By David Yager,
Entrepreneur. Consultant. Journalist. Political Activist.
It was billed as a court decision of major importance. In mid-May Alberta’s Court of Queen’s Bench determined that in the case of insolvent Redwater Energy Corp. secured lenders – the bank – had the right to cherry pick the assets to recover outstanding loans before the Alberta Energy Regulator (AER) could direct funds towards environmental cleanup by setting aside cash for well decommissiong (WD). The issue, of course, is this decision created more wells destined for the Orphan Well fund.
The court-appointed receivers for Redwater had been called upon by the AER to set aside funds for WD. In a Globe and Mail article May 20 Kelly Cryderman wrote, “The decision says that receivers do not have to take responsibility for assets they deem to have no economic value – including well sites requiring expensive environmental cleanups beyond their actual value”.
What the court really determined is who gets first call on the assets. As the senior secured creditor, the lender believed it should be entitled to recover its money first and the WD liabilities would follow if there was any cash left. AER disagreed and off to court they went. The case had an interesting but ultimately irrelevant political twist. The secured lender seeking repayment was Alberta Treasury Branch, an arm of the Alberta government, while the other party, AER, was another provincial agency.
The decision should surprise no one. The sanctity of debt, security and the rights of lenders to recover their funds has centuries of legal foundation in British common law and current federal law. The notion that an insolvent company must meet its regulatory and environmental obligations first is, by comparison, a relatively new concept.
Without passing moral judgement on the merits of the AER’s case, this is the right decision. Borrowers must be obligated to service their debts. This is a foundation of commerce. The holders of trillions of dollars in sovereign government bonds from all over the world would become understandably anxious if environmental cleanup obligations of the various countries ranked ahead of the debt holders. The integrity of debt is essential to the continued functioning of global capital markets.
The unanswered question is how did Alberta and its oilpatch get into this mess in the first place? According to AER figures Alberta entered the year with 77,658 “inactive” wellbores, more commonly described as “suspended”. These are wells that are not producing but are not abandoned nor the surface location reclaimed and remain the property and responsibility of the mineral title holder or lessee. In addition, another 768 (at March 31, 2016) wells were in Alberta’s Orphan Well Association program, ownerless wellbores to be cleaned up with cash from the rest of the oil and gas companies operating in the province. If each and every one of these could be satisfactorily reclaimed at only $100,000 each, this would require $7.8 billion.
This figure is likely low given rising WD costs. Then are another 196,000 active and producing wells in Alberta today. If the total cost of satisfactorily decommissiong all these (suspended plus active) averaged $200,00, the total liability would be $55 billion. You don’t have to be an oil analyst or economic guru to conclude Alberta’s black and blue oilpatch doesn’t have the money, nor is it likely to ever have the money unless crude gets back on the high side of US$100 a barrel. And the way things are going $55 billion may not be enough.
This conclusion is sacrilege given the current level of public discourse. The obligation of satisfactory WD falls on mineral rights lessee. The mantra “polluter must pay” is cited by governments and environmentalists regularly. Nobody in the oil industry has ever disputed that whoever drilled the well should abandon and clean it up. The problem is the backlog of wells that should be properly abandoned and reclaimed is growing and activity is near zero. The oilfield service sector that would benefit from WD activity is starving; oil companies with wellbores to abandon are trying to stay solvent; and the courts are ruling lenders have first charge on the assets, if there are any. What a mess.
What nobody is talking about, and what must be discussed, is the Alberta government’s role in creating this situation.
For the past 25 the rules and regulations surrounding satisfactory WD compliance have been growing increasingly complex and expensive. In 1990 Directive 9 demanded groundwater isolation meaning wells that weren’t cemented to surface when drilled would have to be re-cemented prior to abandonment. Obviously this is a good idea but according to the Canadian Association of Petroleum Producers (CAPP) Statistical Handbook, 181,753 had already been drilled in Canada prior to this directive, most of them in Alberta. This procedure was not required when these wells were drilled. So perforating, cement squeezes and proof of success through cement bond logs have become increasingly common when abandoning older wellbores.
The groundwater isolation rules were made even tougher in 2010 through Directive 20. Again, the regulatory changes were well intentioned but according to CAPP 468,019 wells – most of them in Alberta – had already been drilled. Depending on the construction of the wellbore, saline content of various aquifers and other factors, this again greatly increased the cost of WD for a lot of wellbores.
