CanPol - Alberta edition

[KrazyHorse]

Flubber, how would the government get screwed? There would be an auction. That would be on a single dimension (this is what I meant by sliding scale). That way bids would be strictly comparable.

In other words, auction off the rights to field F according to X*10 million dollars + X% royalties.

(or you could get a little more complex and do f(X)% where f(X) is some monotonic increasing function of X)

The problem with setting a fixed percentage and then only auctioning on cash is that you might be introducing a very large amount of risk from the company's perspective (say, the company thinks it can reasonably extract at 50% of market cost and the government takes 25%; the company's exposure to market and cost swings is now leveraged by a factor of two).

[Flubber]

If you think that's a joke, look at the upfront capital costs to set up a 25,000 barrel a day operation in Alberta vs with conventional oil.

We're talking orders of magnitude.

Such a massive investment represents tremendous risk alone. You add in confounding variables such as political instability, pending tree-hugger legislation, and fluctuating royalty rates and it's very, very risky.

Asher has this right-- The models add in all kinds of risk. In most plays the biggest of these is "exploration risk"-- ie the risk that there will not be commercial or any hydrocarbons when you drill.

In oilsands they have generally drilled enough to 'know" the size of their resource or at least have a very good p10 , p90 range of the resource size. That leaves oil price risk, construction cost risks and a wide gamut of political risksincluding royalties and carbon taxes and new environmental legislation and and and . . .

NYE you are aware that for a lot of oilsands projects the simple break-even point required prices (weighted, life of project of course in the 70s and 80s)-- So to say there is little risk or no risk is ludicrous

[KrazyHorse]

I don't think I'm going to get much exposure to commodities products, which is unfortunate. I find them interesting. I think I'll be mostly on structured and fixed income stuff.

[Flubber]

Flubber, how would the government get screwed? There would be an auction. That would be on a single dimension (this is what I meant by sliding scale). That way bids would be strictly comparable.

In other words, auction off the rights to field F according to X*10 million dollars + X% royalties.

(or you could get a little more complex and do f(X)% where f(X) is some monotonic increasing function of X)

The problem with setting a fixed percentage and then only auctioning on cash is that you might be introducing a very large amount of risk from the company's perspective (say, the company thinks it can reasonably extract at 50% of market cost and the government takes 25%; the company's exposure to market and cost swings is now leveraged by a factor of two).

I do not trust government to appropriately weight cash now versus royalties.

I can just envision plays where someone gets a huge field for 200 million plus a 2% royalty because they overweight cash .. Or alternatively they overweight royalties and someone picks up big leases for no/little cash but the project can never move ahead because they bid a royalty that isn't economic. I see too many chances for abuses, stalled projects or government mistakes.

A 25% royalty is reasonably fair. In offshore newfoundland they actually add in an additional royalty once the porject has returns to the owners of say 30% and I see that as fair as well as long as its known before they do their investing. 1% before payout to me is 'fair" as well. Think about it. You have a resource that makes you no money until someone spends billions. Isn't it fair that they get their billions back before you start sharing in a big way in the revenue produced?

I don't think I explained that well but I have to run. My bottom line is that I think bidding royalties could be a very bad idea. Perhaps government could weight things well but I have little confidence of that

[KrazyHorse]

I do not trust government to appropriately weight cash now versus royalties.

Yet you trust them to set a fixed royalty rate over heterogeneous fields?

By the way, I don't find an overweighted cash bid a problem. The other way is a problem because it's the equivalent of introducing a large tax wedge, which has a large deadweight cost.

If there was no political risk, my preference would be for cash only bids. There are no agency problems in that scenario. Unfortunately, when the gov't gets its money up-front there is the temptation to make a second grab at the pie (as they already have!) which means that companies will charge a larger implicit risk premium.

25% might be fine for some reasonably easy to extract fields, but for marginal fields it might stop there from being any bids at all, because (risk-weighted) extraction costs exceed 75% of market price. And again, even for those fields which do attract bids, the 25% might represent enough of a tax wedge to seriously affect production.

[notyoueither]

Yes, that's correct. Alberta broke that contract which was due to expire in 2016 anyway. This was politically expedient for a moron populace who think now they'll just get more money, it was severely damaging to Alberta's long-term investment potential because you can't trust the agreements you make with the government of Alberta now.

