Today, the Alberta Government announced new reclamation guidelines for oil sands mining operations and for coal mines. Reclamation liabilities associated with the activities from the oil sands should be front-of-mind for the Government, and with activity growing all the time, the liability held by the Province in excess of escrow holdings is also growing. Pembina’s figures for the scale of the current un-funded liabilities are $15 billion (full Pembina report here), and I have to agree with them that to shift further into the future the collection of payments sufficient to provide full financial security for the Province is simply not an acceptable solution. At first blush, it appears that this continues a disturbing trend of the Government implicitly subsidizing activity in the oilsands through either under-valued resources or through risks and liabilities borne by those who own the resource and on whose behalf our Government is supposed to be acting. It turns out, on further investigation, that we might be better off fiscally collecting the costs later since we will end up paying for less of them in gifted bitumen through the royalty regime. However, I believe that the costs of deferring the liabilities, in terms of both the incurred risk and the signal it sends to companies doing business here, is much higher than the potential savings on royalties or the potential increase in investment.
Deferring a payment is not going to appreciably increase investment – not when you are talking about lucrative, multi-billion dollar projects. Capital markets are not perfect, but they are reasonably good at tabulating the present value of future costs. For example, when Imperial Oil decided to invest $8 billion in the Kearl project, you can rest-assured that their models took careful account not just of the operating and capital costs of the mine and their oil and carbon price forecast, but also of the future reclamation expense. Think that’s not an issue for the oilsands industry? Read here, where Suncor’s Kirk Bailey, Executive VP Oil Sands talks about the value of their TRO process in, “improving our economics by moving the liability of reclamation off our books more quickly.” So, deferred payments for reclamation security will improve near-term cash flow, but they will not appreciably change the investment go/no-go decision for oilsands projects since the net present value of these costs should not be affected assuming that the end-of-mine-life liability is fully secured by either up-front or deferred payments.
There is a difference in royalty treatment with respect to when costs are incurred, because oil sands royalties have always “recognized any new environmental fees or levies as an eligible cost of doing business, and therefore deductible in determining royalties on oil sands projects.(page 12)” If the payments are incurred up front, my reading is that these payments would fall under the attributable costs of a project, and would therefore extend the period over-which the facility would be subject to the gross revenue royalty of 1-9% until costs had been fully paid back. If the costs are incurred later in the life of the project, they would still be attributable against the earned revenues of the project in the year the costs are incurred, and thus would be deductions against the higher of the same gross revenue royalty or the net revenue royalty of 25-40%. So, a cost incurred at start-up, if the escrow payments are attributable (and I hope someone from the Alberta Government or industry will clarify this) as environmental costs, would end up being paid for almost fully with bitumen that would otherwise collect a royalty. If the payments are made later, the Crown share of these costs would decrease somewhat. So, simply collecting the costs up-front is not necessarily a winning proposition for us, the resource owners.
In deferring a payment, there is always a risk that the holder of the liability will not be around or sufficiently solvent to cover the costs when the time comes. The companies operating in the oil sands are large and seemingly very stable, but the energy business is not known for long-term stability. Imagine if we were, today, trying to collect deferred liabilities from those extracting natural gas in the province and you will immediately understand what I am talking about. While I agree that it is a remote possibility, I believe that it is very important to consider the ability to enforce the escrow payments once the majority of the value has been extracted from the mine and after much of the un-funded liability has been incurred. It also behooves the government to consider how these rules would work in both environments of high and low future oil prices (see gas example above) It might do the Alberta Government well to send a representative or two to Ottawa to talk to those whose pension liabilities were to be covered by the fortunes of what was then Canada’s largest publicly traded company, Nortel. Of course, they could also take a slightly longer trip to Ecuador, and return via Washington to inquire as to how well the Canadian government would fare in trying to extract payments for environmental harm from US companies. I expect we would fare better than the Ecuadorians, but the risk is not completely absent.
So, the remaining question, and I believe it is a valid one to consider, is whether the increased risk of the deferred security payments is worth the small change in royalty treatment and the minuscule change in project bankability. My inclination is that it is not, and that the impression we give through these deferrals is that the environment is of secondary concern and may be placed on the back burner to improve the investment environment. We hear from both government and industry officials that over half of the world’s investable oil is here in the Province of Alberta. It is important that we feel that we can set reasonable conditions under which these mines will operate and show the world and the companies that wish to operate here that we are committed to the environment. If a company proposed to hire only young workers, and made a reqeust to not fund their pensions until a few years short of retirement, I don’t think we would allow them to do business in that way in our province and we would likely point to Nortel. We should not allow similar behavior on our Crown land by those extracting our most valuable resource.