Archive for November, 2007

A Sticky Mess

November 10, 2007

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A public relations battle of wills has been fought for the past several weeks between the Alberta provincial government and private sector energy companies extracting oil and gas from publicly owned lands. Alberta Premier Ed Stelmach appointed a Royalty Review Panel to assess rates charged to oil and gas producers by the province. Its completed report recommended an increase in royalty rates and provided a comprehensive plan for doing so.

On page one of the National Post’s financial section for Saturday, September 29, 2007, was an article entitled, “Royalty row divides Alberta”. In the article, “outsiders” were reported to be “watching in horror as their investments and trust in Alberta falter.” The Panel’s report was described as unfairly creating “the perception that Albertans are getting ripped off by big oil, despite the government’s continuing budget surpluses fuelled by oil activity.” In a statement released by the Deutsche Bank Group, a leading investment bank for corporate and institutional clients, the province was described as “The Bolivarian Republic of Alberta”, while the Panel’s report was characterized as having the appearance of being “authored by a visiting delegation of Venezuelans.”

Similar sentiments were related in other major publications. Saturday, October 13, 2007, on page one of the Globe and Mail’s Report on Business section, the government’s consideration of raising royalty rates was described as “stupid” and “uneducated”. David Yager, chief executive officer of HSE Integrated Ltd. and columnist for Oilweek Magazine, described the panel members as having “grossly underestimated key data regarding industry costs”. Mr. Yager said “rage” was the predominant emotion among industry insiders after the Panel’s recommendations were released.

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Inflammatory articles such as these leave the reader with the perception that the energy companies are going to be taken advantage of by Alberta’s government if the recommended changes in the royalty regime are implemented. Worse still, the companies themselves warn that any attempt to fully implement the recommendations of the Panel will result in economic stagnation for the province, a situation that they have openly threatened to foster in retaliation.

EnCana Corporation, Canada’s largest oil and gas producer, has “threatened to move $1-billion worth of spending from Alberta [next year] if the full scope of the recommendations is adopted.” Canadian Natural Resources, Ltd., the country’s second largest producer, says it will “slash spending by $800-million next year if the recommendations are fully adopted”. Talisman Energy Inc., and ConocoPhillips Co. are said to be considering withdrawing another $500-million of investment each in 2008 if the recommendations of the Royalty Review Panel are implemented. The reduction in future operational investments on this scale would potentially result in tens of thousands of lost jobs, tens of millions in lost provincial revenue and an overall economic slowdown in Alberta.

In its News Release of October 9, Canadian Natural warned, “if the Panel’s proposals are adopted, many oil and natural gas activities in Alberta would be rendered uneconomic. Canadian Natural would have no choice but to reduce activity and, via our contractors, would result in an estimated 3,900 less direct jobs and 16,000 less indirect jobs for Albertans.”

The meaning of “uneconomic” is not synonymous with “unprofitable”. It is inferred that continued operations in Alberta requiring an investment that yields profits lower than desired over the short-term would simply not be worth their while. As with the other energy giants, Canadian Natural may simply invest its money elsewhere in order to achieve a greater rate of return on that investment. EnCana Corporation has been quite candid on this point, declaring, “if the Royalty Panel’s recommendations are adopted in full … we would have no choice but to slow down our Alberta-based activity and move investments to other areas in Canada and the U.S. that are more economically attractive.”

Looking past the hyperbole of these business-oriented reports predicting disaster, it is apparent to any objective observer that the situation is not as dire for private sector investors as the reader may be led to believe. While news releases depict the Royalty Panel’s recommendations as reckless, leaving corporations “no choice” but to invest elsewhere, ignored is the fact that the energy industry has been doing quite well in Alberta and will continue to do so, even if the panel’s recommendations were fully implemented.

Despite the Royalty Panel’s recommendations, the stock prices of energy companies continue to rise on both the Toronto Stock Exchange and the New York Stock Exchange. Despite the potential for reduced profit margins in Alberta, the Deutsche Bank is still optimistic about commodity investments, highlighting that “crude oil lived up to its reputation as ‘black gold’ once again in September. The oil price rose 13 percent, taking it to new record levels … while the [natural] gas price rose 14 percent.” The day after the panel’s report came out, as the hue and cry began, both Petro-Canada and Teck Cominco bought an increased share in Alberta’s massive Fort Hills oil sands project.

In Canadian Natural’s News Release of August 2, 2007, Vice Chairman John Langille stated that the company “generated a record cash flow of just over 3.1 billion [dollars] in the first half of 2007.” The company’s cash flow was 4.9 billion dollars for all of 2006. Net earnings for 2006 were more than 2.5 billion dollars.

Talisman was established in 1992 and has its headquarters in Calgary, Alberta, Canada. Over the past 15 years, Talisman has grown production per share by 10% annually and cash flow per share by 25% annually. In 2006, the Company increased its annual dividend by 32%, Net income was a record $2 billion versus $1.6 billion a year earlier and cash flow increased 2% to $4.7 billion. The Company expects to generate approximately $5 billion in cash flow in 2007.

