New oil and gas royalty system ends ineffective subsidies

New oil and gas royalty system ends ineffective subsidies


When oil and natural gas resources are produced in British Columbia, the province charges producers with either a royalty or a royalty production tax on behalf of British Columbians.

In the case of public resources, producers are charged by the county. Most of British Columbia’s natural gas and oil is publicly owned and operated by the province. The governorate grants oil and gas companies licenses to develop these resources and collect royalties from oil and natural gas production on those lands. Producers who develop resources on freehold land pay the freehold production tax. The legislation itself covers royalties and production taxes on a freehold basis, both of which are commonly referred to as royalties.

Money raised through oil and natural gas royalties and freehold production taxes is used to fund vital public services, such as education and health care, some of which is shared with First Nations communities under revenue-sharing agreements.

royalty discounts

The current monarchy system in British Columbia was established nearly three decades ago. Royalty deductions reduce royalties owed to the Crown when production occurs. The Deep Well Equity Program was established in 2003 and was initially intended to offset the higher drilling and completion costs incurred by wells considered particularly deep. The reduction program is sometimes seen as a fossil fuel subsidy.

The way natural gas is produced has changed dramatically over the past three decades, as have market conditions, drilling technology and costs, and global concerns about the need to address climate change.

property rights review

On October 7, 2021, the Department of Energy, Minerals and Low Carbon Innovation launched a comprehensive review of BC’s decades-old oil and gas equity system to ensure it is modernized, in line with government climate goals and provides a fair return for British Columbians.

As part of the review, the province released an independent assessment of British Columbia’s current property system, completed by Nancy Olweiler, Director and Professor in Simon Fraser University’s School of Public Policy, and Jennifer Winter, associate professor of economics and scientific director of the Department of Energy Research and Environmental Policy in the School of Public Policy, University of Calgary.

The independent evaluation found that BC’s legacy royalty system is dysfunctional and does not contribute to governmental and societal objectives.

On November 10, 2021, the province released an equity review discussion paper and launched a broad consultation process on the design of a new oil and gas royalty system.

The majority of British Columbians who participated in oil and gas ownership said in the Public Participation Review that they supported a revamped ownership system.

On May 19, 2022, the province introduced a new oil and gas ownership system that puts the interests of British Columbians first and eliminates outdated and inefficient fossil fuel subsidies.

A transitional regime will come into effect on September 1, 2022, with a new royalty framework set to be effective from September 1, 2024.

New royalty framework

The new framework will be based on a revenue-less-cost royalty system. It will use price-sensitive royalty rates designed to yield a 50% return on revenue on the public resource after accounting for costs. Revenue minus cost royalty systems are recognized globally to maximize economic value and minimize distortions.

BC’s new royalty framework will use a 5% royalty rate during the prepayment period (ie from initial production until revenue from the well exceeds the total capital cost of drilling and completion). Actual development costs (drilling and completion) will be used to determine the cost of each well. Producers will present these costs to the government after production of the well begins. Cost bids will be subject to scrutiny.

Once revenue from capital costs significantly exceeds, a rate-sensitive royalty rate (between 5% and 40%) will be applied. The exact range of price sensitivity varies by commodity type.

The minimum royalty payable will be 5% of the monthly production.

The government intends to implement this system on September 1, 2024.

Moving – new wells

Effective September 1, 2022, new wells (that is, those beginning drilling on or after that date) will not be eligible to qualify for the Old Deep Well Ownership Program, Marginal Well Royalty Program, Ultramarginal Royalty Program, Low Productivity Equity Program, or Equity Programs Clean Growth Infrastructure.

Wells drilled beginning on September 1, 2022 will pay a royalty rate of 5% for the first 12 months of production (8,760 production hours). At the end of this period, these wells will pay the prevailing price-sensitive royalty rates.

Move – Existing Wells

Existing wells and any wells that start drilling before September 1, 2022 will pay royalties based on the current equity framework until September 1, 2024.

Effective September 1, 2024, these wells will transition to the new ownership framework rules. After this date, these wells will not be eligible for price reductions under the Marginal Well Royalty Program, the Ultramarginal Royalty Program, the Low Productivity Royalty Program, or the Clean Growth Infrastructure Royalty Program.

Deep wells with unused deep well discounts will be able to continue to use those discounts to reduce royalties due until September 1, 2026.

Beginning in early 2023, producers will be given periodic opportunities to repurpose unused deep well discounts by converting them into a land reclamation and emissions reduction complex. These combined deductions are discussed below.

Effective September 1, 2026, producers will no longer be eligible to reduce royalties on deep wells using deep well discounts and no further transfer of unused deep well discounts to the LRA complex will be permitted.

Calculate costs under revenue minus cost

The Revenue Less Cost Royalty Framework compares the cost of bringing a well into production with the revenue earned from that well in determining when price-sensitive royalty rates should be applied. A specific cost policy is under development and will consider costs related to assembly and processing, as well as excavation and completion.

The new royalty framework will seek to use actual costs when accounting for drilling and completion costs. Producers will be required to provide cost data within six months of the start of production for the new well. The methodology for determining which costs are eligible to be included in determining these costs will be consistent with the current CRA tax standard – Canada Development Expenditures consisting of actual costs and most of the expenditures below the surface that cannot be removed or transferred to another location, designed to fit the BC context.

This process is intended to be transparent and lead to a fair set of policies that classify drilling and completion amounts into the royalty system. Additional engagement with oil and gas stakeholders will occur during summer 2022 to further develop and define the allowable cost policy and the amounts involved in the drilling and completion amount.

Land treatment pools and emissions reduction

Producers will have the option to convert unused deep well deductions to the LTR complex before September 1, 2026. Multiple “transfer windows” will be provided between early 2023 and September 1, 2026, to allow producers to allocate deep well deductions to the LTC complex. Producers will have the option to allocate some or all of the deep well deductions associated with a well to their pool.

Once assigned to the product pool, royalty deductions will no longer be available to reduce royalties on the well to which they were originally associated. Transfers between producer groups will be allowed only in circumstances related to the acquisition of companies.

The complex aims to support work that goes beyond regulatory requirements to reduce emissions or cumulative impacts on the land base. The final scope of activities supported by the gathering will be developed in the coming months based on discussions within the government, with First Nations in northeastern British Columbia, environmental groups, industry, and other stakeholders.

Next steps

The ministry will conduct annual invitations for projects from producers who wish to do business to qualify for discounts from the Land Treatment and Emission Reduction Group. Producers will be able to reduce royalties equal to expenditures on approved projects through these annual calls up to the value of the discounts they have in their group.

2022-05-19 20:18:01

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