Sponsored Content: Shedding Liabilities In A New Energy Paradigm

Unquestionably, the Canadian oil and gas industry is suffering from the effects of low commodity prices and shifting energy markets. The plunge in the price of oil to half the value of three years ago, and the surge in U.S. shale gas and tight oil production that has shrunk Canadian producers’ main export market have led to the biggest energy market contraction in a generation.

Managing the basin’s legacy assets in this environment is increasingly cumbersome and constraining for many producers. According to Sproule, as of June 30, 35 per cent of Alberta’s conventional oil production and 41 per cent of gas production came from wells older than 10 years, representing almost one million barrels of oil equivalent production per day from 102,000 wells. Some of these legacy assets offer minimal, if any, return for owners and investors going forward. As such, they represent a challenge to growth-oriented oil and gas companies and a risk to the Orphan Well Association (OWA) if not dealt with through the remaining cash flow.

Historically, as oil and gas companies have grown, many did not focus on cost management but instead relied on increasing commodity prices and access to capital to mute the impact of inflated operating costs.

This paradigm has changed. “In our current environment, significant effort has been put into lowering both the capital and operating cost structure as well as evaluating promising enhanced recovery technologies. Sproule has assisted many companies with evaluating enhanced recovery technologies and helped small and medium size companies reduce their expenses through its asset management services,” said Randy Green, senior vice-president, Asset Management with Sproule. “We are currently managing 502 producing wells, facilities and injectors, 19,000 land files and doing the accounting for 3,600 cost centres. On average, we can manage a property for $650 per month per producing well (this includes non-operated wells as well).

“The next step in our new energy paradigm is to effectively deal with abandonment and reclamation of the legacy assets. The industry needs to think out of the box, looking for alternative service / ownership models and / or evolving our regulatory liability management program. We need to address abandonment and reclamation of the legacy assets from a sustainability perspective to support growth in our industry.”

Transitioning the legacy assets to service companies would ensure an unrelenting focus on cost management, significant job opportunities and appropriate retirement of the abandonment and reclamation obligations, said Green.

Assuming commodity prices remain flat, service providers can play a major role in maximizing the value of these assets, as can a supportive regulatory environment for those assets where the future undiscounted cash flow could cover the undiscounted liabilities using today’s commodity prices. According to Sproule’s commodity forecast team, the analysis indicates that prices will remain relatively flat over the next 12 to 18 months pierced only by moderate fluctuations. As such, there is an opportunity to support our industry by transferring these legacy assets to the service sector.

“Currently we are being impacted by a regulatory liability management program not designed for a prolonged downturn or end of life assets,” Green said

Falling prices, lower industry activity and limited capital commitments to new projects have left many small and medium sized producers offside of their Licensee Liability Rating (LLR) and Liability Management Rating (LMR), creating abandonment and reclamation liabilities that can stifle growth. These companies are investing valuable time and resources into maintaining legacy wells and eventual abandonment and reclamation costs, which in some cases have hamstrung their ability to invest in new projects and grow production.

The LLR program was initiated by large oil and gas companies to ensure growth oriented companies maintained sufficient resources to cover abandonment and reclamation liabilities while growing. But with the conventional sector in contraction, the model no longer works as intended, subsequently negatively impacting many producers with the burden for the orphaned wells falling back on the remaining few.

The OWA’s inventory of wells for abandonment has soared during the downturn under the existing liability management system. The Alberta Energy Regulator (AER) and the provincial government are reviewing this in concert with stakeholders, recognizing the need to rethink the current framework.

For example, one of the biggest impediments is a restriction requiring companies to put down money in the form of cash or a letter of credit, with unintended consequences. “If you are an end-of-lifecycle company, you effectively must provide twice the capital you really need, because you have to place it with the regulator and then spend it to do the work before you can get it back. That model is very punitive,” Green said.

If our current liability management is stifling growth — is there a better solution?

One possible solution would be the creation of abandonment and reclamation trusts, whose sole purpose would be, firstly, maintaining production of legacy wells through their economic lifespan and, secondly, the eventual abandonment and reclamation of the wells, using current cash flow in both instances.

“The idea is to capture the residual value of the producing assets in the trusts to self-fund the abandonment and reclamation liabilities. The model works and provides potential for improved economics for stakeholders and service providers through outperformance.

“A further enhancement to the trust model would be to amend the existing tax structure to allow companies to carry expenses to the point where abandonment and reclamation take place,” Green said. Having a longer period to use expenses to offset positive cash flow would provide a smoothing mechanism.  This would be a similar provision that exists currently for pipelines and mining reclamation through Qualified Environmental Trusts.

“The dollars would be spent, but they may not be spent for another decade. Therefore, an effective tax vehicle would allow us to shelter the revenue until we conduct the abandonment and reclamation.

“It is better for our industry if we find the right market-driven solution to deal with these legacy assets in a responsible manner. It allows producers to continue to do what they do best, which is to use their intellectual and monetary capital to grow their portfolio rather than managing legacy assets,” said Green.

Sproule is a global energy consulting firm with a 65-year legacy of driving value for clients by helping professionals in the oil and gas sector make better business decisions — decisions that build sustainable prosperity from resource assets around the world. Sproule is anchored by deep geoscience and engineering expertise combined with a strong commercial understanding of energy markets. Headquartered in Calgary, Canada, Sproule has offices in Colombia, Brazil, and the Netherlands. Learn more at Sproule.com