Financial

In the book, World’s Greenest Oil, the suggestion is made that royalty rates should be amended and will have multiple benefits. However, no detailed economic analysis was provided, as it was considered too technical for inclusion in the book. For this reason it is provided here. The following analysis suggests that altering royalty rates can significantly cut greenhouse gas emissions by up to 90 million tonnes/year, equivalent to 7% of Canada’s total CO2 emissions. It would also give very strong bottom-line incentives to companies to cut their emissions, as well as provide more than $20 billion in additional revenues to the Albertan Government over a 10-year period.

Altering royalty rates

The current royalty rate varies solely with the price of oil. The net royalty rate starts at 25% of profits and rises to a maximum of 40% of profits when oil is priced at $120 or higher (Column #3, Table 1). Indeed, it quite likely that over the next 10 years the price will rise to at least $120 per barrel. ^[1]

If royalty rates are altered the best way may be to add both “carrots” and “sticks” to induce a reduction in CO2 emissions. In this case final royal rates would be based upon total CO2 emissions that occur during the “life-cycle” of production ^[2] . Possible inducements could include a reduction or increase in royalty rates of up to 20% (Column #3, Table 1). This would produce a wide range of possible royalty rates (Column #4, Table 1).

Table 1 – Possible Royalty Rate Adjustments

#1 “Life-Cycle” CO2 emissions (gCO2/e/MJ Gasoline) [3]	#2 Existing Royalty Rate at $120/barrel (%of profit)	#3 Change to Royalty Rate (%)	#4 Total Revised Royalty Rate at $120/barrel (% of profit)
less than 25	40%	-20	20%
25-30	40%	-15	25%
30-35	40%	-10	30%
35-40	40%	-5	35%
40	40%	0	40%
40-45	40%	+ 5	45%
45-50	40%	+ 10	50%
50-55	40%	+ 15	55%
more than 55	40%	+ 20	60%

This possible solution is worth exploring in detail as there are a large number of potential benefits. As with any model, it depends upon the assumptions made, so these need to be discussed first.

Status Quo assumptions

In terms of the status quo option, there are three main assumptions. Firstly, that as more extraction occurs using steam-assisted gravity drainage (SAGD), so greenhouse gas emissions will increase ^[4] . As this occurs it will become increasingly likely that regulatory changes will be implemented which will make investment in new oil sands developments less and less economically attractive.

The second assumption is that oil sands output will peak at 2.5 million barrels per day ^[5].

The third assumption is that the majority of this output will be upgraded outside of Alberta ^[6].

It is assumed that in the status quo scenario companies will be paying 40% of net profit in royalty rates on oil from 2020 onwards (Column #2, Table 1) ^[7].

Assumptions following changes in Royalty Rates

In the revised model, what are the economic outcomes? Here, the assumptions are different. The first is that a change in the royalty rate would occur as indicated (Column #3, Table 1). However, it has also been assumed that this would be transitioned over time, and wouldn’t be fully effective until 2020. This would give a wide range of potential royalties on profits (Column #4, Table 1) ^[8]. Clearly, this will provide a very strong incentive for companies to lower their total CO2 emissions as much as possible in all their operations. To put this in context, until 2007 the royalty rate was 25% of the project’s net revenue, and currently the lowest royalty rate is 25%, so this lowest possible rate of 20% is little different from these.

Such a change would be widely publicized as soon as it was implemented. It would allow the oil sands to appropriately claim that, in terms of CO2 emissions, it was the “World’s Greenest Oil”. This is because it would be the only regime in the world in which higher CO2 emissions were penalized and lower CO2 emissions rewarded ^[9].

This would lead to a paradigm shift in the way the oil sands are perceived. Even those strongly opposed to the use of oil in general, and the oil sands in particular, would surely desire that any oil produced should have the lowest possible impact on greenhouse gas emissions. For these reasons, the approach outlined can be supported both by environmentalists and the oil sands industry.

