“Unintended Consequences of Alberta’s New Royalty Framework” Mr. Gordon Stollery Board of Directors Highpine Oil & Gas Limited
Tuesday, April 15, 2008 1
Unintended consequences are outcomes that are not (or not limited to) what is intended in a particular situation. The unintended results may be foreseen or unforeseen, but they should be the logical or likely results of the action
Definition
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$80/bbl vs. Oil Rate
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New Royalty Framework (“NRF”) Summary
THE PROPOSED NEW ROYALTY FRAMEWORK WILL UNINTENTIONALLY HURT ALBERTA (PUBLIC AND PRIVATE) BASED OIL & GAS COMPANIES, EMPLOYEES AND SERVICE PROVIDERS
• These Companies drill 60% of the NEW EXPLORATION wells in the Province
THE PUBLIC ARE SYMPATHETIC TO THE QUESTION – “WOULD MORE BE FAIR?”
• The Public doesn’t realize “BIG OIL” earns vast amounts from their overseas operations where royalties are higher but the assets are significantly larger – Alberta’s average well is only 18 B/D, versus Norway at 6,000 B/D and Alaska at 600 B/D – Alberta’s Average Oil Pool is 0.5% of the Average World Pool
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New Royalty Framework (“NRF”) Summary
THE PROPOSED ROYALTY PLAN IS NOT A “20%” INCREASE
Natural Gas – for a modest well producing 600 MCF/D, the royalty rate increases from 30% to 50% = “66 2/3% increase”
Oil – Depending on the size of the well, under the NRF the royalty rate increases from approximately 26% to 50% = “approximately 100% increase”
FIRST ALBERTA LAND SALE of 2008 WAS $25 MILLION COMPARED TO $78.5 MILLION IN 2007
• Yet Saskatchewan and B.C. saw substantial increases
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New Royalty Framework (“NRF”) Summary
CANADIAN OIL & GAS COMPANIES HAVE SEEN THEIR EQUITY PRICES FALL SINCE THE ANNOUNCEMENT
• There are only nominal amounts of new equity coming into Alberta financings. Over the last 3 years only 27% of capital investment for Canadian independent oil & gas companies has been from cash flow – the balance were funds from new equity funding (46%) and debt (27%). With the NRF, new equity and bank borrowings will be a scarce commodity. There will be major cut-backs in activity which will affect hundreds of small businesses, shops, hotels, restaurants in every community.
ECONOMICS – AT $80 PER BARREL • Companies are earning, before Federal and Provincial Income Tax,
approximately $37.50 netback per bbl for light oil. The new royalty rates would reduce the netbacks to approximately $20.50 per barrel. But, the averaging Finding & Development Cost equals approximately $20-25 per barrel.
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New Royalty Framework (“NRF”) Summary
THE GOVERNMENT SHOULD GRANDFATHER EXISTING WELLS
• Companies require the cash flow to re-invest. Otherwise, capital will not be available to maintain existing production and then overall royalty income to the Province will actually decline.
CROWN LAND AGREEMENTS• Any company that purchased land leases at the
Alberta Crown Sales last year or the year before assumed certain in place economic parameters. Now the Return on Investment (R.O.I.) has been drastically reduced – Companies will now state, “We want our LAND MONEY BACK”.
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Unintended Consequences of the NRF
• Penalizes junior exploration companies• Royalties on high risk/high rate wells double under NRF, rendering
these projects uneconomic• Canadian junior explorers drill 60% of the new exploration wells in
the province• High rate oil wells pay 60% of the conventional oil royalties• Enhanced Oil Recovery (“EOR”) projects on existing wells are
discouraged
• Cashflow, investor confidence and investment capital lost and bank lines reduced
• Juniors do not fund themselves the same way as major oil companies or utilities – i.e. 70/30; Debt/Equity
• Juniors over the last 3 years have been funded as follows: 46% equity, 27% debt, 27% cash flow
• Anticipate reduction in government revenues of $400 million estimated over the next five years
• Reduced investment activity means lower production base• High risk/high rate wells, which pay 60% of the current royalties,
will not be drilled
The proposed NRF will result in an immediate reduction in cash flow, investment capital, drilling and production, resulting in Alberta actually receiving LESS royalties by mid-2010
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Land Sales
Lowest land sale bonus paid since 2002
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Cost Escalation is Real !