But it didn’t end there. The next step was Directive 50 in 2012 titled Drilling Waste Management. This effectively moved industry away from against the use of traditional excavated drilling sumps and flare pits, a hole in the ground into which drilling mud returns and cuttings were placed and stored while drilling was underway. This led to the development of today’s sumpless drilling (using tanks). While it cost more to drill the well this way it also eliminated cleaning up sumps and flare pits. Good idea, but again CAPP reports 489,745 wells had already been drilled what was now the wrong way, most of them in Alberta.
Directive 50 cites a parallel piece of legislation regarding site reclamation called Alberta Tier 1 and Tier 2 Soil and Groundwater Remediation Guidelines. It reads, in part, “Alberta Environment and Parks works with the public and industry to maintain soil and groundwater to the highest quality, applying codes of practice, guidelines, policies, and programs to protect them. Assessment and monitoring tools for restoring the quality of soil and groundwater to their full potential are also developed. The Tier 1 guidelines are generic guidelines for application at a range of sites within a given land use. The Tier 2 guidelines describe how to develop site-specific guidelines by modifying the Tier 1 guidelines using site-specific information.”
This has taken surface location reclamation to a whole new level. While abandoning the wellbore itself is relatively straightforward by comparison, the total time and cost of the surface site reclamation is often unknown. The operator of the well has to prove to regulators the site has been returned to the same condition is was in prior to drilling the well before a reclamation certificate is issued, which effectively means the file is closed for the mineral rights licensee. This can take several years on agricultural land because the oil company has to produce multiple crop samples proving the ability of the dirt to grow plants on the reclaimed site is the same as the surrounding lands. Many operators regard the compliance process as unpredictable and arbitrary. If the sump or flare pit was buried in a method acceptable to regulators at the time, the oil company may have to go back and retest the soil and possible dig it up and again if it fails the new guidelines.
Good idea? Sure, why not? Of course the environmental impact of oil and gas development should be as close to zero as possible.
But the cumulative impact of all the foregoing is the total cost of a successful WD project in Alberta is now often unknown. As was opined so many years ago, the road to hell is indeed paved with good intentions. In today’s tight market for cash the one thing any responsible oil company cannot agree to is approving a capital expenditure on a WD project when the total cost or completion date is unknown. The known cost is annual mineral rights rent and surface lease. What is unknown is WD liability. So increasingly oil companies kick the WD can down the road for another day.
Which brings us back to Redwater Energy, the growing suspended and Orphan Well count and a starving oil services sector. While so many are comfortable explaining the seriousness of the problem, nobody is talking about how to solve it. The closest anybody has come to breaking the log jam is an attempt by the Petroleum Services Association of Canada (PSAC) to persuade the federal and provincial governments to set aside funds to reduce the cost of WD through cash grants or royalty or tax credits to reduce the financial risks for well operators as an inducement to get on with WD activity.
While the Alberta government is correct in reminding oil companies it is their legal obligation to abandon expired wells and reclaim the site, nobody from the Crown nor the regulator has admitted nor acknowledged that 25 years of new and increasingly restrictive and complex rules and regulations have pushed the cost of satisfactory WD through the roof.
As importantly, nobody on the government nor regulatory side seems to publicly understand that when an oil company is faced with economic survival, its willingness to earmark funds for WD projects with an unknown total cost or time frame might be something they would intentionally avoid if there are alternatives. And the reality of the Redwater Energy court decision is that going broke by handing the keys to the bank is preferable to going broke more gradually trying to figure out how to satisfy governments and regulators who seem incapable of rendering an understandable decision on WD as simple as, “That will do”.
At this critical time for Alberta’s oil and gas industry there is no point in being doctrinaire. What is required is solutions, not a rehash of who should be doing what. To move ahead the province must acknowledge the reason the number of wells requiring WD is piling up is at least partially its responsibility after a quarter century of piling on with new, stricter and more expensive regulations without anticipating how they might affect the behavior of the industry.
This has been ignored or pushed into the future for so long it is likely impossible to ameliorate the situation without help from the government. Discussions with industry about relaxed regulations or a cap on WD liability would be a good place to start.
Otherwise, we will continue to talk about this problem for a long, long time.
About David Yager – Yager Management Ltd.
Based in Calgary, Alberta, David Yager is a former oilfield services executive and the principle of Yager Management Ltd. Yager Management provides management consultancy services to the oilfield services industry in a number of areas including M&A, Strategic Planning, Restructuring and Marketing. He has been writing about the upstream oil and gas industry and energy policy and issues since 1979.
David Yager can be reached at Ph: 403.850.6088 Email: [email protected]