Questerre Energy Corporation

Taken from Quebec's Budget Plan.

3.2 Stimulating gas exploration in Québec

As a result of its geology, Québec’s territory is located in a favourable region for the
discovery of hydrocarbons. In recent years, a great deal of exploration work has
been carried out in Québec’s sedimentary basins. In 2008, nearly thirty
geophysical surveys were done and fifteen wells were drilled in the St. Lawrence
Valley. This work represents investments estimated at over $60 million.
This exploration work in Québec’s subsoil has confirmed attractive potential in gas
shales4 in the St. Lawrence lowlands.

In the current economic situation, the government is acting to pursue exploration
activity and increase the possibilities for production to come on-stream in the near
future. To do so, the government is announcing:
? the implementation of a five-year royalty holiday of up to $800 000 per well
for wells put into production by the end of 2010;
? the participation of the Société générale de financement du Québec (SGF) to
apply the tools at its disposal to support the development of this industry in
Québec;
? implementation of a program for the acquisition of geoscientific knowledge;
? implementation of a strategic environmental assessment program.
To stimulate natural gas exploration in Québec, the government will provide the
industry with support of $10.8 million over the next two years.
The government is also preparing for the future by announcing an overhaul of the
existing system of natural gas royalties with a view to modernizing it to reflect the
new realities, while securing a fair return for Quebecers on the resource they own
collectively.

TABLE F.25

Cost to the government of measures to stimulate gas
exploration in Québec
(Millions of dollars)
2009-2010 2010-2011 Total
Five-year royalty holiday for gas development 0.8 3.0 3.8
SGF support for the development of the
gas exploration industry in Québec ? ? ?
Program for the acquisition of geoscientific knowledge 2.0 2.0 4.0
Strategic environmental assessment program 1.5 1.5 3.0
TOTAL 4.3 6.5 10.8

In 2006, Québec consumed almost 200 billion cubic feet of natural gas, accounting for 13% of total energy
consumption in Québec.
Breakdown of energy consumption in Québec — 2006
Electricity
40%
Oil
37%
Natural gas
13%
Other
10%


Source: Ministère des Ressources naturelles et de la Faune.


Since Québec does not produce natural gas, it obtains all of its supplies from Western Canada. The cost of these
supplies totalled roughly $2 billion in 2006.
Accordingly, the development of natural gas would enable Québec to be more self-sufficient in terms of energy
supplies.
Natural gas development potential in Québec
Québec’s geology is conducive to the presence of natural gas, mainly in the St. Lawrence lowlands, where gas shale is
found.
Exploration work done in this region in 2008 has produced impressive results: Québec’s gas shale could contain
between 35 000 and 163 000 billion cubic feet of natural gas.
If one quarter of the gas shale potential were recovered, production could satisfy Québec’s needs for more than 40
years. At the February 2009 price, this represents a value of $45 billion.
Québec’s estimate gas shales potential
Theoretical potential 35 000 to 163 000 billion cubic feet
Commercial potential (25%) 8 750 to 40 750 billion cubic feet
Consumption reserve1 41 to 190 years
Production value2 $45 to $210 billion
1 Based on 2007 annual consumption of 215 billion cubic feet.
2 According to the February 2009 price of natural gas, $5.15 per thousand cubic feet.

Apart from gas shale, many other geological structures favourable to hydrocarbon accumulation have also been
identified in Québec. The potential of these structures has yet to be identified, but industry experts are optimistic
about the possibility of discovering large quantities of hydrocarbons with commercial potential

3.2.1 Five-year royalty holiday for gas development

Hydrocarbon development work requires substantial investment that also involves
financial risk for the industry. In the case of unconventional natural gas (gas
shale), investments of many millions of dollars are needed for exploration and the
spin-offs for Québec are substantial.
Difficult economic context
The drop in prices for hydrocarbons and the financial crisis have not spared the
natural gas industry. For companies in this sector, it has become less profitable to
continue their activities and some have recently adjusted their development
projects downward.
This difficult economic situation could prompt other companies to postpone their
investments, depriving Québec of significant economic spin-offs. The development
of natural gas wells must begin as quickly as possible to ascertain Québec’s true
potential and reassure the industry.
Consequently, investment support measures are essential until prices and
economic conditions improve. It is also important to reduce the financial risk
associated with natural gas exploration in Québec, where the potential for profit is
still uncertain.
Implementation of a royalty holiday
Currently, natural gas development corporations must pay a royalty of 10.0% or
12.5% of the value at the well based on average daily production.
The life of a well averages 20 years and half its production is achieved during the
first five years. Consequently, over 50% of the royalties are paid during the first five
years.
CHART. F.12
Annual production of an average well and royalties payable1
0
50
100
150
200
250
300
350
400
450
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years of production
Annual production (Mft3)
0
50
100
150
200
250
300
350
400
450
500
Annual royalties ($ 000)
Royalties
Annual production
Mft3: Million cubic feet.
1 For production of 2 000 Mft3 over 20 years, at the February 2009 natural gas price of $5.15 per thousand
cubic feet and using the 10% royalty rate in force.
Sources: Ministère des Finances du Québec and ministère des Ressources naturelles et de la Faune.
Accordingly, to foster the development of a gas industry in Québec, the government
is announcing the implementation of a five-year royalty holiday of up to
$800 000 per well for wells put into production after the day of the budget and
before January 1, 2011.
Over a period of 20 years, this incentive will cut the royalties that would otherwise
have been paid for an average well in half. At the February 2009 price, thanks to
the royalty holiday, a development corporation would have to pay $494 374 to the
government, i.e. $535 729 less than the situation without the incentive.
3.2.2 Société générale de financement support for the
development of the gas exploration industry in Québec
The discoveries that have confirmed Québec’s natural gas potential were possible,
in particular, thanks to the work done by Québec exploration companies (juniors).
These juniors hold a large share of exploration permits in Québec, i.e. almost 70%
of the total surface area under permit.
TABLE F.26
Holders of oil and natural gas exploration permits –
March 2009
Surface area under permit
(Hectares) (%)
Québec juniors 6 004 739 68.4
Others 2 780 069 31.6
TOTAL 8 784 808 100.0
Source: Ministère des Ressources naturelles et de la Faune.

