This article was first published by the Infrastructure Journal on Sep 1st, 2010.
Regulation of natural resources industries has become tighter and more environmentally focused in recent years, occupying a prominent social, economic and political role. Canadian companies must keep on top of recent regulatory developments or else risk lagging behind.
This is exemplified by the furore surrounding the recent BP Deepwater Horizon oil spill disaster off the Gulf of Mexico. The dangerous exploratory techniques that lead to the explosion are arguably a direct result of the difficulty many oil and gas companies face in attempting to satisfy an increasing demand for energy using traditional onshore methods whilst also facing a stringent array of regulation.
That said, Canada is a hot bed of activity and worthy of attention, with its oil and gas sectors demonstrating greater growth than the US due in large measure to its oil sands reserves. According to a recent RBC Economics report Canada has a projected economic growth rate of 4.1 per cent in 2010 and 2.3 per cent in 2011. This growth is mainly a result of increased crude oil and mineral production, not just in the Alberta oil sands but elsewhere also. Exxon Mobil has to date invested CAD$1 billon in developing satellite gas fields as part of the Sable Island Offshore Energy Project and is searching for further gas-fields to develop.
With the Canada Nova Scotia Offshore Petroleum Board increasing incentives to attract companies to Canada for new exploration development, this article provides a summary of significant regulatory developments (and hurdles) in the Canadian oil and gas sector facing companies today and the factors that affect their business decisions on a legal and commercial level.
Exploration and extraction of oil and gas in Canada is subject to the dual layers of federal and provincial regulation. For the purposes of this article, attention is paid to federal regulation Where appropriate. On a very high level Canada’s regulations are geared towards a more long term approach of disaster prevention and recovery rather than to regulate commercial gains and activities in the short term.
Under the Canada Oil and Gas Operations Act, no drilling project is approved unless the operator’s drilling plans include robust safety, emergency response and environmental protection. These must meet the National Energy Board’s (NEB) approval. Every single project that is authorised by the Board must be safe for workers and the public and must protect the environment.
The Canadian Environmental Assessment Act and the Canada Oil and Gas Operations Act ensure that applications for offshore drilling projects are subject to a full and comprehensive environmental assessment. This is viewed to be a thorough and rigorous process that considers all relevant factors, including potential impacts from the project, accidents and malfunctions, as well as measures to prevent, mitigate and monitor those impacts.
Furthermore any operator authorised under the Canada Oil and Gas Operations Act has full and primary responsibility to anticipate, prevent, mitigate and manage accidents and oil spills of all shapes and sizes. Canada’s oil and gas extraction industry spent CAD$2.8 billion on environmental issues in 2006, more than any other industry. These are largely made in response to an array of environmental regulations and conventions.
Canada Oil and Gas Drilling and Production Regulations require companies to have a management system to ensure compliance with the regulations and the Canada Oil and Gas Operations Act and are an amalgamation/modernisation of the Drilling Regulations and the Production and Conservation Regulations under the Canada Oil and Gas Operations Act (COGOA), the Canada-Newfoundland Atlantic Accord Implementation Act and the Canada Nova Scotia Offshore Petroleum Resources Accord Implementation Act (Offshore Accord Acts). Part 12 of the new regulations amend parts of the Canada Oil and Gas Certificate of Fitness Regulations, the Canada Oil and Gas Installations Regulations and repeals the Canada Oil and Gas Drilling Regulations.
In contrast to President Obama’s very vocal reaction to the BP Deepwater Horizon oil spill in the United States, Canada has not imposed a moratorium on future offshore deepwater drilling, with its Environment Minister citing the non-occurrence of such events in Canadian waters as an indication of ‘the strong regulatory environment that we have had with the National Energy Board (NEB)’.
Much like in Norway following the disaster, public pressure was great and a moratorium was considered, but ultimately the government continued with a large auction of its offshore exploration blocks, and a general moratorium was dismissed. Nevertheless, the Canadian government has commissioned a review to investigate the risks associated with offshore drilling and has issued a halt on Arctic drilling in the meantime.
Alberta Oil Sands
An interesting effect of the Deepwater Horizon oil spill can be found when looking at Canada’s famous oil sands, which boast reserves (containing a substance known as bitumen) second in size only to Saudi Arabia. Chevron has interests in oil sands’ projects at Athabasca and Ells River in Alberta and its net daily production in 2009 was 27,000 barrels of crude oil, 4 million cubic feet of natural gas and 26,000 barrels of bitumen from oil sands.
Furthermore the Athabasca Oil Sands Expansion Project is expected to increase the project’s bitumen production capacity to more than 255,000 barrels per day by late 2010. The oil sands have one large problem associated with them it is far more polluting to extract from than conventional sources. However, in light of the effects and costs associated with the BP oil spill, the environmental costs associated with bitumen are relatively manageable in comparison.
