the Innovative Energy Technologies Program (IETP) funding envelope be doubled to further encourage innovation in the extraction and production of oil and gas, and the mandate be expanded to include environmental technology. That the program be evaluated from an administrative efficiency and capacity perspective to address challenges related to onerous and unnecessary reporting, delays in allocation of funds and narrow/ inconsistent interpretation of project eligibility requirements. 4.2. Oil Sands Royalty Allowed Costs CAPP recommends that the Oil Sands Royalty regime be modified to encourage additional innovation in oil sands development based on the following considerations: Enable cost deductibility for all project-specific research costs incurred prior to a project s approval effective date. Develop a mechanism for the recognition of the cost for research and development of technologies that increase resource recovery (including solvent technology), gain efficiencies in bitumen reduction and the processing of cleaning bitumen, increase product marketability, improve environmental performance and enhance public confidence. More broadly, consider the regime as a significant tool to be used to support and encourage innovation, where aligned with regime principles. Other considerations include government participation in oil sands research, similar to the AOSTRA program from previous years. 4.3. Royalty Infrastructure Cost Allowance Program CAPP recommends Creating an infrastructure royalty deductibility program for companies that develop infrastructure to support maximizing resource recovery from mature assets, exploration and development of oil and gas, Creating a separate and complementary clean infrastructure royalty allowance program to enable the deduction of costs for project-related clean infrastructure investments. Such an approach would also assist companies in meeting their climate policy objectives. 4.4. Oil and Gas Research Authority CAPP recommends creating an oil and gas research authority, building on existing collaborative organizations, to coordinate public and private sector research efforts to enhance innovation and technology commercialization of oil and gas extraction technologies and environmental performance. 11

4.5. Assessment of Near-Term Diversification Opportunities Cogeneration Any consideration of structural changes to the power market consider the development of cogeneration as a low cost, baseload, low intensity generation source to complement the development of renewables, replace retiring generation and take advantage of the natural fit with oil sands development. Ensuring adequate and reliable transmission access to support capital investment decisions for new cogeneration in Northern Alberta, starting with a commitment to building both northeast and northwest transmission lines without further delay. Providing appropriate long-term policy certainty, clarity and transparency around the treatment of cogeneration within Alberta s future climate strategy to ensure investor confidence in new cogeneration. Improving the regulatory process for industrial cogeneration, especially with respect to direct transmission connection and industrial systems designations. Reviewing the current treatment of cogeneration in the Oil Sands Royalty framework and identify opportunities for the government to further support as part of its GHG reduction efforts. Natural Gas Electricity Fuel Switching CAPP recommends prioritizing the development of natural gas as a key electrical generation baseload fuel source as a central plank of government efforts to encourage innovation and add value to the economy while reducing emissions in the electricity sector. Petrochemicals CAPP recommends engaging the upstream oil and gas industry in a review of the Incremental Ethane Extraction Program (IEEP) that would seek to encourage petrochemical sector value-add and diversification through a marketoriented approach and strategy developed in collaboration with the upstream and petrochemical industries Oil Sands Value-Add and Diversification CAPP recommends that investments in value-add commercialization remain unaffected by the royalty structure. Investments in upgrading, refining and marketing must be based on sound economic principles to ensure the energy value chain in Alberta remains competitive. CAPP further recommends: Adopting measures to improve cost competitiveness across all industries through development of increased labour mobility, training and productivity. Working with industry to explore the opportunity to extract some low-value bitumen components as feedstock for conversion to potentially higher margin economic products as a means to diversify Alberta s economy. Continue the agreed upon market based Bitumen Royalty in Kind (BRIK) mechanism that was jointly developed by the Alberta government and industry, in the event the government elects to collect royalty inkind to support its projects and commitments. 12