Janice Buckingham, Kevin Lemke, Dana Saric
Dec 9, 2015
Political and Commercial Climate in 2015
Unprecedented political, legal and market developments during 2015 posed significant challenges to the energy industry.
The extraordinary election of a New Democratic Party (NDP) majority in Alberta followed by a Liberal Party majority in Ottawa set in motion potentially significant changes in government policy affecting the energy industry, many of which are still under development. Provincially, corporations paid 2% more in income taxes immediately, and faced economic uncertainty from future royalty review and climate change initiatives. Federally, reform to the environmental assessment process and climate change regulation is expected, while promises to phase out fossil fuel subsidies, a pending moratorium on oil tanker traffic off B.C.’s North Coast and efforts to improve the duty to consult and accommodate First Nations also factor high on the federal government’s agenda. U.S. President Obama’s move to deny the presidential permit to build Keystone XL dealt a further blow to an industry whose global competitiveness requires export options.
From a market perspective, crude oil prices seesawed downward, with one month’s gains being erased by the next month’s losses. Energy companies slashed budgets, removing $31 billion from the economy. Job losses in the sector exceeded 35,000 and the “lower for longer” pricing reference became the new reality. OPEC maintained rather than curtailed production rates as Saudi Arabia ceased being the swing producer – perhaps in an attempt to slow the United States’s fracking boom and Canadian oil sands development, to create economic hardship for Russia, to secure relationships with European and Chinese buyers in a lower price environment, or some combination of these.
Significant oversupply dominated the year as onshore storage space dwindled and commercial tankers holding 100 million barrels sat anchored outside numerous ports in China, Malaysia, Indonesia and the Gulf of Mexico. Devastating terrorism attacks in Paris, mere weeks before the UN climate change conference there, added to the global pressures and uncertainty affecting the energy industry.
Key Legal Development
(a) Taxes and Royalties
In June 2015, the Alberta government passed Bill 2 – An Act to Restore Fairness in Public Revenue, which received Royal Assent on June 29, 2015. Under this Bill, effective July 1, 2015, the corporate tax rate was increased from 10% to 12%. For 2015, corporate income tax will be prorated based on the number of days in the corporation’s taxation year that are before July 1, to which the prior 10% rate will apply, and the number of days after and including July 1, to which the new 12% rate will apply. In 2016, the 12% rate will apply for the full year.
Federally, the Liberal Party platform includes a promise to phase out fossil fuel subsidies. Full details on what this means are not currently known as the platform indicates that the Department of Finance will be instructed to conduct a detailed analysis of all fossil fuel subsidies. It is estimated that the phase-out will increase federal revenue by approximately $250 million by 2018.
A significant focal point of the provincial NDP platform was a promise to review the current oil and gas royalty regime and recommend changes to “ensure a full and fair return to the people of Alberta for their energy resources.” The government has appointed a four-person advisory panel, which began its review and public consultation process in late August 2015. With the process ongoing, the nature and scope of the changes to the royalty structure are uncertain. However, the panel’s mandate is to finish its review process by December 2015, with the current structure to remain in place until the end of 2016.
The Canadian Association of Petroleum Producers (CAPP) submitted a set of 60 recommendations to the Alberta government regarding the royalty review (CAPP Submission). The CAPP Submission stressed that for Alberta to remain competitive with other jurisdictions in attracting investment, the royalty review panel and the government must consider the full cost of doing business in Alberta. In addition to royalties, this would include municipal taxes, provincial corporate taxes at the new 12% rate, mineral rights and fees, carbon pricing policies and other costs.
(b) Regulatory Reform
The previous federal Conservative government attempted to streamline the process for approval of energy projects through an overhaul of the Canadian Environmental Assessment Act. The incoming Liberal government has promised further changes to the regulatory process, which will likely include repealing many of the changes made by the Conservatives. The framework and guiding principles for these changes are to: restore oversight and thorough environmental assessments under areas of federal jurisdiction; ensure decisions are based on science and evidence, which will include consideration of upstream carbon emissions in the assessment process; ensure that decisions serve the public interest; and provide ways for interested Canadians to express their views and for experts to meaningfully participate in assessments. Based on its platform, it is clear that the Liberal government intends to pay particular attention to the role of Aboriginal peoples in the assessment process, promising to undertake a full review to ensure that the federal Crown is discharging its consultation, accommodation and consent obligations in regulatory processes.
The NDP government has stated its intent to resolve what it sees as the “conflicting mandate” of the Alberta Energy Regulator (AER) as both promoter and regulator of the energy industry. The AER was established by the provincial Progressive Conservatives to try to streamline the regulatory process by having one agency responsible for all environmental legislation and regulations. The AER is currently responsible for the Public Lands Act, the Environmental Protection and Enhancement Act and the Water Act. It is not clear what the restructured regulatory bodies would be responsible for, nor how they would interact to ensure consistency and efficiency.
(c) Climate Change
Both the Alberta NDP and federal Liberal Party have pledged to take steps to address climate change. However, policy development at both levels is in the early stages. The Liberal platform promises a collaborative approach between the federal, provincial and territorial governments to establish emissions reduction targets and ensure that the provinces receive federal funding while retaining flexibility to meet these targets through their own policies and pricing strategies.
The Alberta NDP announced a robust climate change leadership plan on November 22, 2015. It is based on the recommendations of the province’s Climate Change Advisory Panel, whose report was released concurrently with the provincial government’s press conference. Although it is unclear which aspects of the Panel’s detailed recommendations will be adopted into law, the cornerstones of the new plan are: (1) an accelerated phase-out of coal, (2) an economy-wide carbon levy, (3) an absolute cap on oil sands emissions and (4) a methane gas emissions reduction plan.
