OUR GREAT MINDS

    by Alexander MacDonald, Q.C.

    State Ownership in the Canadian Offshore

    Master in its Own House

    In 2007, Newfoundland and Labrador (NL) adopted an Energy Plan to guide and define a provincial vision for energy resource development. As a result, through Crown corporation, Nalcor Energy, the province now owns a 5 percent interest in the White Rose Expansion, a 4.9 percent interest in Hebron, and a 10 percent interest in Hibernia South. The province will also own up to a 10 percent interest in all future offshore projects. This raises the question, should Newfoundland and Labrador be in the oil business?

    Why Does Newfoundland And Labrador Want Ownership?

    In many parts of Canada, there is an ­inherent desire that the public “own” its natural resources, which to most people means the public should reap profit from and exert ­control over the resources. Strangely, in Canada, state ownership of natural resources is limited to the electricity and oil and gas industries, and, for some reason, does not include mines, fisheries, or other natural resources.

    State-owned electrical companies are ­common, with Hydro Québec being the most obvious example. The trend in North America, however, is to privatize these enterprises, reflecting the widespread belief that privately owned companies are more efficient.

    Oil companies have historically been the exclusive domain of private enterprise. The most obvious exception was Petro-Canada as the center piece of the 1980s National Energy Program. However, as economic ­nationalism waned, the ardor for state ownership ­collapsed and the company was privatized. The days of the Canadian state-owned oil company seemed over. Then Danny Williams burst on the scene and Nalcor Energy was born.

    Why Can’t Newfoundland And Labrador Just Take Ownership?

    It is not as easy as you might think for Newfoundland and Labrador to become an equity owner in the offshore. In the absence of other factors, privately owned oil ­companies generally look unfavourably on equity ­participation by governments. A ­complicating factor is that offshore oil is owned by the Federal Government and not by the ­provinces, curtailing the ability of Newfoundland and Labrador to expropriate interests in oil projects.

    Newfoundland And Labrador Makes A Deal

    However, the province has something ­valuable to offer the industry in exchange for an equity interest: royalty certainty over the life of projects. Canada gives oil companies the right to exploit the oil in exchange for royalties. Canada has given Newfoundland and Labrador the right to impose and collect royalties.

    The province collects two types of royalty: one is a percentage of gross revenue of ­projects before any expenses, and the other is ­percentages of the net profit after ­allowance for repayment of capital with a return. The province is not required to invest capital to collect royalties. Newfoundland and Labrador must also approve development plans for the offshore. Having control of royalty and approval gives the province considerable leverage when it comes to acquiring equity interests and stipulating local benefits and employment.

    Therefore, even without the equity interest in the projects, Newfoundland and Labrador (1) approves the mode of development and negotiates local procurement, assembly and employment targets, (2) collects shares of both gross and net profits from all of the oil companies, (3) can increase the royalty any time it chooses, and (4) makes no capital investment in the project.

    So Now Newfoundland And Labrador Owns An Oil Company

    Newfoundland and Labrador could have ­chosen to increase the royalties, so that the royalty paid would equal what it could have earned as an equity participant. Instead, it decided to become an investor. What does this mean? It means the province (1) still ­collects its royalties, (2) has agreed to royalty ­stability over the life of projects, (3) receives up to 10 percent working ­interest in projects, (4) must invest and risk the same ­percentage of ­capital in the project, and (5) sits at the table as a member of the ­management ­committee of projects. A less obvious but potentially ­important benefit is that a future ­government could sell its equity interest, thereby ­reaping immediate cash. It would be virtually ­impossible to monetize future royalties.

    So What Does Newfoundland And Labrador Get?

    In either case, the same amount of money could be collected by the province. As an equity player, it sits at the management table, can sell its equity interest, and, in exchange, it has provided stability on future royalties and agreed to invest and risk capital in the project. But is that a fair price to pay for the benefits received? Which scenario results in the most benefits to the public? That is for you to decide.

    Alexander MacDonald, QC, is the ­managing partner at the St. John’s office of Cox & Palmer, practicing in energy law.

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