Generational sellout – In-Sights

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I am resigning today as a public servant and would like to draw attention to certain issues in our province’s gas royalties program and administration. With four years experience as a royalty analyst for the province, five years of field experience in upstream oil and gas operations and undergraduate economics training, I offer my somewhat informed perspective below with the hope of catalyzing increased transparency and perhaps improvement to B.C. gas royalty policy.

The Ministry of Finance and the Ministry of Energy, Mines and Petroleum Resources, EMPR, jointly govern and administer natural gas royalty policy. However, policy is largely controlled by EMPR, with Finance tasked with administering the corresponding royalty calculations based on monthly production data.

Gas production and technology has changed rapidly, along with the economics of this industry, over the past 15 years, during which time our gas royalty policy has remained largely unchanged, with the said extension of the deep-well credit to shallow wells being added.

In my opinion, much of our royalty policy is not functioning as originally intended, leading to unwarranted ballooning of industry subsidy amounts. This expensive subsidy growth is hidden by complexity and less-than-transparent public-facing information. EMPR has become responsible to promote the B.C. natural gas and LNG industry internationally, as well as creating a policy that encourages gas sector growth and profitability.

However, there is a natural conflict of interest between promoting gas producers profitability and ensuring the B.C. public receives a fair royalty for the private extraction of our shared natural resource. A segregation of duty should exist between policy makers and industry promoters but, from my perspective and experience, clearly does not. Consequently, there is no unbiased champion for the B.C. taxpayer’s rights at the policy table, and the costly consequences of this absence are hidden behind complexity.

The Crown has issued more revenue-offsetting deep credits than it has collected in actual total oil and gas royalty revenue. Royalty agreements exist to compensate owners of mineral rights for the removal of their mineral resources.

The deep-well program continues to ensure that B.C. citizens, as collective owners of B.C. natural gas, receive a net negative return for the depletion of our gas resources. We issue more royalty/tax offsets annually than the revenue we receive. Put simply, the Crown is giving out $2 in available royalty tax rebates for every dollar in royalty tax payables.

The deep credit program does not achieve any measurable behavioural impact on industry or benefit society other than increasing the profitability of gas production at the expense of the public.

When the program began, only a small fraction of new wells would qualify for credits. A single deep well produces more gas than many shallower wells. Therefore, fewer total wells needed to be drilled, with less surface equipment and roadbuilding reducing costs and environmental harm.

However, in the past four years, 99 percent of all new wells qualify for the program. An industry would drill these types of wells regardless of our policy, due to the inherent cost savings and productivity gains that arise from horizontal fracking versus vertical fracking and profitability achieved by this modern, commonplace type of well construction.

Royalty tax reduction programs should be employed to change behaviour and solve specific problems, rather than a complex and misleadingly labeled subsidy.

The cost of drilling and completing a deep gas well in B.C.’s main formations has declined drastically over the past decade. Yet our royalty discounts per new deep well remain fixed.

Producer cost of service allowances, another additional royalty reduction program, are calculated based on an approximation of the ‘Crown share.’ The policy compensates producers for certain field-gathering costs associated with the ‘share’ of their production value collected as a Crown royalty payment.

In theory, this means that if the province assesses a 10 percent royalty of the value of a producer’s gas production, we could compensate for 10 percent of the associated costs — i.e., the cost of service.

“In reality, the Crown’s share is approximated by a factor called the weighted average royalty rate, or WARR. The WARR is consistently inflated two to three times higher than the amount we actually collect from producers because this factor is a measure of ‘gross’ royalties before deductions, which are far higher than actual royalties payable.

The average effective royalty rate payable is about 5 percent in the province of B.C., whereas the average WARR — that’s the weighted average royalty rate used in the PCOS allowance calculation — is several times that on average over the last few years. The Crown pays for 10 percent of the costs and receives 5 percent of the benefit.

The total producer-cost-of-service allowances offset Crown revenue annually by over $100 million. In my opinion, the unfair and illogical way the allowance is granted to producers overcompensates them by many tens of millions of dollars per year at the expense of the B.C. public.

The problem is very difficult, if not impossible, to understand by reading public-facing information alone. The policy rewards high-cost operators while disincentivizes industry behaviours that might lower costs or increase efficiency.

B.C. gas royalty policy is exceedingly complex, and the province has made strong efforts to monitor the industry. However, the royalty regime could be greatly simplified by the use of fixed, fair, monthly reference prices for all the product types and assigning fixed, fair costs that would apply to all producers.

In my opinion, a much closer look should be taken at any cross-jurisdictional, royalty-competitive comparisons, as B.C.’s current natural gas royalties includes revenue from gas, liquids and field condensate, which is dissimilar from other provinces, such as Alberta. A comprehensive policy review and simplification could significantly benefit industry, government, staff and the B.C. taxpayer.

This content was originally published here.

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