ConocoPhillips has assets of approximately $171 billion dollars. Total revenue for 2006 was $188.5 billion dollars and Net income was $15.5 billion dollars, up 15% from 2005.

According to EnCana’s 2006 Annual Report, the company’s Net earnings for 2006 were 5.6 billion dollars. In July 2007, EnCana announced to investors that its second quarter cash flow exceeded US$2.5 billion, or $3.33 per share – up 55 percent from 2006: “Second quarter cash flow and operating earnings are significantly higher than one year ago, production is on track to meet our full-year targets and capital costs are tracking below budget at mid-year. Our sustainable low-risk business model is delivering on our expectations and we are well positioned to create strong, long-term performance,” said Randy Eresman, EnCana’s President & Chief Executive Officer.

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For EnCana Corporation, the issue seems to be about making as much money as possible, as quickly as possible. In the company’s September 28 news release to investors, it stated: “If the proposed recommendations are adopted, EnCana plans to cut its 2008 capital investment in Alberta by about $1 billion, or 30 to 40 percent of the $2.5 billion to $3 billion the company has planned for Alberta-based activity. Most of the reductions would be to EnCana’s natural gas activity in areas where the proposed royalty scheme makes those activities uneconomic or uncompetitive in its portfolio. The company plans to reallocate capital to investments outside Alberta.”

Simultaneously, EnCana’s public media statements portrayed an entirely different view: “We care deeply about the impacts the Royalty Review Panel’s recommendations, if adopted in full, would have on the communities where we operate and on the Alberta economy. We agree that changes to the royalty structure are needed – just not in the way the Review Panel has proposed. We want to work with the Alberta government to find a solution. One that works for all Albertans. One that strengthens Alberta’s future.”

Royalties charged by the province have been artificially low by industry standards since they were established. A rate of 1% has been charged on start-up projects in the oil sands until the investors’ original investment was recovered. The intent was to encourage exploration and development of the available resources. When the Review Panel examined the basic accounting data available concerning provincial royalties, it was discovered that the Alberta energy department had no accurate records of how much money was owing compared to how much was actually collected – which meant that there was no way to find out if the department had collected the right amount over many years. Companies were not required to submit receipts for all of their claimed expenses and no procedures were in place to authenticate the legitimacy of their claims.

With oil prices and profits reaching all-time high records, it had become impossible for corporations to successfully argue for maintaining the established royalty regime. Since a rate increase was inevitable at some point and everyone knew it, EnCana and its fellow energy giants chose to negotiate new royalty rates in the court of public opinion, utilizing threats and coercion to intimidate both the government and the public.

Following the public discourse on oil revenues in Alberta, it was obvious that the government had also been polling the public’s opinion, while distancing itself from the process by putting the recommendations into the hands of an appointed commission. The government already intended to increase its share of revenue and the corporate sector was prepared to make concessions. Most Albertans also supported charging higher royalty rates; the only question was – how much would be enough?

Despite the media’s constant denunciations of the government’s plans, the energy companies were not entirely successful in their efforts to minimize the panel’s recommendations, although Premier Stelmach did make compromises to placate them when he announced the rate changes on October 25. As reported in the Globe and Mail on Friday, October 26, about “three-quarters of the recommended increases to royalties” were adopted. The new royalty framework will increase the government’s share from oil sands projects, from the current 1% before project payout, to a range of 1% to 9%, depending on oil prices. When investment is recovered, projects will see royalty increases from the current 25% to a range of 25% to 40%, also depending on oil prices. For the oil sands, the government share will increase to between 57% and 66%, while the panel was recommending an increase to 64%. For conventional oil, the government’s share goes up from 44% to 49%, which is what the panel proposed. The new rates will boost the government’s share for natural gas from 58% to 60%, rather than the 63% recommended by the panel. These changes will not be implemented until 2009, leaving ample time for the government to reconsider its decision, or the energy industry to successfully lobby for what it considers more palatable rates.

The past decade has seen massive development of the Alberta tar sands, also known as the oil sands. The world’s largest oil sands deposits occur in two countries: Canada and Venezuela. These oil sands reserves are estimated to be approximately equal to the world’s total reserves of conventional crude oil.

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Oil sand is composed of sand, bitumen, mineral rich clays and water. Bitumen, in its raw state, is a black, asphalt-like oil. According to the Alberta Energy and Utilities Board, Alberta’s oil sand deposits contain approximately 1.7 to 2.5 trillion barrels of bitumen, of which over 175 billion are recoverable with current technology. New methods of extraction are currently being developed. Including the oil sands, Alberta has the second largest petroleum reserves in the world, second only to Saudi Arabia. The Athasbasca Oil Sands Deposit is potentially the largest petroleum resource in the world.

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Bitumen.

As the world’s conventional oil reserves dwindle and the issue of peak oil becomes everyone’s concern, it is difficult to see how the energy giants, always seeking new sources of oil, can credibly threaten to ignore the development of Alberta’s oil sands, however much they loath sharing the proceeds with its owners. While there may be fluctuations in economic investment and adjustments to the way business is conducted in Alberta, the potential to sustain vast profits into the foreseeable future is irrefutable.