However, because of the collapse of financial markets in recent months, juniors
find it difficult to raise the capital needed to carry out their exploration programs.
Moreover, gas shale exploration requires major investments and highly specialized
knowledge, which sometimes prompts juniors to turn to the majors for financing
and expertise.
To facilitate access to capital and foster partnerships between juniors and majors,
the government is encouraging the Société générale de financement du Québec to
apply the tools at its disposal to support the development of this industry in
Québec over the next two years. ( The beauty of socialism )

3.2.3 Program for the acquisition of geoscientific knowledge


In recent years, the ministère des Ressources naturelles et de la Faune has carried
out geophysical surveys in the Bas-Saint-Laurent and Gaspésie regions whose
results have prompted many exploration companies to acquire exploration permits
and carry out major development work.
To date, however, knowledge of the territory remains both superficial and
incomplete. Much work remains to be done to keep companies interested in
exploration, guide their research and ensure optimum development of the
resource. To enable other discoveries and attract new players to the industry, it is
important to more thoroughly detail and promote Québec’s potential.
Accordingly, the government will allocate $4 million over two years to the
implementation of a program for the acquisition of geoscientific knowledge.
The program will, in particular, help improve knowledge of the hydrocarbon
potential of all Québec’s sedimentary basins, including those of the St. Lawrence
Valley, Gaspésie, the estuary and Gulf of St. Lawrence, as well as northern Québec.

3.2.4 Strategic environmental assessment program

In recent years, fears have been expressed as to the potential impact of seismic
surveys, in particular on marine mammals and on various economic activities that
communities of coastal and island regions depend on.
It is essential that the activities relating to hydrocarbons be carried out in an
environmentally friendly way, to ensure sustainable development for current and
future generations. To protect the environment and the communities affected by
the effects of possible hydrocarbon development, an annual envelope of
$1.5 million for the next two years will be allocated to implement a marine
strategic environmental assessment program.

3.2.5 Modernize the natural gas royalty system

Québec’s natural gas royalty was designed many years ago and no longer reflects
the state of the market. The government wants to modernize this system.
The new system must be competitive, predictable and simple to administer for
companies and the government, while securing a fair return for Quebecers on the
resource they own collectively.
To give this nascent industry the predictability it needs to develop Québec’s natural
gas resources, the government is unveiling the major guidelines that will govern
this industry in the coming years.
Introduction of a variable rate royalty system
The government is announcing that the structure of royalties on natural gas
development will be reviewed and modernized to adapt it to new realities.
Current system
Under the current system, the royalty rate varies only with the volume of production
but takes no account of the rise in the price of the resource on the market. The
royalty rate applicable to natural gas development is 10.0% or 12.5% of the value
at the well depending on whether average daily production is less than or greater
than 84 000 cubic metres. The value at the well represents the average retail price
of natural gas, excluding taxes and after deducting certain costs.5
A new system in 2011
In 2011, at the end of the royalty holiday eligibility period, the current system will
be changed and the royalty rate will vary with the price of the resource, which is not
currently the case. The new system will be much closer to those in force in other
provinces, especially British Columbia’s system.
Reduced rates for low-productivity wells
Moreover, the government acknowledges that price is not the only influence on the
profitability of developing this resource: production also varies from one well to
another. Geological characteristics can vary depending on the production zone and
affect productivity and operating costs of different wells. The new royalty system
will therefore offer reduced rates for wells with lower productivity.
Making the royalty rate a function of productivity will provide the flexibility needed
to adapt the system to market conditions and the production characteristics of
each well. This will ensure a fair division of risks and rewards between the
government and the companies.
Within the next year, the government will propose the legislative and regulatory
amendments needed to give effect to these orientations. The Minister of Natural
Resources and Wildlife will give consideration to the results, which he will receive
from the industry, concerning the commercial development potential of geological
formations in Québec, further to the development work under way.