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“Unintended Consequences of Alberta’s New Royalty Framework” Mr. Gordon Stollery Board of Directors Highpine Oil & Gas Limited Tuesday, April 15, 2008.

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Presentation on theme: "“Unintended Consequences of Alberta’s New Royalty Framework” Mr. Gordon Stollery Board of Directors Highpine Oil & Gas Limited Tuesday, April 15, 2008."— Presentation transcript:

1 “Unintended Consequences of Alberta’s New Royalty Framework” Mr. Gordon Stollery Board of Directors Highpine Oil & Gas Limited Tuesday, April 15,

2 Unintended consequences are outcomes that are not (or not limited to) what is intended in a particular situation. The unintended results may be foreseen or unforeseen, but they should be the logical or likely results of the action Definition 2

3 $80/bbl vs. Oil Rate 3

4 New Royalty Framework (“NRF”) Summary  THE PROPOSED NEW ROYALTY FRAMEWORK WILL UNINTENTIONALLY HURT ALBERTA (PUBLIC AND PRIVATE) BASED OIL & GAS COMPANIES, EMPLOYEES AND SERVICE PROVIDERS These Companies drill 60% of the NEW EXPLORATION wells in the Province  THE PUBLIC ARE SYMPATHETIC TO THE QUESTION – “WOULD MORE BE FAIR?” The Public doesn’t realize “BIG OIL” earns vast amounts from their overseas operations where royalties are higher but the assets are significantly larger – Alberta’s average well is only 18 B/D, versus Norway at 6,000 B/D and Alaska at 600 B/D – Alberta’s Average Oil Pool is 0.5% of the Average World Pool 4

5 New Royalty Framework (“NRF”) Summary  THE PROPOSED ROYALTY PLAN IS NOT A “20%” INCREASE Natural Gas – for a modest well producing 600 MCF/D, the royalty rate increases from 30% to 50% = “66 2/3% increase” Oil – Depending on the size of the well, under the NRF the royalty rate increases from approximately 26% to 50% = “approximately 100% increase”  FIRST ALBERTA LAND SALE of 2008 WAS $25 MILLION COMPARED TO $78.5 MILLION IN 2007 Yet Saskatchewan and B.C. saw substantial increases 5

6 New Royalty Framework (“NRF”) Summary  CANADIAN OIL & GAS COMPANIES HAVE SEEN THEIR EQUITY PRICES FALL SINCE THE ANNOUNCEMENT There are only nominal amounts of new equity coming into Alberta financings. Over the last 3 years only 27% of capital investment for Canadian independent oil & gas companies has been from cash flow – the balance were funds from new equity funding (46%) and debt (27%). With the NRF, new equity and bank borrowings will be a scarce commodity. There will be major cut-backs in activity which will affect hundreds of small businesses, shops, hotels, restaurants in every community.  ECONOMICS – AT $80 PER BARREL Companies are earning, before Federal and Provincial Income Tax, approximately $37.50 netback per bbl for light oil. The new royalty rates would reduce the netbacks to approximately $20.50 per barrel. But, the averaging Finding & Development Cost equals approximately $20-25 per barrel. 6

7 New Royalty Framework (“NRF”) Summary  THE GOVERNMENT SHOULD GRANDFATHER EXISTING WELLS Companies require the cash flow to re-invest. Otherwise, capital will not be available to maintain existing production and then overall royalty income to the Province will actually decline.  CROWN LAND AGREEMENTS Any company that purchased land leases at the Alberta Crown Sales last year or the year before assumed certain in place economic parameters. Now the Return on Investment (R.O.I.) has been drastically reduced – Companies will now state, “We want our LAND MONEY BACK”. 7

8 Unintended Consequences of the NRF Penalizes junior exploration companies Royalties on high risk/high rate wells double under NRF, rendering these projects uneconomic Canadian junior explorers drill 60% of the new exploration wells in the province High rate oil wells pay 60% of the conventional oil royalties Enhanced Oil Recovery (“EOR”) projects on existing wells are discouraged Cashflow, investor confidence and investment capital lost and bank lines reduced Juniors do not fund themselves the same way as major oil companies or utilities – i.e. 70/30; Debt/Equity Juniors over the last 3 years have been funded as follows: 46% equity, 27% debt, 27% cash flow Anticipate reduction in government revenues of $400 million estimated over the next five years Reduced investment activity means lower production base High risk/high rate wells, which pay 60% of the current royalties, will not be drilled The proposed NRF will result in an immediate reduction in cash flow, investment capital, drilling and production, resulting in Alberta actually receiving LESS royalties by mid

9 Land Sales Lowest land sale bonus paid since

10 10 Cost Escalation is Real ! Costs have risen dramatically in a very short time period Economic comparisons and studies have failed to keep pace with relevant costs Alberta royalty framework must provide a return on real costs

