The collateral costs of abandoned wells

The collateral costs of abandoned wells

 By Chinomso Iliya-Ndule & Jason Unger

 

When a headline starts with “Taxpayers could be on hook” people take notice (–funnily enough the headline changed during the drafting of this blog).  The article tells the story of continued financial repercussions of the downturn in oil prices and the continuing increase in unpaid lease payments related to oil and gas well sites.   In this blog we provide additional context to this ongoing story as the issue should add further motivation for government, industry and Albertans to seek a review of how we develop and manage liability in the resource sector.

Pursuant to section 12(1) of the Surface Rights Act (SRA), any operator in Alberta who intends to conduct resource activities or activities incidental to the operation of a pipeline, power transmission line or telephone line is required to obtain a right of entry or enter into a surface lease, whereby the operator agrees to pay rent to the landowner in exchange for the right to access the surface of the land.

Where the operator fails to make its payment, section 36(3) of the SRA permits a landowner to apply to the Surface Rights Board (SRB) for the recovery of outstanding rental payments. Upon written application and the provision of satisfactory evidence by the landowner, sub-sections 36(4) and (5) of the SRA, empowers the SRB to send a written demand notice to the operator. If the operator fails to comply with the demand notice, the SRB may direct the Minister to pay the landowner, the outstanding rent due, from the General Revenue Fund.[1] The General Revenue Fund is a fund appropriated to the public service of Alberta into which all public money is paid.[2] Section 36(7) further provides that the Minister may be responsible for additional outstanding rental payments until the transfer or reclamation of an orphan site is complete.  (See Shaun Fluker’s blog for review of SRB decisions and the nature of payments that might be covered when operators enter into bankruptcies.)  It is then up to the Minister to seek recovery of the debt from the operator, should they be around.

With the crash in oil prices, a number of operators are having solvency problems (with a number going into bankruptcy and the numbers of orphan sites increasing significantly). The total count of orphan wells as of June 30, 2016 is 1114 wells compared to 162 as of March 31, 2014.[3] This represents a significant increases in liabilities that will be covered by the rest of industry through the orphan well program (see the Orphan Well Association).  There is also a real potential that tax dollars may go to cover some portion of the abandonment and reclamation of these orphaned sites (see this ELC blog in this regard).

Beyond the significant costs of reclamation and remediation we have the surface lease rental payments being made by the Minister, which continue to escalate. Between the years 2014 and 2015 alone, the SRB has directed the Minister to make about six hundred (600) rental payments totalling over $2 million(with payments between $1,000 to over $15,000).  The Surface Rights Board chairman Gerald Hawranik has been quoted as predicting that rental payments by the Minister will hit $3.5 million by the end of 2016.

Section 36 applications

Year s. 36 ApplicationsReceived: Resolved: Paid by Minister $ Amount Paid by Minister
2016 3,500,000?
2015 765 : 475: 423 1, 700,000
2014 505 : 241 : 209 722, 063.49

Above and beyond these direct payouts we have the administrative costs of these applications and of the operations of the SRB itself. The escalating costs should be of interest to taxpayers, government and industry alike. Technically the rental payments made by the Minister can be recovered from the operators, however, the costs associated with such debt recovery and the fact that most operators failed to pay their rent due to insolvency will make this impractical in most instances. With a continued slump in oil price, an increase in the number of orphan sites is inevitable and, with it, the costs to Albertans.

In response the Alberta Energy Regulator has adjusted its liability rating system which resulted in more operators being required to provide financial security.  Changes to the LLR system however throw a level of uncertainty into the system as operators struggle to remain solvent.  In effect, a perfect storm is created for all involved as operators feel the constraints of additional security and decreased flexibility in managing properties, and the regulator struggles to find a way to deal with the outstanding liabilities of the sector.

Until recently there has been significant resistance to tackling these liabilities head on: amending the liability rating system to more accurately reflect the costs for well site abandonment and reclamation was slow to occur (see additional details in the ELC publication here at pages 14 and 15), the liability system was often not capturing the true financial risks of an operator (see Ecojustice paper here), and there appeared to be hesitance within industry to be more proactive in addressing liability risks.

The system as it has been for the past few decades set the stage for small and mid-sized operators to take on riskier properties to extract a dwindling resource; perhaps too much freedom and flexibility was granted to exploit and manage what might be viewed as marginal properties.

This inadequate system of liability management was relatively easy to ignore when times were good however it appears the chickens have come home to roost.  It is time to step back and do a full assessment of liabilities related to orphaned, abandoned, and inactive wells and to undertake a public discussion about the most appropriate regulatory approach in the future.

 

[1] Surface Right Act, ss 36(6)..

[2] Financial Administration Act, s 14

[3] http://www.orphanwell.ca/OWA%202013-14%20Ann%20Rpt%20Final.pdf

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1Comment
  • Ron J. Thiessen
    Posted at 13:41h, 17 September Reply

    Hi! This is a timely blog. Regarding your closing comment about doing a full assessment of liabilities, please consider a recently published article in the SPE Economics & Management journal: Oil and Gas Wellsite Reclamation Liability Estimation (http://dx.doi.org/10.2118/184395-PA).

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