By Darren Campbell -- The current royalty regime and a lack of revenue sharing leaves NWT governments with little to show from oil and gas development. Their leaders want to change that. All they need is the federal government to play along.

Pius Rolheiser remembers the first time he saw anyone try to link the construction of the Mackenzie Gas Project with the expansion of oil sands production in Northern Alberta’s Athabasca region. It was October of 2005 and the Sierra Club of Canada had just released an open letter to Lee Raymond, then chairman and CEO of ExxonMobil Corp., majority shareholder of the MGP’s lead proponent, Imperial Oil Ltd. In the letter the Sierra Club asked Raymond to abandon the MGP in favour of advancing an Alaska natural gas pipeline.

The province of Alberta is one fat financial cat these days. For that it can thank, largely, the massive royalties it derives from its vast stores of oil and natural gas. With prices for both commodities hitting record highs the past couple of years, the province is richer than ever. Projected royalties from oil and gas in Alberta for the 2005-2006 fiscal year are estimated to be approximately $11.5-billion.

That’s a number Northwest Territories Premier Joe Handley must dream about at night. To run his territory of approximately 40,000 people, the premier’s government tabled a budget in February of $1.07-billion and he says the government is barely getting by on that total. “We’re probably 75 years behind most jurisdictions,” Handley says. “We don’t have roads to most of our communities. If I look at municipal infrastructure, it’s almost the same situation. We’re still dependant on some pretty basic ways of doing things.”

Which is why the premier views the proposed $7.5-billion Mackenze Gas Project as the territory’s potential economic saviour. If approved and built, the 1,200-kilometre natural gas pipeline will industrialize the NWT’s Mackenzie Valley as oil and gas companies explore for and produce the 82 trillion cubic feet of natural gas that is potentially waiting to be discovered onshore and offshore in the NWT. A pipeline with that much gas flowing through it translates into resource royalties for governments – hundreds and hundreds of millions of dollars worth during the pipeline’s estimated 25-to 30-year lifespan. Those dollars could then be invested in many things – roads, schools, health care and education – to improve the lives of NWT residents.

The problem is, unlike the province of Alberta, the NWT doesn’t manage its oil and gas resources. It also doesn’t garner the royalties from them. The federal government gets the money and the NWT doesn’t get a red cent. So with the NWT on the cusp of increased petroleum development thanks to the MGP, Handley is desperate to get a new resource revenue sharing deal negotiated before the mega-project takes place. Without a deal – and the resource royalties that would flow from it to NWT governments – the territory’s residents won’t truly benefit from its oil and gas resources. They need the federal government to play along.

There are basically five ways governments earn revenues from the oil and gas they own. The revenues can come from corporate taxes, property taxes, land sales, pipeline tariffs and royalties. But royalties are the big game in that group for the NWT. It’s the revenue stream that will create the biggest financial returns on those resources. Royalties are payments made by producers to owners for the right to develop and produce a resource. Royalty structures vary from place to place in Canada. In the NWT they are set out in the federal Canadian Petroleum Resources Act, which sets out royalties for offshore and frontier resources.

This royalty structure combines a low gross royalty in the early years of a project and a high net profits royalty when the capital invested by the producer, plus current costs, have been paid off. Pre-payout royalties are 1 percent of gross revenues for the first 18 months and rises by 1 percent every 18 months thereafter until the rate gets to 5 percent. Once the project has been paid out, royalties are the greater of 30 percent before-tax profits or 5 percent of gross revenues.

With any royalty structure there is a tricky balance governments must strike. The balance is having a structure that isn’t so punitive that companies decide to invest elsewhere but also isn’t so generous that it doesn’t garner the government fair value for the resources. That’s why oil and gas royalties are always a hot topic. In the NWT it is no different with the current royalty structure having its share of supporters and critics.

As the lead proponent of the MGP and majority owner and operator of the Norman Wells oilfield, Imperial Oil Ltd. knows the NWT’s royalty regime intimately. And it’s okay with it, according to Imperial Oil spokesperson Pius Rolheiser. “For the MGP the royalty structure in place is appropriate for the project,” he says of the CPRA regime. “It’s similar to the royalty structure for larger projects like the oil sands and offshore on the East Coast.”

Rolheiser says what Imperial Oil also likes about the regime are the low royalty rates it imposes on producers in the early years of their projects. Because the NWT is so large and so lacking in infrastructure like roads and pipelines, any exploration and development here requires massive investments by companies compared to what they would have to spend in mature basins in the south. Those large investments mean there is a period of years where the companies and government don’t see any revenue from the project because it’s being paid off.

The CPRA rates allow companies to pay off their investment before any serious royalties kick in. By reducing the risk to industry this way, some investment in the NWT’s frontier lands does occur. In 2004, according to the Department of Indian and Northern Affairs Canada, which is responsible for NWT oil and gas development, 19 new wells were drilled in the NWT and there were seven producing oil and gas fields. Royalties paid from the NWT’s oil and gas production was approximately $20.6-million. That’s not much exploration, production or royalties, but Handley still thinks it’s the right regime for the NWT.