Absent from the debate on how to share future profits derived from Alberta’s oil sands was any recognition of the truly significant, long-term issues at stake. Tar sands oil extraction is extremely detrimental to the environment. Fragile ecosystems comprising thousands of square kilometers of boreal forests and vegetation are being destroyed through strip-mining and open-pit mining. To produce a single barrel of oil, it requires digging out four tonnes of materials, leaving behind a mix of sand, shale and toxic chemicals.

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Spent shale, Athabasca tar sands.

Billions of gallons of fresh water are being consumed annually to extract the oil. Up to 5 volume units of water are used to produce each volume unit of synthetic crude oil. Despite recycling, almost all of the water used ends up in tailings “ponds”, some of which are larger than the regions’ natural lakes. Since 2005, production from 29 companies has exceeded 1 million barrels of crude oil per day. It is anticipated that production will near 3 million barrels a day by 2015.

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Syncrude Plant, Athabasca tar sands.

Refineries are releasing huge amounts of carbon dioxide into the atmosphere along with a variety of other toxins – 80 kg of greenhouse gases for every barrel of oil refined.

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Oil sand refinery, Alberta Canada.

To obtain a single barrel of synthetic crude oil, an average of 250 cubic feet of natural gas is used mining the raw material and 500 cubic feet of gas is needed to upgrade the bitumen to a barrel of synthetic crude oil. This gas is enough to heat a Canadian home for 4.5 days. The tar sands industry consumes about 0.6 billion cubic feet of natural gas daily, enough to heat 3.2 million Canadian homes each day.

Rather than focusing on conserving the existing conventional fossil fuel energy reserves while developing clean, sustainable alternative energy sources, the priority has been to maximize profits, both public and private, through escalating the exploitation of Alberta’s unconventional oil resources. No legitimate consideration has ever been given to the long-term impact such monumental waste and environmental devastation will have on our future health and quality of life. Once the situation becomes untenable, of course, it will be local communities and their stricken populations who are burdened with the economic costs and environmental repercussions of irresponsible business practices. The consequences for regional ecosystems are foreboding; the impact on global climate change unknown. An environmental catastrophe in Alberta would make the fight for oil profits seem no more significant than a struggle over a deck chair on the Titanic.

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Open pit mining, Alberta Canada.

Climate change caused by global warming is a concern gaining in significance every year. Canada’s previous federal Liberal government ratified the international Kyoto Agreement, which was intended to curtail the production of greenhouse gases globally and to begin the reduction of future emissions by industrialized countries. Yet that same government turned a blind eye to the environmental consequences of the development and exploitation of the Alberta Oil Sands, the single major source of increased greenhouse gas emissions in Canada since the Accord was signed. The oil sands development also made Energy the single largest growth sector of the Canadian economy over the past decade. Under the Kyoto Protocol, Canada pledged to reduce carbon emissions by 6 per cent, based on 1990 levels of emission, by 2012. Current levels of green house gas emissions have gone so far beyond that 1990 benchmark that to achieve it will require a 30 per cent reduction in current emissions to reach the originally intended goal. Our current Prime Minister, Conservative Stephen Harper, from Calgary, Alberta, no longer questions the legitimacy of the scientific evidence validating global warming as he did in the past. He now questions the timetable adopted for reducing emissions, insisting that implementing the proposed reductions by 2012 would cause an economic recession in Canada. “This party has no intention of doing anything that will destroy Canadian jobs or damage the health of the economy,” Mr. Harper was quoted as saying during Question Period in the House of Commons. In October 2007, the Kyoto Protocol was all but abandoned. While Environment Minister John Baird stated that Canada would not formally withdraw from the Protocol, the Conservative government in its latest Throne Speech declared that the objectives in the treaty were “unattainable”.

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Above: Sources of Canada’s greenhouse gas emissions as a percentage of total emissions.

Global demand for oil continues to rise while governments and businesses ignore the long established, wasteful practices in our use of oil. National governments everywhere have been oblivious to the need to conserve existing oil supplies, along with other non-renewable natural resources. They have been neglecting their collective responsibility to protect the integrity of the earth’s remaining ecosystems by allowing unregulated economic growth to continue. The development of the Alberta tar sands over all other considerations exemplifies this universal disregard for our collective well-being.

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Suncor strip mining, Alberta Canada.

Economic growth as we understand it cannot be sustained. Our human population is larger than ever before, consuming more than ever before, at a rate that is faster than was ever before imaginable. Our appetites have become insatiable. Human beings have consistently undervalued the earth’s natural resources while overestimating nature’s ability to rebound from abuse and human misuse. The world’s biodiversity is declining at an unprecedented rate. Populations of species in terrestrial, marine and freshwater ecosystems have declined by more than 30% since 1970. We are squandering our legacy as fast as possible, not appreciating that our survival is dependent upon a symbiotic relationship with all other life forms. The World Wildlife Fund warns that current global consumption levels could result in a large-scale ecosystem collapse by the middle of the century.

In the meantime, environmental degradation escalates while short-term profits grow, and the cost to future generations is tacitly ignored.

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