The traditional, historical view is that environmental costs stemming from land based extraction remain localised and are manageable, although this maybe shifting with recent reports indicating that the exploitation of oil sands found in Canada’s Alberta province pose a significant risk to the environment, causing damage to land, air and water.
As a result of the recent BP environmental disaster, the Canadian oil and gas industry is encountering and bracing itself for a heightened regulatory focus on safety and the reduction of environmental risk associated with exploration and extraction.
In May 2010, the House of Commons Standing Committee on Natural Resources commenced a consultation to determine whether Canadian laws and regulations are suitable enough to prevent such a disaster occurring on its shores. This consultation involved the participation of senior industry figures. Max Ruelokke, Chairman and CEO of Canada-Newfoundland and Labrador Offshore Petroleum Board (C-NLOPB) issued assurances that emergency measures and oil spill response plans are being addressed. Mark MacLeod, Chevron VP for Atlantic Canada and David MacInnis, Chevron VP of Policy, Government and Public Affairs, told and assured senators that extra safety measures are being taken.
However, it was admitted that it could take up to two weeks for Chevron to transport a vessel on-site that can start drilling a relief well in case of a blowout similar to that of the BP Horizon Deepwater oil spill. On the other hand, Paul McCloskey, Husky Energy Inc. VP for East Coast Operations assured the committee that his company has full confidence in the safety systems implemented at the White Rose offshore operations.
In comparison with the steps taken by Canada in specific response to the BP oil disaster and its devastating and enduring environmental knock-on effects, the UK government has established an Oil Spill Prevention and Response Advisory Group to conduct a review of the UK’s ability to prevent and respond to oil spills.
Although the Department of Energy and Climate Change (DECC) believes that the current system in the UK is fit for purpose, the Energy Secretary believes it is necessary to strengthen regulations in light of the recent Gulf oil spill, citing that ‘Deepwater Horizon gives us pause for thought and, given the beginning of exploration in deeper waters West of Shetland, there is every reason to increase our vigilance’. The UK government has also announced it will increase inspection of North Sea oil rigs and monitoring of offshore compliance and safety standards.
The DECC has taken note itself and is increasing its oversight of drilling operations and strengthening regulations by doubling the number of annual environmental inspections to drilling rigs. As soon as a detailed analysis of the factors contributing to the Deepwater Horizon explosion is available, the UK government has said it will review new and existing procedures. The UK has taken note of recent events, is transforming its regulatory framework and is focused on preventing such an environmental disaster happening on its watch.
International Financial Reporting Standards
In addition to recent regulatory pressure to improve internal controls and prevent environmental hazards, the Canadian natural resources sector now faces a new, albeit different challenge the introduction and adoption of International Financial Reporting Standards (IFRS) by Canadian Publicly Accountable Enterprises (PAEs). The IFRS marks a change in direction for financial reporting from the Canadian Generally Accepted Accounting Principles (Canadian GAAP).
IFRS6 (Exploration for and Evaluation of Mineral Resources) warrants particular attention for the purposes of this article it is the only industry-specific standard. This standard addresses some of the accounting issues in relation to costs incurred in the exploration for and the evaluation of mineral resources and provides limited guidance for the industry and offers different accounting policy alternatives for companies to adopt.
As a brief overview, IFRS 6 requires entities to identify and account for pre-exploration, exploration and evaluation and development expenditure separately, to identify examples of industry specific impairments and to ensure that previous GAAP impairment cannot be continued automatically.
Companies involved in the oil and gas industry will therefore have to contend with the new IFRS provisions and ensure they implement them accordingly, and phase out the GAAP predecessors. For example, full-cost requires that all costs incurred in searching for, acquiring and developing the reserves in a country cost centre are capitalized, whether or not proved reserves are found. Under IFRS, full-cost will no longer be appropriate and it will look more to the successful efforts method of accounting which differs significantly.
In relation to impairment, the test under GAAP is very different than under IFRS. Impairment is more likely to occur under IFRS, because it is currently a fair value test as opposed to the current two-step impairment test under Canadian GAAP and this could lead to earnings volatility.
Regulations will continue to evolve rapidly in response to environmental issues and public opinion and these changes will impact and cause organisational changes to regulatory bodies as well as changes to the nature of regulations themselves. As a leader in the field of oil and gas exploration and extraction, Canadian companies are forced to consider regulatory issues as a key driver to their future strategies and commercial viability. It is vital they keep on top of and remain informed of the regulatory developments that affect their business and must not shy away from understanding them, be they financial, environmental or economical.