Escalating development costs for the Hebron oil field will bite into provincial benefits in the near term, keeping royalties lower for longer and increasing the amount taxpayers will front for the project.
But the Newfoundland and Labrador government is confident in the project’s long-term prospects, saying estimated benefits are higher than first forecast when spread over the coming decades.
Last week, the ExxonMobil-led Hebron consortium announced formal sanction of the project.
ExxonMobil indicated that capital costs for Hebron are now expected to total $14 billion.
That number is up sharply.
When the deal to develop Hebron was announced in 2007, those estimates were closer to $5 billion.
And less than two years ago, they were tagged at $8.3 billion in filings with the province’s offshore regulator.
The increased costs represent a bit of a double whammy for the province’s fiscal benefits from Hebron — at least in the near term.
"I would describe it as short-term pain for long-term gain," Natural Resources Minister Jerome Kennedy told CBC News.
"What essentially we’re doing is investing in the future."
Those investments include hundreds of millions of dollars forked out through Crown-owned Nalcor Energy in the coming years to pay Hebron development costs, and lower royalties in the early years of the project.
As part of the Hebron deal, the province — through Crown-owned Nalcor Energy — bought into the project.
That 4.9 per cent equity stake cost $110 million.
Ownership means Nalcor is on the hook for its share of development costs of the project.
'I would describe it as short-term pain for long-term gain. What essentially we’re doing is investing in the future'—Natural Resources Minister Jerome Kennedy
That share of development costs has now risen to $690 million.
On the flip side, there is a big benefit to equity ownership. Nalcor will also get its share of profits from every barrel of Hebron oil when the project comes online by the end of 2017.
According to Kennedy, a 150 million barrel increase in estimated reserves at Hebron means an even greater long-term benefit to the treasury than first forecast.
"The fields will last longer," he said.
The government now expects a windfall of $23.7 billion over the life of Hebron, compared to $20 billion a few years ago.
The equity stake accounts for $2.7 billion of that total.
Hebron is expected to remain in production for two decades after first oil.
Short-term royalty rate impact
In the long term, the increase in recoverable reserves should help royalties. The more oil, the better.
But over the short term, the big bump in the costs of getting at that oil will have the opposite effect.
In a concession the province offered to the Hebron partners in 2007, the royalty rate for the project will remain one per cent until development costs — that full $14-billion figure — are recovered.
After that happens, the rate then jumps to 20 per cent.
The Hebron regime skipped a series of increases offered by the generic offshore royalty regime between those two levels.
In exchange for keeping the rate low in the early stages, the Newfoundland and Labrador government negotiated a "super-royalty" on the back end.
At the top royalty level – after development costs are recovered and an additional return allowance on the investment made by the oil companies is taken into account – the Hebron rate jumps to 36.5 per cent, instead of 30 per cent in the generic system.
That "super royalty" applies only when the price of oil is above US$50 a barrel for West Texas Intermediate crude.
More than five years ago, when the Hebron deal was announced, government officials glossed over the early royalty concession, and later stressed that it was no big deal.
"We gave something on the downside which is low risk to us to achieve a very high gain on the upside," Kathy Dunderdale, then the minister of natural resources, told CBC News in 2007.
Government officials indicated at the time they expected Hebron to whoosh through the early royalty levels, meaning the concession would not amount to much.
That may possibly still be the case.
But at current oil prices, the province can expect at least a couple of additional years of low royalties before the higher rate kicks in.
Skyrocketing development costs were one of the two main risk factors in the early royalty concession.
That happened. Capital cost estimates have nearly tripled in five years.
The other risk factor was a sudden plunge in the price of oil.
So far, all is good on that front. WTI crude is currently hovering around its 2007 level, in the high $80s.
Other projects will need equity infusion
And Hebron is not the only natural resources project to require an equity infusion of tax dollars in the coming years.
Two other oil projects — Hibernia South and the White Rose Extension — along with the $7.7-billion Muskrat Falls hydro project will all require significant government capital.
That leaves critics concerned about what will happen to government services in the coming years, with cash being funnelled into equity for big projects.
"We’ve got a lot of financial commitments to meet in a very short time frame," Liberal MHA Yvonne Jones said.
"And I think this hasn’t been well planned out by government."
Hebron will become N.L.’s 4th producing project
Climbing costs and potential short-term money crunch aside, the announcement of Hebron’s sanctioning last week remains good news for the province.
The three current fields — Hibernia, White Rose and Terra Nova — are all past peak production.
Hebron will help ease that decline.
The project will also provide employment for thousands of people in the province during the construction phase.
Peak employment levels exceeding 3,000 are expected in 2014, according to the Hebron website. Two major modules for the project will be built at Marystown and Bull Arm.
ExxonMobil says there are roughly 1,200 people currently working on the project in Newfoundland and Labrador.
The Hebron field, located 350 kilometres southeast of St. John’s, is now estimated to hold more than 700 million barrels of recoverable resources.
In addition to operator ExxonMobil, the other Hebron co-venturers are Chevron Canada Resources (26.7 per cent), Suncor Energy Inc. (22.7 per cent), Statoil Canada (9.7 per cent) and Nalcor Energy (4.9 per cent).