•Costs have risen dramatically in a very short time period
•Economic comparisons and studies have failed to keep pace with relevant costs
•Alberta royalty framework must provide a return on real costs
Unintended Consequences: Signs of Domino EffectJuniors Require and Reinvest Capital
Alberta GrowthEngine
CapitalSpending
Cashflow30%
New Investors60%
Banks10%
• NRF capital concerns• Major loss of cash flow• No equity available for investment• Reduced bank lines• With lack of external and internal funding, capital budgets being cut and overall oil field activity will drop
Uneconomic = No investment = No activity = Royalty Shortfall
Oilpatch Equity Financings
0
200
400
600
800
1000
1200
Oct-05 Oct-06 Oct-07
$tho
usan
ds
AB Conventional
Other
Data Source:Sayer Energy Advisors
$
mil
lio
ns
Dramatic capital reduction
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Unintended Consequences: Signs of Domino Effect
Uneconomic = No Investment = No Activity = Royalty Shortfall
• Drilling rig utilization 35% below last year
• Since the AARP report was released the average share price of a cross section of Non Alberta Oil & Gas Companies has risen approximately 48% and the average price of a number of Alberta based Oil & Gas Companies has declined by 17%, (see graph next page)
• First Alberta land sale of 2008 dropped to $25 million from $78.5 million a year ago – Daily Oil Bulletin
• Saskatchewan and B.C. land sale revenue and activity increasing
Data Source: Sayer Energy Advisors
Oilpatch Equity Financings
0
200
400
600
800
1,000
1,200
Oct-2005 Oct-2006 Oct-2007
$MM
AB Conventional
Other
Dramatic capital reduction
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Investors Have Sold & Walked Away From Alberta Focused Companies
Comparison of AB/SK focused Junior Oil & Gas Company share price performance following AARP
announcements
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
9/18/07 10/02/07 10/16/07 10/30/07 11/13/07 11/27/07 12/11/07 12/25/07 1/08/08 1/22/08
Re
lati
ve
Pe
rfo
rma
nc
e
Sask and BC Average Alberta Average
SEP 18/07AARP Report Released
OCT 24/07Government Decision Announced on AARP Report Released
CPG.UN, PRY.A, PBG
ACN, WAV.A, GO.A, HPX, KCO, WTL
Average Share Price of Non-Alberta Focused Oil and Gas Companies
UP 48%
Average Share Price of Alberta Focused Oil and Gas Companies
DOWN 17%
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Sources of External Capital have Disappeared Therefore Capital Expenditures in Excess of Cash Flow
Will Cease
• Junior Canadian Oil companies have spent over 3x their internal cash flow over the past 3 years
• The capital in excess of cash flow is mostly sourced external to Alberta and has dried up
• With the lack of external funding, capital budgets will be cut and overall oilfield activity will drop substantially
• For every dollar spent by the oil business in Alberta, $4.60 dollars flow to the general economy*
*R. Mansell – University of Calgary
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Economic Returns do not justify the costs
under the NRF• Canadian junior explorers have posted low or negative net
earnings even at high oil prices as costs in the Alberta basin escalate and reserve sizes decrease
• Finding & development costs are averaging approximately $20/barrel of oil equivalent, (BOE), as verified by National Instrument 51-101 compliance requirements
• Another calculation is depletion, depreciation and accretion expenses (DD&A) which are an approximation of Finding and Development costs. These expenses are an ongoing normal write-down of assets as they are used in business. The Median of DD&A for 77 public companies for the third quarter 2007 equated $23.76/BOE which is greater than the Cash Netbacks/ BOE after the Proposed New Royalty Framework. (Source: Iradesso Quarterly).
• Under the proposed new royalty, deep exploratory wells for conventional oil are rendered marginal or uneconomic
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Deep ‘Half Cycle’ Light Oil Exploration Initial Returns vs. NRF = NO ECONOMICS
Current Proposed
WTI PriceC$70/Bbl
Royalty
Operating/ Transport
US$80/Bbl
C$18/Bbl
C$12.00/BblG&A/Interest C$3.00/Bbl
C$70/Bbl
US$80/Bbl
C$35/Bbl
C$12.00/Bbl
C$37.00/BblCash Netback
C$20.00/Bbl
Field Price
F&D Cost
C$3.00/Bbl
Cash Netback
C$25.00/Bbl C$25.00/Bbl
Recycle Ratio
(Dollars Returned divided by dollars invested)
$1.48 returned forevery $1.00 invested
$0.80 returned forevery $1.00 invested
Projected Royalty Revenue will Actually go Down due to Low Activity Levels
• As a result of a lack of capital and resulting lack of drilling activity, it is projected that Alberta will actually receive less royalties by mid 2010
• High levels of capital investment are essential to curb production decline in a mature basin
• The capital required to maintain production targets is not available under the terms of the NRF
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At Current Prices Alberta is Already Collecting $1.4 Billion More In Royalties
• Alberta does participate in the price upside since the province collects its royalties “in kind” and sells its oil at the world price
• As a result of the current $90 price of oil, Alberta is already collecting an additional $1.4 billion annualized in royalties, relative to the $60 price level that was used in the Royalty Review Panel Report
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Huge Gaps in Royalties Paid
• 5% of Alberta’s existing wells pay 60% of the royalties
• The majority of these wells are deep and have been drilled in the last 5 years
• The new royalty renders most of the deep conventional plays uneconomic
• It is estimated that the majority of deep exploration activity will cease under the new royalty proposal
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Truly an unintended consequence - High productivity wells pay disproportionate share of royalties, which would NOT be drilled under NRF, as drilling becomes uneconomic.
5% of the wells (high productivity) pay 60% of the royalties
Unintended Consequences
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$80/bbl vs. Oil Rate
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Summary
• Recently announced solutions to unintended consequences do nothing for high productivity oil
• $1 million exploratory credit (post April 10th 2008) depths greater than 2000 meters
• Nothing for development wells• Gas was awarded royalty credits for development, why not
oil?
• Does not address real costs of exploring and developing high productivity premium crude
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