Budget Bulletin: Offshore Royalties Increasing

Offshore Royalties Increasing

• Royalties to reach $14 million in 2001-02.
• $1 billion committed to exploration.

Relatively strong North American natural gas prices are setting the stage for significant increases in royalty revenues for the Province of Nova Scotia. Royalty payments from the offshore are estimated to reach $14 million in budget 2001-02 compared to the original budget 2000-01 estimate of $6 million. The royalty rate on the Sable Offshore Energy Project (SOEP) is fixed at 1 per cent of gross revenues for the first three years of the project (2000, 2001 and 2002). The rate cap is removed at the end of 2002.

The government expects project owners to have recovered a significant portion of their investment when the rate cap is removed. The minimum royalty payment rate at that time will be 2 per cent of gross revenues. The actual rate depends upon how much investment recovery has occurred.

Once the investment has been recovered and a reasonable rate of return is achieved, royalty rates switch from being calculated on gross revenues to being calculated on net revenues. Net revenues are the cash flow from a project less the direct expenses.

On the Sable Project, the minimum net revenue royalty rate is 30 per cent topping out at 35 per cent. Based upon the assumption of strong natural gas prices in the short term, net revenue royalties are forecast to begin as early as 2005 or 2006. Current projections show yearly royalty revenues from SOEP to peak at around $300 million annually. SOEP offshore royalties will be a significant revenue generator for the province for the next 20 years.

The current long-term projection of $2.5 billion in royalties from SOEP is based upon the assumption that natural gas prices will fall to lower levels in 2003. This projection is based upon a long-term average natural gas price of $2.50 US/MMbtu netback at Goldboro (i.e., sales price before transportation tolls) in constant 1995 dollars.

Future offshore energy projects in Nova Scotia fall under the province’s Generic Royalty Regime. This regime is designed to encourage risk and exploration in areas and depths where much less is known about hydrocarbon potential. The first project in such a new high-risk area has a cap on the net revenues at 20 per cent. Subsequent projects in these and other low-risk areas would see net royalties rise to 35 per cent.

Prior to the establishment of the generic regime incentives, exploration commitments offshore Nova Scotia stood at approximately $200 million. Since the generic royalty regime was put in place, Nova Scotia has seen an additional $800 million committed to exploration activity in the offshore, for a current total of more than $1 billion on 50 exploration blocks. Forty exploration wells at a cost of $25 to $50 million each are expected to be drilled over the next four years.

The first offshore project under this generic royalty regime is expected to be PanCanadian’s billion-dollar, one-trillion-cubic- feet Deep Panuke Project. Nova Scotia is expecting additional royalty revenue from this project, which is scheduled to commence production in 2005. Once a development plan is filed (fall of 2001), the province will be in a position to project royalty revenues for this project.

Based upon the fact that the Deep Panuke exploration program took place in a previously unexplored geological structure, the province designated this area as high-risk for royalty purposes before exploration took place.

Royalty revenue projections for the Department of Finance are prepared by the Nova Scotia Petroleum Directorate based upon NYMEX futures market prices, royalty estimates, historic movement of the commodity prices, actual sales proceeds, and terms of sale contracts. Royalty projections for budget 2001-02 are based upon the following assumptions: above-average natural gas prices for 2001 ($4.50 US) and lower, but still above-average prices in 2002 ($3.00 US). The average daily production rate for 2001-02 is assumed to be 520 mmcf/d.

NOTE: For other 2001-02 budget information, visit the Department of Finance Web site at www.gov.ns.ca/finance .