“If we were to charge them a full royalty from day one, I’m afraid industry would take their money and do business elsewhere, so I like the formula,” Handley says. “I know there is a lot of hype that the rates are too low but that’s mainly from people who haven’t figured out how the formula works yet.”

The Western Arctic’s new member of Parliament, Dennis Bevington, thinks he knows how the CPRA formula works and he’s no fan of it. He says the percentage of royalties the government takes in should go up as prices go up, and go down if prices drop. And he argues that allowing companies to pay little until project payout doesn’t help Northern governments deal with the immediate impacts caused by that development. “It doesn’t deliver resources to government in a timely fashion to deal with the projects,” Bevington says. “There isn’t going to be much return to government for a number of years and at the same time the costs of development for government – the infrastructure, the socio-economic impacts of development – are when developments are occurring.”

Changing that royalty structure might be difficult. The federal government still seems content to keep it as is. “The advice I have received is the federal royalty regime is competitive and that it addresses the long lead times and high costs of developing in the North,” says Jim Prentice, the minister for INAC.

That situation could change if a devolution deal to transfer responsibilities currently administered by the federal government to NWT public and aboriginal governments can be reached. Those negotiations are ongoing but the NWT public government would likely take on oil and gas management if a deal is ever struck. But some people question whether it hasn’t already bartered away that right to change the existing royalty regime thanks to a “letter of comfort” sent to the MGP’s five proponents on Nov. 22, 2005. The letter, signed by Handley and the NWT’s minister of finance, Floyd Roland, promises the proponents that if devolution happens, the NWT government will maintain a royalty regime for the three anchor fields of the MGP that is currently defined in the CPRA.

Six months after the letter was sent Bill Braden still gets fired up talking about it. Braden, a member of the NWT’s legislative assembly from Yellowknife, says the letter is bad news for future NWT governments. He says Handley overstepped his authority in the letter by speaking for aboriginal governments on the area of taxation. Worse, the premier may have shackled future governments to an outdated royalty structure.

“If for any reason the territorial or an aboriginal government wants to do something that may be counter to this letter, the pipeline guys can wave it around and say, ‘Just a minute, in November 2005 Joe Handley and Floyd Roland said this. Why are you guys changing it?’” Braden says. “It sets a threshold and if a future government is going to change its position relative to what the letter said, it’s going to have some explaining to do.”

Handley counters Braden’s criticisms by saying the letter isn’t legally binding on future governments. He adds the letter simply gives the MGP proponents and the rest of the industry some assurance the NWT government won’t go crazy increasing the royalty regime or taxes if it does take over the management of oil and gas resources after devolution. “It tells them, ‘We’re going to be fair to you. We’re going to be reasonable to you. We’re not going to target you. Don’t be afraid to spend your $7-billion’,” Handley says.

Which is all well and good for companies like Imperial Oil. They’ve received their assurances. The problem is NWT governments don’t have theirs yet. As long as the federal government continues to reap all the revenues from oil and gas development in the NWT, debates over letters of comfort or royalty rates don’t mean much. And that’s why for leaders like Handley getting a resource revenue sharing deal with the federal government looms even larger than striking a devolution deal. After all, what good is taking on new responsibilities without having the money to pay for them?

The deal has been in the works a while. Negotiations on a resource revenue sharing deal between the NWT and the federal government have been going on since 1989. But now Handley is talking about getting a deal done within six to eight months.

And while the aboriginal governments at the table might have different ideas, Handley sees a fair resource revenue sharing deal being 60 percent going to Northern governments and 40 percent to the federal government – with no claw back on the federal transfer payments it gets to help fund the NWT government. “That’s been the general concept and that is doable as well with aboriginal governments,” Handley says. “Of course, everybody is going to negotiate to get as much as they want in the end.”

The previous federal government led by the Liberal Party didn’t seem to be in a hurry to negotiate anything. But in the Jan. 24 federal election the Conservative Party bounced the Liberals out of office. Although the NWT didn’t elect a Conservative to office (Bevington is from the New Democratic Party) it appears the cabinet isn’t holding that against NWT residents. Prentice says his party, in principle, is supportive of resource revenue sharing. But the new INAC minister isn’t commenting on what the split – 60/40 or otherwise – might be. “That’s the position Premier Handley has put forward but I’m not going to get into responding to that,” Prentice says. “There will be very detailed discussions with all of the participants at the table and there is a lot of work to be done yet.... The devil is in the details.”

One detail that isn’t lost on politicians like Handley, Bevington or Braden is that without a fair share of the future resource royalties from oil and gas development, NWT governments will be in rougher shape to dole out programs and services than they are now. The MGP, if it’s built, will place added pressures on the territory’s few roads, its hospitals and its schools. The territory’s governments are going to need additional revenues to meet those needs and prepare the economy for the day when the oil and gas runs out. The NWT might not be in line for any $11.5-billion royalty paydays like Alberta expects to see this year, but with the untapped oil and gas it has, royalties are bound to rise substantially and NWT governments want a piece.

“The last thing we want is to have the gas pumped out of the territory, the oil pumped out and we’ve had no ability to generate a new economy,” Handley says. “We just can’t end up there. Every year we go without a resource revenue sharing arrangement pushes us closer to that type of situation.”