Such a shift in attitude would dramatically lower both regulatory and investment risks for the oil sands, and would significantly also increase the royalty revenues to the Alberta Government ^[10]. The bottom line benefits for companies would also be very significant ^[11].

Stimulating other economic activity

One further suggestion is that the royalty rate change be accompanied by a major qualification, namely that only those companies that upgrade their oil in Alberta would be eligible for the best rates ^[12]. The intent of this qualification would be to add a significant economic incentive to companies to upgrade their oil in Alberta.

This is important for as encouraging companies to upgrade in Alberta increases both the value of the oil to the economy and helps economic diversification ^[13].

Conclusion

The royalty rate changes proposed produces multiple winners. The environment wins with a significant reduction in CO2 emissions compared to the status quo. Albertans benefit by removing major regulatory and reputational risks to Alberta. Companies win by paying significantly less in royalties. The Alberta government wins as the total tax revenue may be as much as $20 billion more over a 10-year period ^[14]. Resource revenues would also be at less risk, which would benefit not only all Albertans, but also all Canadians. Surely, this is a proposal worthy of further discussion?

Notes

1. It is assumed that the price of oil will average $120/barrel in 2020, $135/barrel in 2025, and $150/barrel in 2030 (in 2010 dollars). These price increases will be due to a combination of factors including increased oil use in Asia, the possibility of shortages of cheaper sources of oil, and increased costs due to regulation which will impact both extraction costs as well as likely regulatory actions designed to increase the price of all carbon fuels. These are recognized to be estimates with the exact levels being open to debate. They figures should not be taken as accurate predictions of what will actually happen to the oil price over these time periods.
2. “Life-cycle” measurement includes all CO2 emissions, including those emitted when retrieving the oil from the well, those occurring during upgrading and refining, as well as all those occurring in transporting the oil until the moment it arrives in the gas tank. For these reasons it is often referred to as a well-to-tank (WTT) measurement. The measure therefore gives the total weight of CO2 released during the “life-cycle” of production, and can vary from less than 20 gCO2/e/MJ gasoline to more than 60 gCO2/e/MJ gasoline (measured as grams of CO2 equivalents per megajoule [a unit of energy]).
3. To give some context, in a recent study the average for oil from Saudi Arabia was less than 20 gCO2/e/MJ gasoline, while for oil sands extraction via steam-assisted gravity drainage (SAGD) the average was more than 50 gCO2/e/MJ gasoline. [Study details are as follows: TIAX and Math Pro, "Comparison of North American and Imported Crude Oil Lifecycle GHG Emissions", Figure 6-7, Alberta Energy Research Institute. 6th July, 2009: [Source]
4. Since more than 80% of the oil-sands cannot be extracted by surface mining, so other techniques are used to extract this. Since there will be increasing levels of production from underground sources, it is assumed that most of this will use the current technology of steam-assisted gravity drainage (SAGD). This uses large amounts of natural gas both to heat the water to create the steam, and also in the upgrading process. Currently, SAGD produces less than 50% of all oil from the oil sands, but this percentage is expected to grow considerably from now on. For this reason average CO2 emissions from the oil sands will almost certainly increase over time, unless changes occur. Given the strong international push to decrease CO2 emissions, a likely outcome is that regulatory changes will occur which will make new oil sands projects less economic. This is likely to have a material impact on investment in the oil sands.
5. The assumption is that because of regulatory and other issues production from the oil sands will plateau at 2.5 million barrels/day by 2025. This assumption can certainly be argued, but given all the issues identified in the book it appears overly optimistic to assume that if nothing changes oil sands production will still reach the predicted 3.5 million barrels/day by 2025.
6. Currently, approximately 60% of the1.3 million barrels produced in Alberta are upgraded here. But with a few minor exceptions plans currently are for most additional production to be upgraded in the U.S. Although there are groups, such as Refine It Where We Mine it, that are pushing strongly for more upgrading capacity to be built in Alberta, this is unlikely to occur without strong economic or regulatory incentives. This is because of the large existing capability in the United States, and companies are planning to utilize this in future.
