CIBCEQUITY RESEARCH
May 20, 2022 Flash Research
BC Royalty Framework Announced
Program Offers Similarities To Alberta System
Our Conclusion
While royalty reviews carry uncertainty, we see the outcome of the BC
royalty review as ultimately being a fair one, and largely as expected.
Although details and formulas are still lacking, on the surface, the proposed
royalty system appears to be very similar to the Modernized Royalty
Framework announced for Alberta in 2016. Given producer capital is mobile,
having a program that is competitive to Alberta is a logical outcome,
particularly considering the extension of the Montney across both provinces.
Although there is likely to be subtle differences in operator and play-specific
royalty rates once final formulas are released, we do not expect this will
materially alter drilling economics. We see it reducing uncertainty for
investors and operators in the region, such as ARX, CNQ, KEL, OVV, SDE
and TOU.
Key Points
New framework offers similarities to Alberta. The new BC royalty
framework will employ a revenue-minus-cost system where a new well will
pay a 5% royalty until it reaches payout, after which a 5%-40% royalty rate
will apply, depending on the commodity, production rates, and prevailing
commodity price. The pre-payout rate of 5% moderates royalties during the
most productive point of a well and is a critical feature for well economics.
We surmise that shallower Montney targets (Tier 1) may benefit from the 5%
minimum initial royalty under this system versus previous (6%), while deeper
Montney targets (Tier 2) are likely to see a modest increase from 3% to 5%.
Elimination of deep well drilling credits will be somewhat offset by
capital cost recovery system. The existing system favors deeper drilling
targets, and features a minimum royalty rate of 3% on wells >1,900m in
depth (Tier 2), and 6% on Tier 1 wells (<1,900m depth), until deep well
drilling credits are exhausted. There was also greater incentive to drill to the
west of the BC royalty line (which appears to be removed) with a larger
drilling credit that accompanied this region.
New system takes effect September 1, 2024, with a transition period
starting September 1, 2022. Any well that begins drilling before September
1, 2022 will pay royalties under the current framework until 2024. Wells
drilled after September 1, 2022 will pay a 5% royalty rate for the first 12
months (8,760 production hours), after which they will transition to the
prevailing royalty rates. All wells will transition by 2026.
Unused deep well deductions to be transferred to land-healing and
emissions reduction pools. The pool is intended to support work that goes
above and beyond regulatory requirements to address cumulative impacts
and reduce emissions. The BC government had originally set out to address
indigenous concerns with respect to cumulative impacts, and this initiative is
a step toward addressing these concerns.