New oil and gas royalty system ending inefficient subsidies

Royalty fee

When oil and gas resources are produced in British Columbia, the province charges producers a royalty or freehold production tax on behalf of British Columbians.

In the case of public resources, a royalty is collected from producers by the Province. Most of the natural gas and oil in British Columbia is state owned and managed by the province. The province licenses oil and gas companies to exploit these resources and collects royalties from the production of oil and natural gas on these lands. Producers who develop resources on freehold land pay a freehold production tax. Both royalties and taxes on freehold production are covered by the same legislation, and the two are commonly referred to as royalties.

Money from oil and gas royalties and freehold production taxes is used to fund vital public services, like education and health care, and some is shared with First Nations communities around the world. under revenue-sharing agreements.

Royalty deductions

British Columbia’s current royalty system was established almost three decades ago. Royalty deductions reduce the royalties payable to the Crown when the production takes place. The Deep Well Royalty Program was established in 2003 and was initially intended to offset the higher drilling and completion costs incurred by wells considered particularly deep. The reduction program is sometimes referred to as fossil fuel subsidies.

The way natural gas is produced has changed significantly over the past three decades, as have market conditions, drilling technology and costs, and global concerns about the need to address climate change.

Royalty Review

On October 7, 2021, the Ministry of Energy, Mines and Low Carbon Innovation launched a comprehensive review of British Columbia’s decades-old oil and gas royalty system to ensure it would be modernized, aligned with the government’s climate goals and provide a fair return for British Columbians.

As part of the review, the province released an independent assessment of British Columbia’s current royalty system, conducted by Nancy Olewiler, director and professor in Simon Fraser University’s School of Public Policy, and Jennifer Winter, associate professor of economics and scientific director of the energy and environmental policy research division at the University of Calgary’s school of public policy.

The independent evaluation found that BC’s outdated royalty system is broken and does not contribute to government and societal goals.

On November 10, 2021, the Province released the Royalty Review Discussion Paper and launched an extensive consultation process on the design of a new oil and gas royalty system.

The majority of British Columbians who participated in the public engagement on the oil and gas royalty review expressed support for a revamped royalty system.

On May 19, 2022, the province introduced a new oil and gas royalty system that puts the interests of British Columbians first and eliminates outdated and inefficient fossil fuel subsidies.

A transitional system will come into effect on September 1, 2022, with a new royalty framework expected to be in place from September 1, 2024.

New royalty framework

The new framework will be based on a revenue minus cost royalty system. It will use price-sensitive royalty rates designed to achieve a 50% return of benefits on the public resource after accounting for costs. Revenue minus cost royalty systems are globally recognized for maximizing economic value and minimizing distortions.

British Columbia’s new royalty framework will use a 5% royalty rate during the prepayment period (i.e. from initial production until revenues from a well exceed full cost capital for drilling and completion). Actual development costs (drilling and completion) will be used to determine the cost of each well. Producers will submit these costs to the government after a well begins production. Cost submissions will be subject to verification.

Once revenues from a well exceed capital costs, a price-sensitive royalty rate will apply (between 5% and 40%). The specific range of price sensitivity will vary by commodity type.

The minimum royalty payable will be 5% of monthly production.

The government intends to implement this system on September 1, 2024.

Transition – new wells

Effective September 1, 2022, new wells (i.e., those that begin drilling on or after this date) will not be eligible to qualify for the old deep well royalty program, the Marginal Well Royalty, the Ultramarginal Royalty Program, the Low Productivity Royalty Program or the Clean Growth Infrastructure Royalty Programs.

Wells drilled on or after September 1, 2022 will pay a 5% royalty rate for the equivalent of the first 12 months of production (8,760 hours of production). At the end of this period, these wells will pay the prevailing price sensitive royalty rates.

Transition – existing wells

Current wells and all wells that begin drilling before September 1, 2022 will pay royalties based on the current royalty framework until September 1, 2024.

Effective September 1, 2024, these wells will transition to the rules of the new royalty framework. After that date, these wells will no longer be eligible for rate reductions under the Marginal Well Royalty program, the Ultramarginal Royalty program, the Low Productivity Royalty program or the Clean Growth Infrastructure Royalty programs.

Deep wells with unused deep well deductions will be able to continue to use those deductions to reduce royalties due until September 1, 2026.

Beginning in early 2023, producers will periodically have the opportunity to reuse unused deep well deductions by transferring them to a land repair and emissions reduction pool. These pooled deductions are discussed below.

Effective September 1, 2026, producers will no longer be eligible to reduce Deep Well Royalties using Deep Well Deductions and no further transfer of unused Deep Well Deductions to the Land Repair and Reduction Pool. of a producer’s broadcasts will only be permitted.

Calculation of costs as part of revenue minus cost

A revenue-less-cost royalty framework compares the cost of bringing a well into production with the revenue earned from that well to determine when price-sensitive royalty rates should apply. A specific cost policy is being developed which will take into account costs related to collection and processing, as well as drilling and completion.

The new royalty framework will seek to use actual costs when accounting for drilling and completion costs. Producers will be required to submit cost data within six months of the start of production from a new well. The methodology for determining which costs are eligible to be included in establishing these costs will be aligned with the Canada Revenue Agency’s existing tax standard – Development expenditures in Canada including actual costs and most expenditures under the surface that are not removable or transferable to another site, but are adapted to the British Columbia context.

This process is intended to be transparent and results in a fair set of policies categorizing drilling and completion amounts in the royalty system. Additional dialogue with oil and gas stakeholders will take place in the summer of 2022 to further develop and define the allowable cost policy and the amounts contained in the drilling and completion amount.

Land Remediation and Emission Reduction Pools

Producers will have the option to transfer unused deep well deductions to a Land Healing and Emissions Reduction Pool by September 1, 2026. Multiple “transfer windows” will be provided between early 2023 and September 1, 2026, to allow producers to allocate deep well deductions to the land repair and emissions reduction pool. Producers will have the option of allocating some or all of the deep well deductions associated with a well to their pool.

Once allocated to a producer’s pool, royalty deductions will not be available to reduce royalties on the well to which they were originally associated. Transfers between producer pools will only be permitted in circumstances related to business acquisitions.

The pool is intended to support work that goes beyond regulatory requirements to reduce emissions or cumulative impacts on the territory. The final scope of activities supported by the pool will be developed over the coming months based on discussions within government, with First Nations in northeastern British Columbia, environmental groups, industry and others. stakeholders.

Next steps

The ministry will issue annual calls for projects to producers wishing to undertake work to benefit from deductions from their land remediation and emissions reduction pool. Producers will be able to reduce royalties equal to approved project expenses under these annual calls up to the value of the deductions they have in their pool.