Managing oil and gas liability in Alberta: Changes are being made (kind of)

Managing oil and gas liability in Alberta: Changes are being made (kind of)

In July 2020, the Government of Alberta announced a new Liability Management Framework (LMF) which briefly sketched out several changes which were meant to improve the existing approach to oil and gas liability management.  These changes are built around 5 pillars: licensee capability assessment, licensee special action, inventory reduction program, addressing legacy and post-closure sites, and expanding the mandate of the Orphan Well Association.

What system was in place prior to the introduction of the LMF in July 2020?

Prior to July 2020 and currently, the key tool for managing oil and gas liability is the Licensee Liability Rating (LLR) Program which is delineated in Directive 006: Licensee Liability (LLR) Program. As will be discussed below, the AER is transitioning away from the LLR program to a new, enhanced program which uses holistic licensee assessment.

The LLR Program applies to all upstream oil and gas wells, facilities, and pipelines included within the scope of the Orphan Fund as described in Appendix 1 of Directive 006. The LLR Program is designed to assess a licensee’s ability to address its suspension, abandonment, remediation and reclamation liabilities. This is done by looking at the Liability Management Ratio (LMR) of a licensee which is the ratio of a licensee’s eligible deemed assets to its deemed liabilities. The LMR assessment occurs monthly and at the time of a transfer application. If the licensee’s LMR falls below 1.0, then a security deposit is required.

A LMR assessment include assets and liabilities in the LLR program, as well those under the Large Facility Liability Management Program (LFP) and the Oilfield Waste Liability (OWL) program. The LFP is set out in Directive 024: Large Facility Liability Management Program.  That directive sets out which facilities are included in the LFP, the methodology to calculate deemed assets and liabilities and the LMR, the license transfer process, and other aspects of the program.

The OWL program is outlined in Directive 075: Oilfield Waste Liability (OWL) Program and applies to all AER approved waste management facilities except those which are solely dedicated to landfill purposes. Directive 075 sets out security deposit requirements, the methodology to calculate deemed assets and liabilities and the LMR, the license transfer process, and other aspects of the OWL program.

As evidenced by the existence of a significant number of orphan wells (i.e. wells which are licensed to defunct or insolvent parties, and designated as orphans by the AER), the LLR Program is not always capable of determining when it is appropriate to request security for well clean-up.  Often the LLR Program identifies problems at too late a stage (i.e. the licensee already beset by financial difficulties) with the result that the licensee is incapable of addressing its environmental obligation even before the AER intervenes.

The impact of this shortcoming was highlighted by the Alberta Court of Queen’s Bench decision in the Redwater case (which was upheld by the Alberta Court of Appeal but ultimately reversed by the Supreme Court of Canada).  See our brief commentary on the Redwater decision here.

The new approach…

As a result of the initial Redwater decision, the AER was motivated to take another look at the existing oil and gas liability management approach. The regulatory response has essentially been to enhance the existing approach by requiring more detailed financial information initially, on an ongoing basis, and upon license transfer requests. Time will tell as to whether this enhanced approach is sufficient to catch potential insolvencies and prevent license transfers to underfunded companies (i.e. where closure liabilities exceed company value).

Licensee Capability Assessment System

The AER is transitioning away from the current LLR program to the Licensee Capability Assessment (LCA) system which will be used to determine whether a company is financially stable enough to receive a licence to operate and whether up-front security may be required. Essentially, this is an enhanced version of the LLR program which will use “holistic licensee assessment” to inform decisions about licence applications and, where appropriate, to trigger Licensee Special Action

The AER has taken already steps to replace the LLR program with the LCA system, including making changes to Directive 067: Eligibility Requirements for Acquiring and Holding Energy Licenses and Approvals and introducing Directive 088: Licensee Life-Cycle Management (Directive 088) which came into effect on December 1, 2021. Over several phases, Directive 088 will eventually replace Directive 006 (which has already been amended to remove the components related to license transfers).

The amendments were made to Directive 067 put into place additional requirements to provide financial information at the time of application and throughout the energy development life cycle. The required information is listed in Schedule 3 of Directive 067 and the AER may request additional information as it sees fit.

The information gathered under Directive 067 forms part of the holistic licensee assessment and will be used to:

• assess licensee eligibility (a potential licensee may be determined to have no eligibility, limited eligibility, or general eligibility);
• assess capabilities of licensees and approval holders to meet regulatory and liability obligations throughout the energy development life cycle;
• provide further direction on which material changes can indicate a risk of licensees or approval holders being unable to meet their regulatory and liability obligations;
• administer AER liability management programs; and
• ensure safe, orderly and environmentally responsible development of energy development of energy resources in Alberta throughout life cycle.

In determining whether an particular applicant or licensee poses an unreasonable risk, the AER considers a variety of factors including compliance history; corporate and ownership structure; history of insolvency; outstanding debts to AER, Orphan Fund, municipal taxes, surface lease payments, public land use disposition fees or rental payments; and several other factors.

Directive 088 introduces the LCA system, the licensee management program, and the inventory reduction program. As well, Directive 088 updates the application requirements related to the license transfer process and describes security collection.

The LCA system uses several factors to identify risks posed by a licensee including its financial health (i.e. the financial information submitted under Directive 067) and the estimated total magnitude of liability including abandonment, remediation and reclamation.  Additional information about LCA factors and parameters is found in Manual 023: Licensee Life-Cycle Management. Results from the LCA will be incorporated into the larger holistic assessment of the licensee which informs regulatory decisions regarding the licensee (including license eligibility under Directive 067 and decisions under the licensee management and inventory reduction programs introduced in Directive 088).