11 Unintended Consequences: Signs of Domino Effect Juniors Require and Reinvest Capital Alberta Growth Engine Capital Spending Cashflow 30% New Investors 60% Banks 10% NRF capital concerns Major loss of cash flow No equity available for investment Reduced bank lines With lack of external and internal funding, capital budgets being cut and overall oil field activity will drop Uneconomic = No investment = No activity = Royalty Shortfall $ millions Dramatic capital reduction 11

12 Unintended Consequences: Signs of Domino Effect Uneconomic = No Investment = No Activity = Royalty Shortfall Drilling rig utilization 35% below last year Since the AARP report was released the average share price of a cross section of Non Alberta Oil & Gas Companies has risen approximately 48% and the average price of a number of Alberta based Oil & Gas Companies has declined by 17%, (see graph next page) First Alberta land sale of 2008 dropped to $25 million from $78.5 million a year ago – Daily Oil Bulletin Saskatchewan and B.C. land sale revenue and activity increasing Dramatic capital reduction 12

13 Investors Have Sold & Walked Away From Alberta Focused Companies Comparison of AB/SK focused Junior Oil & Gas Company share price performance following AARP announcements SEP 18/07 AARP Report Released OCT 24/07 Government Decision Announced on AARP Report Released CPG.UN, PRY.A, PBG ACN, WAV.A, GO.A, HPX, KCO, WTL Average Share Price of Non-Alberta Focused Oil and Gas Companies UP 48% Average Share Price of Alberta Focused Oil and Gas Companies DOWN 17% 13

14 Sources of External Capital have Disappeared Therefore Capital Expenditures in Excess of Cash Flow Will Cease Junior Canadian Oil companies have spent over 3x their internal cash flow over the past 3 years The capital in excess of cash flow is mostly sourced external to Alberta and has dried up With the lack of external funding, capital budgets will be cut and overall oilfield activity will drop substantially For every dollar spent by the oil business in Alberta, $4.60 dollars flow to the general economy* *R. Mansell – University of Calgary 14

15 Economic Returns do not justify the costs under the NRF Canadian junior explorers have posted low or negative net earnings even at high oil prices as costs in the Alberta basin escalate and reserve sizes decrease Finding & development costs are averaging approximately $20/barrel of oil equivalent, (BOE), as verified by National Instrument compliance requirements Another calculation is depletion, depreciation and accretion expenses (DD&A) which are an approximation of Finding and Development costs. These expenses are an ongoing normal write-down of assets as they are used in business. The Median of DD&A for 77 public companies for the third quarter 2007 equated $23.76/BOE which is greater than the Cash Netbacks/ BOE after the Proposed New Royalty Framework. (Source: Iradesso Quarterly). Under the proposed new royalty, deep exploratory wells for conventional oil are rendered marginal or uneconomic 15

16 16 Deep ‘Half Cycle’ Light Oil Exploration Initial Returns vs. NRF = NO ECONOMICS CurrentProposed WTI Price C$70/Bbl Royalty Operating/ Transport US$80/Bbl C$18/Bbl C$12.00/Bbl G&A/Interest C$3.00/Bbl C$70/Bbl US$80/Bbl C$35/Bbl C$12.00/Bbl C$37.00/BblCash Netback C$20.00/Bbl Field Price F&D Cost C$3.00/Bbl Cash Netback C$25.00/Bbl Recycle Ratio (Dollars Returned divided by dollars invested) $1.48 returned for every $1.00 invested $0.80 returned for every $1.00 invested

17 Projected Royalty Revenue will Actually go Down due to Low Activity Levels As a result of a lack of capital and resulting lack of drilling activity, it is projected that Alberta will actually receive less royalties by mid 2010 High levels of capital investment are essential to curb production decline in a mature basin The capital required to maintain production targets is not available under the terms of the NRF 17

18 At Current Prices Alberta is Already Collecting $1.4 Billion More In Royalties Alberta does participate in the price upside since the province collects its royalties “in kind” and sells its oil at the world price As a result of the current $90 price of oil, Alberta is already collecting an additional $1.4 billion annualized in royalties, relative to the $60 price level that was used in the Royalty Review Panel Report 18

19 Huge Gaps in Royalties Paid 5% of Alberta’s existing wells pay 60% of the royalties The majority of these wells are deep and have been drilled in the last 5 years The new royalty renders most of the deep conventional plays uneconomic It is estimated that the majority of deep exploration activity will cease under the new royalty proposal 19

20 Truly an unintended consequence - High productivity wells pay disproportionate share of royalties, which would NOT be drilled under NRF, as drilling becomes uneconomic. 5% of the wells (high productivity) pay 60% of the royalties Unintended Consequences 20

21 $80/bbl vs. Oil Rate 21

22 Summary Recently announced solutions to unintended consequences do nothing for high productivity oil $1 million exploratory credit (post April 10 th 2008) depths greater than 2000 meters Nothing for development wells Gas was awarded royalty credits for development, why not oil? Does not address real costs of exploring and developing high productivity premium crude 22


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