7. Assuming production amounts as above, this implies that companies will be paying the Alberta Government royalties of approximately $8.7 billion in 2020, $11.1 billion in 2025, and $12.3 billion in 2030 (in 2010 dollars).
8. It should also be noted that in such a scenario final rates would vary significantly between projects, with some being much higher than others, even within the same company. However, it is highly unlikely that all companies will be able to achieve the lowest rates immediately. Thus, assuming that by 2020 most companies had made some changes, it is possible that the average royalty rate would be 35% in 2020. With further investments it is assumed that by 2025 the average royalty rate was 30%, and by 2030 it was 25%.
9. It would need to be clearly recognized that while such changes would not occur overnight, within a period of perhaps 10 years of this being implemented the mean level of CO2 emissions would be among the lowest in the world, and within 20 years it is very likely that the average CO2 emissions would indeed be lower than oil production from anywhere else on the planet.
10. In such circumstances it can be assumed that production would increase to the amounts predicted by organizations such as CAPP to a total of 2.9 million barrels/day in 2020, and would possibly further increase to 3.5 million barrels/day by 2025 and 4.5 million barrels/day by 2030. At this point the oil sands would still only represent around 5% of global oil production. Taking all of this together, it would imply that companies would make total royalty payments to the Alberta government of $10.0 billion in 2020, $11.6 billion in 2025, and $13.9 billion in 2030 (in 2010 dollars). It should be noted that all of these royalty rates are greater than in the status quo scenario.
11. It is important to also note that the 2025 payment also represents another 1 million barrels/day of production. Given that royalty rates would on average be 10% lower than the status quo option, the total economic benefits to companies are extremely significant. These would occur every year, and would more than compensate any additional one-off costs incurred in reducing CO2 emissions. They would be bottom-line incentives to companies, and thus companies would also be under strong shareholder pressure to reduce greenhouse gas emissions as much as possible.
12. It is assumed that companies that upgrade outside Alberta would have a minimum royalty rate of 35% instead of 20%. This would provide a strong economic incentive to upgrade oil in Alberta.
13. The Alberta government would receive additional royalties from companies involved in upgrading, as well as additional taxes from individuals working in the industry and from related economic activities. Additionally, several studies have suggested that if significant upgrading occurs in Alberta further downstream industries would also develop. These could produce an additional $25 billion in annual economic activity in Alberta. Therefore, there would be significant additional revenues from all these extra economic activities. Such revenues can be conservatively estimated at $0.5 billion in 2020 increasing to $1.5 billion in 2030.
14. Table 2 shows a summary of what the total increase in revenues may be during a 10-year period following full implementation of this suggestion regarding royalty rate changes. Column #2 gives an estimate of what the additional revenue to the Alberta Government will be from royalty rates alone. These increase because, although there is an assumed small percentage decrease in royalty rates discussed in point viii above, this is coming from a larger overall source. Thus, the Alberta Government gets a slightly smaller piece of a larger pie and gains overall. Furthermore, for companies to obtain the best rates they have to invest significantly more in Alberta in terms of upgrading which will stimulate significant additional activity. A possible outcome of this additional activity is shown in Column #3, which is a conservative estimate of the additional corporate and other tax revenue from this economic activity.

Table 2 – Possible Increases In Alberta Government Revenues 2020 – 2030

	Estimated Additional Royalty Revenues (millions)	Estimated Other Revenues (millions)	Estimated Total Additional Annual Revenues (millions)
2020	$1,330	$500	$1,830
2021	$1,050	$600	$1,650
2022	$900	$700	$1,600
2023	$800	$800	$1,600
2024	$650	$900	$1,550
2025	$554	$1,000	$1,554
2026	$800	$1,100	$1,900
2027	$900	$1,200	$2,100
2028	$1,050	$1,300	$2,350
2029	$1,250	$1,400	$2,650
2030	$1,539	$1,500	$3,039
Total	$10,823	$11,000	$21,823