Turning O&G Asset Liabilities Into Opportunities: Sproule’s Three-Phase Model

Decommissioning obligations may have an overwhelming impact on the viability of Western Canada’s oil and gas industry, says Randy Green, but he also sees a chance to empower stakeholders.

“This is a very unique situation, where we have some significant challenges, but we can turn those challenges into opportunities,” says Sproule’s asset management senior vice-president. Green notes decommissioning obligations can create jobs, GDP growth and fulfill ESG mandates.

Alberta alone has around 195,000 wells that are either legacy (producing wells greater than 10 years old), suspended or inactive wells. The liability associated with these wells, including associated pipelines and facilities equates to roughly $19.5 billion. The magnitude and timing of dealing with these obligations poses risk and uncertainty, which in turn creates investment hurdles for an energy sector already reeling in recent weeks.

“With the uncertainty of magnitude and timing around decommissioning obligations for suspended and inactive wells, the banks and investors for the most part treat the obligations as undiscounted liabilities. This can dramatically affect the valuation of a company, discouraging lenders and investors. It’s certainly one of the reasons that capital and bank debt have left the industry.

“Combine this with some of our regulatory uncertainty and our environmental and social governance responsibilities, and the industry is really being challenged.”

As decommissioning liabilities have come to the forefront over the last few years and there has been a realization that the current AER liability management program was not designed for end of life assets. Considerable thought and effort have been spent investigating potential industry, regulatory and policy solutions to the challenge.

Sproule and industry partners have proposed a three-phase licensing model that would ensure liabilities from future activity are addressed at the commissioning of a project, past liabilities are dealt with, growth companies could attract capital, and service companies would benefit from increased activity.

The model incorporates unique licences during growth, end of life assets and retirement. Phase 1 applies to a company that is drilling completing and producing wells for the purpose of generating cash flow for reinvestment and production growth (existing licence model). New wells would require some form of deposit, bond or insurance and existing liabilities would be covered off by a Corporate Health Report Card.

A Phase 2 licensee would be required to apply all free cash flow to maintenance and regulatory matters related to the assets and decommissioning. This licence would apply to a group of assets where the future cash flow is equal to the liabilities. A closure plan approved by the regulator and a trust governing the use of funds would be required components for a Phase 2 license.

A Phase 3 licensee could not produce (all assets are non-producing) and would require a closure plan and sufficient funds available for all decommissioning requirements.

“The E&P company could ring-fence end of life or retired assets and have a unique licence with specific regulatory requirements to deal with those assets.

“Alternatively, a service company could take over the end of life or retired assets. Transferring these assets to a service company is putting the assets in the hands of a party motivated to complete the decommissioning work” Green says, adding that the three-phase licence model would be far more applicable to our entire upstream lifecycle.

Funds either generated from cash flow or provided for pursuant to the Phase 3 licence could be placed in a trust, with the province’s energy regulator being a beneficiary. Green notes that Sproule has this trust model operational at a small scale with some clients but to date, policy does not allow the regulator to be a beneficiary. If done right, he suggested, this model could benefit larger E&Ps, smaller producers and energy services.

“It’s not untested, but we must try and influence the policy and regulatory framework to ensure we empower the whole concept.”

Getting inactive or suspended wells off the books for E&P companies

Convincing anyone to take over oil and gas assets to deal with the abandonment and reclamation, when the abandoned wells and reclaimed sites remain the responsibility of the licensee for life and 25 years respectively, is difficult to say the least, notes Green. It also presents “huge issues” for the regulator, because after 25 years many of these companies could be gone and there may be no entity left to hold accountable.

With respect to being able to offload or transfer licenses upon reclamation certification, Green highlighted one possible solution — an industry sponsored entity to hold all reclamation certified licences with an insurance program to cover any future liability. This would be an ideal scenario for insurance as the likelihood of a significant claims is small and the costs to insure would be minimal.

“You do that, and you create a different environment in terms of how to deal with these assets. If an E&P can ring-fence those assets, or a service company can take them over, then they’re now motivated to get the work done because they know that once the work is done and a reclamation certificate is issued, they can get rid of those licences.”

“If we can get inactive and suspended assets off the books of some of the producers, or identified uniquely as a separate licence and business, we may be able to support E&P companies during what is again, another incredibly challenging period. Long term, the goal is to have the banks and capital providers view E&P companies more favourably and potentially motivate capital and loan opportunities to return to the industry.”

Getting the word out

Prior to the collapse of global crude prices, the Alberta government had wanted to have a new liability management system in place for industry by the end of March. Green acknowledges this could now be delayed, but he still sees the opportunity to influence and create something that meets stakeholders needs and ensures the obligations are dealt with in a responsible fashion — for the future.

“We’re not sure how far along it is with the government at this point. It has to come from the government first, then down to the AER, and then the AER will figure out how to implement it.”

However, Greens says, Sproule has made several presentations regarding this concept, to educate and help influence government and regulators. Green notes that both the Petroleum Services Association of Canada (PSAC) and the Explorers and Producers Association of Canada (EPAC) have reviewed the proposal, canvassed members and are aligned with the model’s concept.

“We’re really trying to encourage industry support for some of these ideas, and ensure they are heard and considered when the new policy and regulatory framework is being built.”