Syncrude's oil sands expansion loses credits

High oil price affects unfinished project

By PATRICK BRETHOUR
Friday, August 19, 2005

CALGARY -- Syncrude Canada Ltd.'s royalty credits from its newest expansion will be exhausted -- months before the latest project even begins operating -- as the massive cash flows from soaring crude prices push the oil sands operation into a higher royalty regime.
Canadian Oil Sands Trust, Syncrude's biggest owner, said yesterday that it expects to begin paying higher royalties in early 2006, perhaps as early as the first quarter. "We're generating so much cash, we're that much more profitable, much more quickly than we expected to be," said trust spokeswoman Siren Fisekci.
And that means that Syncrude will have depleted the royalty credits -- totalling $8.1-billion -- from its UE-1 project several months before it begins using the expanded facilities.
Under a provincial scheme designed to boost oil sands investment, any such project pays a reduced royalty rate of 1 per cent of gross revenues until it has earned back its initial capital investment. Once that happens, royalties jump to 25 per cent of net revenues, allowing companies to first deduct operating and on-going capital expenses.
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The purpose of those rules is to reduce the financial risk of megaprojects, which cost billions, by increasing the cash flow and profits in the early years of production. The royalty regime allows a company such as Syncrude to replenish its pool of credits through the expansion of existing projects, although add-ons that are deemed to be separate cannot be used to defray royalty payments from earlier operations.
Ms. Fisekci said Canadian Oil Sands had not yet calculated the per-barrel impact of the higher royalty rates or their total cost. But officials with Alberta Energy said the changeover would increase a project's royalties by a factor of at least eight, and perhaps as much as 20-fold.
Canadian Oil Sands first flagged the possibility of imminent higher royalty payments in April, when president and chief executive officer Marcel Coutu said Syncrude could begin paying higher levies in the latter part of next year.
But that prediction depended on average crude price of $45 (U.S.) a barrel this year. Prices have been far higher than that for months, with oil closing at $63.27 a barrel yesterday on the New York Mercantile Exchange.
The shift to higher royalty rates for Syncrude has come quickly, even though the UE-1 project was massively over budget, costing close to double the original estimate. Yet, the additional expenditures do mean that Syncrude will see its production rising with commodity prices lingering near record levels.
Syncrude will have lots of company when it switches over to higher royalty. Alberta Energy said 26 of 55 oil sands projects are paying the higher rates. Suncor Energy Inc. already pays the higher rate on part of its operations, a result of the province deciding that its Firebag expansion was a standalone project.
There is a similar dynamic at play in the conventional side of the oil and gas sector, where companies are close to depleting their tax pools, which reduce their corporate tax bill. Greg Stringham, a vice-president at the Canadian Association of Petroleum Producers, said the industry as a whole is close to entering taxable status, although individual companies may still have some tax shelters.