No contracts were broken. Stelmach asked the older projects to renegotiate. They did.

There is a lot unspoken that would make Syncrude and Suncor want to renegotiate, like they could cooperate with this guy or take their chances with whatever other party comes to power. They face that uncertainty every time we have an election.

[KrazyHorse]

By the way, Flubber, I have no idea why you're on about "fair". This is a competitive bidding process. There is no "fair". There is the structure which the government sets up to extract the most value for the people of Alberta from their depletable natural resources, and there is the competitively determined price paid for those resources. Fairness is a red herring.

[KrazyHorse]

Yeah, yeah, NYE. The companies renegotiated out of the goodness of their heart. Not because they had a gun to their head.

Do you really think they care how the government expropriated them? They know that it happened, and so does everybody else who's not intent on denying it. This affects all future contracts with the government of Alberta, and THIS is the only thing that matters. Not fairness or legality.

[Jon Miller]

I have generally thought that cash up front trades have genearlly been disadvantageous for the government. Generally it is done by politicians who just want to sell for ideological (or paybacks to their backers) or to stay in power reasons, and this causes the selling now to be overvalued, rather than waiting and getting a better offer.

JM

[Asher]

No contracts were broken. Stelmach asked the older projects to renegotiate. They did.

Are you kidding me?

Why the **** would companies give up billions more dollars than they need to? They weren't "asked" to renegotiate, they had to. Think about it.

It was a bush-league move reminiscent of the kind of names you throw around as the alternatives for people dealing with Alberta.

You've got your head in the sand here.

[KrazyHorse]

I have generally thought that cash up front trades have genearlly been disadvantageous for the government. Generally it is done by politicians who just want to sell for ideological (or paybacks to their backers) or to stay in power reasons, and this causes the selling now to be overvalued, rather than waiting and getting a better offer.

JM

Jon, there are a few things to consider:

1) If there is a reasonably competitive market, the government will not end up leaving that much cash on the table.

2) Your perceptions may be swayed by highly publicised privatizations which ended up working out well for the buyer, while the less publicized cases of the purchaser losing money on the bargain aren't as prominently detailed. Also, in a lot of cases the private entity ends up throwing a lot of cash and organizational capital to improve whatever it purchases, which makes it difficult to evaluate even ex-post what the true initial value was.

[notyoueither]

Are you ****ing serious?

The royalty rate is a percentage. The raw price has nothing to do with it.

It does now. The rate scales up with price.

Also, natural gas is dying. The price of gas has a lot to do with it.

This is total bull****. There was a distinct lack of oil-business representatives that were consulted, part of the reason they're so up in arms.

Name me one other country abroad that retroactively changed royalty rates on companies after they've spent hundreds of billions of dollars to invest in that region?

Russia, Venezuala, Nigeria...

This is not uncommon, Asher.

There's no uncertainty??? How the hell can you honestly think that?

Rhetoric. When arguing with KH late at night with much beer it comes easy.

[notyoueither]

Are you kidding me?

Why the **** would companies give up billions more dollars than they need to? They weren't "asked" to renegotiate, they had to. Think about it.

It was a bush-league move reminiscent of the kind of names you throw around as the alternatives for people dealing with Alberta.

You've got your head in the sand here.

Asher, Stelmach asked. They agreed. It's quite simple.

Why did they agree? That's a good question. I agree it is because they were under the gun in public debate. I gather their hopes are that by making a reasonable deal with Stelmach they may avoid a future confrontation when a less oil freindly government is in power.

[Asher]

Russia, Venezuala, Nigeria...

This is not uncommon, Asher.

Cite details

[Asher]

Asher, Stelmach asked. They agreed. It's quite simple.

Why did they agree? That's a good question. I agree it is because they were under the gun in public debate. I gather their hopes are that by making a reasonable deal with Stelmach they may avoid a future confrontation when a less oil freindly government is in power.

You must be incredibly naive if you think they just did this for good PR. Amazing.

Here's a hint: If they did it for just PR, they wouldn't have their lawyers arguing and whining about royalties like they do.