Skyrocketing inactive well counts are driving major changes to Alberta’s liability management regulations, two experts told an exclusive Daily Oil Bulletin subscriber webinar held in September.

Key changes to the liability management framework, released in July 2020, include liability reduction spending targets and timelines, corporate financial health assessments, and legacy and post-closure site management requirements, said Brad Herald, vice-president for Western Canada Operations for the Canadian Association of Petroleum Producers (CAPP). Herald described the new liability framework as the “most significant package of changes in a generation.”

The framework is currently being converted into regulations at the AER, with the final draft of a new Directive expected this fall.

Low commodity prices, COVID-19, and a lack of focus on closure in Western Canada has led to a large inactive well inventory, said Herald. In Alberta, there are now 96,000 inactive wells. The tough economic times have also resulted in a major increase in orphan wells, climbing from 578 in 2014 to 7,782 in 2020 as companies went bankrupt throughout the downturn. The Orphan Well Association (OWA) budget has climbed to $72 million from $12 million in response. While the OWA is funded by industry, there is concern the public could be left holding the bag if numbers were allowed to increase.

“The bottom line for government is to protect the public from liability of orphan sites,” Herald said.

Adding to the urgency in dealing with inactive wells was the four-year saga surrounding Redwater Energy Corp. In 2015, Redwater became insolvent and its receiver advised the Alberta Energy Regulator (AER) that it would only take control of around 20 of the 127 sites that still held value. AER issued a closure order, and the trustee/receiver disclaimed the uneconomic assets. The case worked its way up to the Supreme Court of Canada (SCC), and in early 2019 the court found receivers or trustees cannot walk away from the environmental obligations. Had the case gone the other way, it would have had significant impacts on the OWA, said Herald.

In the time leading up to the SCC decision, receivers and trustees renounced their interest in more than 10,000 AER-licensed sites. Renounced sites had deemed liabilities of almost $335 million, increasing OWA’s inventory by more than 300 per cent.

“Redwater was the point where the potential risks crystalized,” said Herald.

Both the previous Alberta NDP government and current UCP government, along with CAPP, have put a high priority on reducing the inactive well count. CAPP’s goal throughout has been to influence the legislation and new regulations to ensure they took a systematic approach to both reducing inactive assets while managing costs, said Herald.

The AER is currently building the new liability management framework into a Directive containing the requirements and processes that licensees must follow in managing their asset retirement obligations (AROs).

“This is the first time the regulator has been given legislation to reduce AROs,” said Mark Taylor, a former AER executive now leading Taylor Energy Advisors. “Up until the last two governments there was not much enthusiasm in government to provide a legislative background for new regulations.”

The new Directive will set out mandatory annual spending targets for well closure activity, said Taylor. But it will not proscribe to licensees how the money must be spent. It will allow for technology development, area-based closure efforts, and other opportunities to optimize and manage ARO costs. “Proscriptive regulations limit that. The legislation is focused on outcomes.”

The mandatory spending targets provide flexibility to the AER to manage inactive well counts, Taylor adds. “It’s easy to change spending targets. If counts come down like a rock it can tighten up on spending targets. Regulators can turn the dial up to reduce well counts if needed. It’s a simple tool and very transparent. The spending targets are released years out so companies can plan.”

Another key element of the new regulations is a much more intensive review of the financial health of licensees throughout the lifecycle of the assets they hold, designed to replace the Licensee Liability Rating (LLR) program.

“The LLR is not a tool designed to assess the health of a company,” said Taylor, pointing out there have been companies reporting good LLR scores that went into insolvency a month or two later.

The new system will take a holistic view of the financial health of operators that seeks to understand the short-, medium-, and long-term risks facing licensees. For public companies, it will use existing financial data to identify risks. For private companies it will use data that lenders would use in assessing risks.

“It’s about full lifecycle management,” Taylor said. “Historically, no one worried about AROs until end of life. Now licensees have to focus on AROs before they have one foot into insolvency. They need to be on top of AROs early on.”

Taylor said the new Directive is unlikely to be the last word on dealing with the backlog of inactive assets.

“There is going to be additional updates and likely adjustments,” he said.

For deeper insights into the how the new asset liability regulations could impact your business, please register for our Dec. 2 course Navigating new AER regulations for liability management at: https://learning.jwnenergy.com/store/1198610-navigating-the-new-aer-regulations-for-liability-management-dec-2-2021