Directive 088 indicates, regardless of what agreements between parties may say, all license transfers must be approved by the AER and will trigger holistic licensee assessment of both transferor and transferee. The AER may approve, approve with conditions (including security), or deny the license transfer. If a license transfer application involves inactive licenses, then the transferor must update its reported closure activities and spends before submitting the transfer application. Further, in some cases,  a site specific liability assessment completed within 3 years must be submitted along with an evaluation of cost changes since the time of the assessment (see Directive 001: Requirements for Site-Specific Liability Assessments in Support of the ERCB’s Liability Management Programs). The AER considers the whole package of licenses to be transferred and may reject an application that does not include licenses that have either received reclamation certifications or are abandoned and classified as reclamation exempt.

Directive 088 also addresses security deposits. The AER considers the holistic licensee assessment in determining whether to require a security deposit (and its quantum). In particular, the AER considers whether a licensee poses an unreasonable risk as per section 4.5 of Directive 067. The maximum security amount is the licensee’s total liabilities including cost of care and custody, and the cost to permanently end operations (which includes abandonment and reclamation). Requests can be made for a refund of security deposits which triggers holistic assessment of licensee to determine if a refund is appropriate.

Licensee Special Action

According to the LMF, licensee special action will provide “practical guidance and proactive support for individual or distressed operators”. Presumably, the rationale being that assisting operators through difficulties will prevent the creation of more orphans. This concept appears as the Licensee Management program outlined in Directive 088.

The Licensee Management program is meant to proactively monitor licensees to support the responsible management of energy development. The results from holistic licensee assessment (i.e. under the LCA program and Directive 067) are used to identify those licensees that are at greater risk of potential failure in meeting regulatory and liability obligations. If a licensee is determined to be at greater risk of failure, the AER may undertake specific engagement or regulatory actions with the licensees. These actions include education, encouragement to follow industry best practices, and initiation of regulatory actions where appropriate (such as changing license eligibility under Directive 067, placing restrictions on new applications, requiring security deposits or issuing orders). As well, the AER will encourage licensees to use collaborative closure planning tools – such as, area based closure – to reduce overall closure costs and work more efficiently to reduce liability on the landscape.

Inventory Reduction Program

The Inventory Reduction program introduced by Directive 067 sets mandatory closure spend targets for closure activities and spends by licenses (also see Bill12: Liability Management Statutes Amendment Act, 2020 which made changes to the OGCA and Pipeline Rules to enable these spend targets).  Each licensee must meet their annual mandatory target, report annually to the AER on all closure activities and spends, keep records of all closure activities and spends, and provide information as requested to the AER. In lieu of meeting the mandatory target through closure work, a licensee may provide a security deposit in the amount of the mandatory target. Failure to meet the mandatory target or provide security in lieu, will result in the AER requiring an additional amount to compensate for increased liability accumulated through the year. As well, other regulatory actions may be taken to ensure compliance and achievement of outcomes.

Mandatory closure spend targets have been set for 2022 and 2023, along with forecasts for 2024 to 2026, in Bulletin 2021-23: Mandatory closure spend targets. The industry-wide targets for 2022 and 2023 are $422 million and $443 million, respectively. Individual annual mandatory targets will be determined by the AER taking into account liability and historical closure spending, and the financial information required by Directive 067.

As well, the site rehabilitation program has been established to distribute $1 billion in federal funding to oil field service companies for the performance of oil and gas site closure and reclamation work. One interesting aspect of this program is a nomination process wherein landowners, First Nations peoples on reserves or Métis Settlement residents can nominate an inactive site for clean-up. Once a site is nominated, the government posts it online, and a company may apply for a grant. Nomination of a site does not guarantee that it will be cleaned-up or that a grant will be made.

Addressing Legacy and Post-closure Sites

The LMF provides that there will be a “process to address legacy and post-closure sites, or sites that were abandoned, remediated or reclaimed before current standards were put in place and sites that have received reclamation certificates and the operator’s liability period has lapsed”. Aside from indicating an intention to establish a panel to consider how to address this gap, there is no indication of what this process may consist.

Expanding the Mandate of the Orphan Well Association

The mandate of the OWA was expanded in June 2020 by The Liabilities Management Statutes Amendment Act. This includes enabling the OWA to better manage orphan sites (including operation of those that are still capable of production) and to monitor the behaviour and condition of orphan wells. It seems that the LMF does not envision additional changes to the OWA’s mandate beyond those made in June 2020.

Will this new approach be enough?

The AER’s current LLR approach to oil and gas liability has resulted in numerous legacy and orphan wells on the Alberta landscape leaving a significant liability on the public purse (estimates run as high as $260 billion, see Mike De Sousa et al. and Carolyn Jarvis et al.).

While changes have been made and will be made to address the shortcoming of the current liability model, it is “patched-up version of the old approach” – there still is no default security, no timelines for closure, no protection against oil-price crashes, debt calls by creditors and AER attempts to enforce come too late (i.e. when there are financial red flags, see Fluker & Yewchuk). Furthermore, consistent ongoing monitoring of the financial health of every AER licensee is a tremendous undertaking which requires dedication of expertise and funding which it may not actually possess (see Fluker & Yewchuk). As well, the sufficiency of the mandatory closure spend targets is questionable (see Yewchuk).

Rather than merely fiddling with the existing approach to oil and gas liability, the ELC would like to see:

• security deposits to address environmental obligations being required for all oil and gas activities before work commences.
• legislated timelines for reclamation and remediation to avoid inactive wells languishing on the landscape without clean-up.
• Monitoring being put in place for all inactive, orphan, legacy and post-closure sites.

Albertans deserve an approach which is predictable and relatively administratively simple; does not allow wells to languish without clean-up; and adheres to the polluter pays principle.

Interested in more detail? 

Oil & Gas Liability in Alberta at a Glance

Published: December 7th, 2021

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