Big oil is taking no chances with the outcome of Alberta’s royalty review currently underway. In 2007, the industry was surprised when royalties were jacked up despite dozens of corporate presentations to the royalty review panel warning of the fragility of investment economics and the damage increased royalties would cause. Therefore producers and others with significant vested interest have already started the lobbying process.
Such is the case with Canadian Natural Resources Limited (CNRL) which made a slide presentation to the new NDP Alberta government on August 20. The industry has obviously learned never to assume politicians actually understand what makes the economy and oil industry work.
The presentation’s key messages were: CNRL is a responsible operator in every way; jobs are created by investment, supported by a positive return on capital; Alberta needs a supportive environment which creates jobs; Alberta is a high cost place to do business, and historically, returns on investment have been poor. That’s when prices were high. It is worse now.
CNRL has been very successful because it is all business. Any oilfield service contractor working for CNRL knows how much price matters to that operator. The company’s Mission Statement reads, “To develop people to work together to create value for the Company’s shareholders by doing it right with fun and integrity.” There is little confusion about why CNRL is in business and what it is trying to accomplish. The presentation ended with the message, “Share the contents of this presentation with your friends and family.” So here we go.
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You hope when CNRL talks somebody listens. The company is a made-in-Alberta success story. The public corporate entity started life in Vancouver in 1973 as AEX Minerals Corporation, a junior miner which explored for zinc and lead in the Yukon. In 1975 it was renamed Canadian Natural Resources Limited and registered in Alberta 1982. The company has been on a breathtaking growth tear ever since.
On June 30, 2015, CNRL was Canada’s largest oil and gas producing company by any measure. Production on a barrel of oil equivalent (boe) basis was 806,000 boe/day. Put into perspective, Imperial Oil Limited, Cenovus Energy Inc. and Encana Corporation had combined production of only 1,008,000 boe/day. Revenue for the quarter ended June 30 was $3.8 billion, all from the sale of oil, gas and liquids. All the other companies with similar or greater revenues own refineries or downstream operations. CNRL is the top well licensee so far in 2015 and, to the end of June, was the seventh busiest driller.
CNRL has 7,000 employees in Alberta living in 90 communities. Last year, the company created 74,000 person-years of direct and indirect employment in this province. This does not include operations in B.C., Saskatchewan, North Sea, offshore Africa and South Africa. It spends heavily on R&D, investing $450 million in 2014 alone, making it one of Canada’s largest spenders in developing new technologies and processes. It works with 30,000 separate landowners and 55 Aboriginal communities. CNRL paid $227 million in property taxes in Alberta last year and another $50 million to surface and mineral title holders. More than $10 million was spent on community donations and sponsorships in 2014.
With the motherhood statements made, CNRL gets down to business. The company declares there is a direct linkage between oil and gas investment, government revenues and jobs. It all ties back to Return on Capital Employed, or ROCE. The higher the ROCE, the more money the company can and will invest.
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The reward for governments that create an attractive economic environment is jobs and revenue. The numbers are clear. In 2014 there were 74,000 person-years of employment in Alberta, a figure that will fall to 57,000 this year. In the future, it can grow or shrink. Outside of commodity prices, how the Alberta government manages and regulates the upstream oil and gas industry will be a major factor.
CNRL notes Alberta’s current royalty system is price sensitive and fair. If prices go up, the government gets more and the opposite is true when prices fall. CNRL warns, “Adjusting this balance (between the industry and government take) is very difficult and more often than not has unintended consequences.” The drivers of ROCE are assets (geology), commodity prices, government fiscal terms, the regulatory burden, capital and operating costs. Commodity prices are beyond anyone’s control. But the fiscal and regulatory terms are entirely under the control of the Alberta government.
CNRL goes to great lengths to illustrate the oil and gas business as nowhere near as profitable as many believe. According the company, in 2012 and 2013 “Canada / Alberta oil & natural gas” ranked behind arts and entertainment and recreation, agencies / brokers, alcohol and tobacco, insurance companies, construction, agriculture, forestry, banking, mining and pharmaceuticals in terms of ROCE. In those years, the average price of WTI was US$94.19 and US$98.00 respectively.
CNRL pegged its ROCE in 2014 at 10 percent and this year at -1.9 percent. Notes to the slide read, “At high crude prices, just made cost of capital. At low oil prices, destroyed capital.” Regardless, CNRL invested heavily in 2013 and 2014. But the company asks itself the question, “If the industry is doing so poorly, why does there seem to be so many high paying jobs across Alberta?”
The answer is very interesting, and not what you might expect from a giant oil company. CNRL says the oil business is like a horse race, where only the top three ponies make money with a win, place and show. All the others lose. But the entity that always make money is the race track, which is the Alberta government. And if one race track isn’t paying out enough money to winners, the bettors and horses go elsewhere. Such is the case with oil and gas investment in Alberta.
To emphasize the point, the oil business has more winners than losers (thus supporting the low ROCE case for oil versus other industries). CNRL lists the top 30 producers from 15 years ago. Only 43 percent of the companies still exist. The rest have sold their shares or assets to others because they could not achieve an attractive ROCE (companies with a high ROCE and share prices are rarely taken over because there is no upside for the new owner).
On the issue of high paying jobs, CNRL’s slide notes read, “…having a few winners is what keeps investors investing in Alberta, and investment creates and maintains jobs. If the conditions are right both Alberta and Canadian Natural can win. This competition has been good for workers in Alberta. In the oil and gas business, companies compete to get the best people from geologists to finance folks to the operators in the field. In recent years there has been a shortage of skilled people and as a result compensation for people throughout the industry has gone up dramatically. The individual prosperity created by this competition for talent is a benefit for all Albertans.”
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Alberta has several advantages, including a large resource base with low decline rates, proven ingenuity and technology and a skilled workforce. But CNRL says the world has changed. Technology has allowed the U.S. to re-emerge as a major oil producer. There is more oil available than the world needs and Alberta is an expensive place to do business. Two more slides show how oil from the Middle East and Russia is substantially cheaper than oilsands and shale oil from Alberta and the marginal cost of shale oil from the U.S. keeps coming down as technology improves. CNRL also has a chart showing Alberta’s current royalty rates are already higher than in B.C. or Saskatchewan.
CNRL wraps up by warning about the negative impacts on ROCE and Alberta’s prospects, should the province proceed with raising corporate taxes, carbon taxes and royalties. The first two have already been announced. The company cites examples like the United Kingdom’s sector of the North Sea which jacked up royalties in 2011, saw investment disappear and production decline, then lowered them again to get back in the game.
In closing, CNRL wrote, “Alberta is facing significant challenges due to capital and operating cost increases that have occurred in the past 10 years, including escalating regulatory and policy requirements. Therefore, CNRL is attacking costs in six key areas: reductions in costs related to contractors; improved productivity; material cost reductions; right scoping; technology and innovation adaptation; and improved regulatory process and fiscal policy outcomes.”
One can only hope the government policy makers across the table were listening and understand the message.
By David Yager for Oilprice.com
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