Canada: New Newfoundland And Labrador Offshore Oil Royalty Regulations Effective November 1, 2017: Key Changes To The Offshore Regime

Last Updated: November 15 2017
Article by Doug Skinner and Trent Skanes

On November 3, 2017, the Newfoundland and Labrador Government published new Offshore Oil Royalty Regulations replacing the Royalty Regulations, 2003. The new regulations apply to all offshore leases issued after November 1, 2017. The changes to the regulations attempt to simplify some of the calculations and administration of offshore royalties in the Province. Whatever the outcome of this attempt, under section 33 of the NL Petroleum and Natural Gas Act the ability to contract out of sections of the new Regulations by agreement with the Province remains.

Here are 10 of the key changes the new regulations make to the offshore royalty dispute regulatory regime:

Moving to a "recovery factor" model. The basic royalty payable now depends on a formula that calculates the applicable "recovery factor" for an interest holder, resulting in a basic royalty rate between 1% and 7.5%.

Defining the concept of "net royalty" and removing Tier I and II incremental royalties. The net royalty regime is simplified: after payout is reached, net royalty payable in a month is now the applicable net royalty rate multiplied by net revenue in the month, less basic royalty payable. Calculating payout remains based on interest holders' actual costs, rather than an "average industry costs" model such as that Alberta uses in its Modernised Royalty Framework.

New net royalty rate calculation. The applicable net royalty rate is now determined by formula in the new regulations (section 13). When the recovery factor is between 1.00 and 3.00, the new regulations use a special calculation. The minimum net royalty rate is 10% and the maximum rate is 50%.

Monthly reports. In what appears to be an attempt to put more focus on monthly reporting, the new regulations' monthly reporting provision now requires interest holders to complete month reports "in full" and to state what amounts are "actual amounts" versus "true estimates". Further, a person of authority must now certify in writing that the monthlies are correct and complete to the best of their knowledge.

Strict 120-day requirement for annual reconciliations. A new subsection 32(2) states, "[a]n annual reconciliation...shall not be amended or revised more than 120 days after the end of the period." This section purports to remove any opportunity for interest holders to amend their annual reconciliations, even for error correction, without the Province's written consent. Additionally, the annual reconciliation provision now specifically calls for certain types of supporting information, namely recovery factor, basic royalty, net royalty, gross revenue, payout and cumulative production.

Modified transportation rules and removal of "transportation costs" exception to interest payable. The new regulations adopt and modify the framework under the old regulations (Part XI.1) for dealing with transportation costs for leases issued between 1990 and 2001. Additionally, in the old regulations, interest was not payable on underpaid royalty if the Minister was satisfied the discrepancy resulted from the use of transportation costs. This provision is not in the new regulations.

Removal of formula for eligible pre-development costs. In the old regulations, subsection 64(3) provided a formula to calculate eligible pre-development costs. The new regulations remove this formula, apparently leaving the determination of eligible pre-development costs fully in the Minister's discretion under subsection 60(2).

Removal of uplift and return allowance provisions. In the old regulations, sections 65, 66, and 70.7 provided for uplifts for eligible operating costs (10%), eligible capital costs (1%), eligible tanker operating costs (10%), and eligible tanker initial capital costs (1%). The old regulations also contained a "return allowance" – calculated using a factor tied to the consumer price index – that was added to an interest holders' cumulative costs for the purposes of calculating net royalty payable. The new regulations strip away these benefits for interest holders, meaning the time value of money is no longer being recognized in the regime.

New types of disqualified costs. Most fundamentally, the new regulations now mandate that all overhead costs must be "incurred in Newfoundland and Labrador"; otherwise, they are disqualified under section 63. Additionally, they stipulate two new disqualification criteria for eligible transshipment costs (section 79): (1) payments made to purchase an interest in a transshipment asset previously used to transship oil produced in the offshore; and (2) costs resulting from wilful or deliberate misconduct, or gross negligence, of manager/supervisory personnel of a transshipment facility administrator or a third party contractor.

Removal of arbitration as the dispute resolution mechanism. The new regulations remove the arbitration provisions entirely, fundamentally changing the dispute resolution process by limiting interest holders' ability to challenge determinations by the Province respecting royalties. The new regulations no longer contemplate an arbitral procedure to resolve disputes at all, under either international or domestic arbitration models. Instead, ministerial decisions are now "final and binding", and can't be appealed to the courts (section 85). There is also a two-year limitation period to apply for judicial review of a ministerial decision on a question of law or jurisdiction (section 86).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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