The first prong of the new strategy will be to accelerate the phase-out of coal-fired power production by 2030. In its place, natural gas-fired power production is expected to provide the base load reliability while renewable power is expected to fill two-thirds of the new capacity. The province is expected to provide limited long-term fixed price emission offset credit contracts to renewable project developers to mitigate some of the merchant power pricing risk that has historically stymied renewable project financing in Alberta. However, both natural gas and renewable power producers will have to contend with merchant power pricing risk when securing financing, and coal plant operators spurned by the new plan may refuse to make the capital investments to smoothly transition the balance of power sources in Alberta.
The second prong of the new strategy is a carbon price applicable to the wider economy. In addition to the increased carbon levy of $30 per tonne to be paid by large industrial emitters, announced in June 2015, Albertans will be subject to an economy-wide carbon tax of $20 per tonne effective January 2017, growing to $30 per tonne by January 2018. The Climate Change Advisory Panel also recommended an annual escalator of 2% more than inflation, but it is not clear whether the government will adopt that recommendation. The broader economy-wide carbon price is expected to touch 78–90% of all emissions in the province, the largest proportion in Canada. A key feature of the proposal is the pledge that all proceeds of the broader carbon tax would remain in and be put to work within provincial borders, through investment in green infrastructure (such as public transit), energy-efficiency programs, renewable energy research, development and investment (including the payment of emission offset contracts to be offered at auction for renewable power projects), and an adjustment fund. This fund would be used to help lower-income Albertans offset the cost increases of carbon pricing and to provide financial support to small businesses, First Nations and those working in coal facilities subject to the accelerated phase-out of coal-fired power production.
The third prong of the new plan is an absolute limit on oil sands emissions of 100 megatonnes (Mt) per year, with provisions for new upgrading and cogeneration. This announcement was largely unexpected and of great significance, since oil sands production in the province is currently responsible for approximately 70 Mt of annual emissions. For new projects with top-quartile or better potential emissions performance, the new treatment may provide significant advantages, but for those with high prospective emissions intensities (or significant risk of such an outcome), the policy will magnify risks and may make such projects less attractive. An absolute cap on oil sands emissions is a significant departure from the previous intensity-based cap and risks stymying the development of future oil sands projects. Given that the industry currently emits 70% of its new capped emissions allotment – and additional approved, but not yet operational, projects will contribute to such emissions – unless there are significant efficiency-based emissions reductions from existing projects, new projects will have to compete for the remaining capacity in order to come online. Companies may have incentives to seek regulatory approval for new projects before the absolute cap is reached. An absolute cap without the opportunity to buy or trade emissions capacity could also stifle the development of new projects.
As the fourth prong of the new plan, a methane gas emissions reduction strategy is intended to reduce emissions from Alberta’s oil and gas operations by 45% of 2014 levels by 2025. The details of this strategy are expected to unfold in early 2016.
(d) Transparency Legislation
In June 2015, the Extractive Sector Transparency Measures Act was proclaimed into force by the previous Conservative government in furtherance of its international anti-corruption and transparency commitments. This legislation requires extractive sector businesses operating in Canada to make public and report payments made to domestic and foreign governments in relation to the commercial development of oil, gas or minerals. For further analysis of the legislation please see the article entitled “Continuing crackdown on foreign corruption and new transparency measures.”
(e) Oil Pipeline Projects
On November 6, 2015, President Obama officially denied the presidential permit required to build the Keystone XL Pipeline Project (KXL). This decision will place greater importance on the other proposed pipeline projects to export oil from Canada: Trans Mountain Expansion Project, proposed by Kinder Morgan; Energy East Pipeline, proposed by TransCanada PipeLines; and Northern Gateway, proposed by Enbridge. Each of these projects will face uncertain regulatory regimes, as the Liberal Party has promised significant changes to the assessment and approval process for such projects. Within weeks of being elected, Prime Minister Trudeau instructed federal Transport Minister Garneau to “formalize a moratorium on crude oil traffic on British Columbia’s North Coast, working in collaboration with the Minister of Fisheries, Oceans and the Canadian Coast Guard, the Minister of Natural Resources and the Minister of Environment and Climate Change to develop an approach,” signalling another blow to Canada’s pipeline industry’s ability to export crude oil.
Both the NDP and Liberal Party expressed disappointment at President Obama’s decision and offered support for the idea that Canada’s energy resources need improved access to global markets. However, they have also been circumspect in providing support for the remaining proposed projects. The Liberal Party has stated that each of the projects will have to undergo thorough regulatory review, and declined to pre-judge the outcome of the review. However, the Liberal Party has been clear in its position regarding Northern Gateway, promising to reverse the decision of the Conservative government to approve the project, citing concerns that the review process did not adequately consult with local communities and Aboriginal peoples.
How Canada’s energy industry will weather the challenges presented by such profound political and market developments remains to be seen, but one thing is clear. Our clients are entrepreneurial, responsible leaders in an industry the world depends on, and have made unparalleled contributions to the Canadian economy. As conventional oil supplies dwindle, let’s hope that when undertaking regulatory reforms on the royalty, climate change, duty to consult, and pipeline fronts, our politicians heed CAPP’s advice: before any value can be captured from such initiatives, resources need to be developed and development is expensive. Hopefully the result of such reforms will continue to motivate energy companies to invest the billions of dollars they invest annually in the very risky economics of an industry whose geopolitical and economic volatility created more barriers than opportunities in 2015.