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Why Provincial Regulations, Coupled with Low Oil Prices, Are Strong-Arming Some Juniors Out of Business

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Some 230 juniors in Alberta are currently teetering on the edge of brankruptcy

BY NICK WILSON

When low oil prices force producers to shut in wells, it’s never long before the regulators call. Alberta Energy can revoke mineral rights and the Alberta Energy Regulator (AER) can force abandonment in some circumstances. Abandonment can cost up to $300,000, depending on the well’s location and age. Some 230 juniors are currently teetering on the edge of bankruptcy, according to the Land Integrity Foundation.

Brad Herald, the Canadian Association of Petroleum Producers’ vice-president of Western Canada, says there are two parts to protecting the public from dormant wells. At the front end is the Licensee Liability Ratio (LLR), which tests assets against liabilities. If this ratio falls below one, “the AER tells the owner to close some infrastructure, sell some stuff, restart production or pay a deposit,” Herald says. “It’s hard on companies right now, but ultimately the public is protected.” The Orphan Well Association is on the back end, where collectively the industry pays for the safety net to protect the public.

Alberta Energy says that after 12 months of non-productivity, it considers serving a notice that can cancel a well owner’s mineral rights. The notice gives a company one year to prove productivity. This can be done by either demonstrating the well is capable of producing in paying quantities, or providing geological or technical data proving productivity. “A company of any size can be served a notice of non-productivity and regardless of size, all companies have equal opportunity to prove the agreement productive with supporting geological and/or technical data,” says an Alberta Energy spokesperson. But some juniors don’t have the wherewithal to provide such analysis. Troy Sidloski, a consultant for Pristine Oil Field Services, says “current regulations sometimes force companies to put cement to a well when it’s potentially still viable in the future. These companies should be afforded some breathing room in recognition that their efforts are important to total recoveries and revenues for the province.”

Fortunately, there are solutions. The Land Integrity Foundation (LIF), a non-profit consultancy, provides a management plan and the assessment of juniors’ wells for the cost of a membership fee that’s kept affordable by employing petroleum engineering students. Deidre Macht, the LIF’s director says, “Asset values and liabilities are often riddled with assumptions. For example, a single well compressor can serve up to 10 wells, so a 10-well liability can be assessed [by the AER] in the belief that the compressor is indeed being utilized to its maximum capacity. The onus is on a one-well firm to come back with a defense argument for changing that application assumption.” The LIF assesses which wells are liable and plugs in the technology and administrative paperwork and charts the production declines. It provides options that would result in one of several outcomes: switch the facility from a liability to an asset, increase the value of the asset or mitigate the risk associated with the abandonment.

Another solution is that the regulations inadvertently allow abandoned wells to be put to other uses such as geothermal energy. Simply putting a greenhouse over the well and adding an electrical pump and heat exchanger changes the well use, which means it only has to carry out zonal abandonment—plugging the well above its production perforations in the well casing. It avoids surface abandonment—restoring the land back to its original state before drilling—which is the lion’s share of most abandonment costs. Mitchell Pomphrey, CEO of Pomphrey Industries, which offers consultancy work on well conversions, including Canada’s first abandoned well to geothermal conversion at Leduc #1 Energy Discovery Centre, says this can be done within the existing directives. “It would be a win-win for well licensees, Albertans and geothermal system integrators,” he says. “It would provide a way to defer the capital cost of surface abandonment indefinitely.” Pomphrey has filed a ground-breaking application for the centre to Alberta Energy to convert the well, which will pave the way for oil producers.

Alison Thompson, chair of the Canadian Geothermal Energy Association, says geothermal energy in western oil-producing provinces offers a significant opportunity for renewable energy, as well as for food production. “The technology transfer between the oil and geothermal industries is significant and the deployment of geothermal energy in Alberta is a meaningful way to help put the oil patch back to work,” she says. Jason Edwards, CEO of Sundial Energy, an oilfield services firm that works in geothermal energy, says the idea can go beyond greenhouses. If an oil producer’s off-gas-grid buildings are close to an abandoned well and use electrical heaters in each building, a geosystem is a cheaper option, he says. “At $100 per barrel nobody cared about these efficiencies, but in this low-price environment cost cutting is a top priority.” Sundial Energy will carry out the conversion work at Leduc #1 Energy Discovery Centre, which is part of its Living Energy Project that will create the world’s first zero carbon oil museum.

Pomphrey says potential geothermal producers could bring in a third party operator as a partner to do the conversion work on their well leases, and then theoretically apply to the AER for a complete refund or relief from their abandonment obligations. “You would effectively be saying that you have completed a zonal abandonment and performed as much surface reclamation as possible, if any, and it is now the responsibility of the third party,” he says. This would follow transferring some control of the asset to them, so they benefit from the geothermal heat to incent the bailout, he says. Pomphrey would like the AER to compare the risk profiles of new energy applications derived from oil wells, such as space heating and cooling, and vertical farming—an extension of the growing season—and apply a different set of liability management regulations to geothermal operators. Thompson recommends that oil producers who convert abandoned wells to geosystems should be able to claim tax benefits and carbon credits.

The next rules that could hurt some juniors lurk just over the horizon with new methane regulations. Prime Minister Justin Trudeau announced in March that Canada will cut the oil and gas sector’s methane emissions to 45 percent below 2012 levels by 2025. This compliments the Alberta government’s planned 45 percent reduction of the province’s methane output from all sources by 2025. The provincial government says in an online report that Alberta’s oil and gas industry is the largest source, accounting for 70 percent of emissions—spewing out 30.4 megatons in 2013. The government will take action on venting and fugitive methane, including enhanced measurement and reporting requirements for facilities.

The plan echoes a report into well emissions by University of Waterloo, which calls for drastic improvement in monitoring and regulation, including more oversight of wellbore cementing and “doing it right in the first place.” The report says 6 percent of Albertan wells leak methane, 10 percent of B.C.’s and 20 percent of Saskatchewan’s.

Geothermal conversion offers a partial solution. “When it comes to methane leakage, using an abandoned well for geothermal heating puts a pair of eyes on it,” Edwards says. Any methane leakage into the well bore would trigger an immediate sudden pressure change in the geo-system.

Another solution for producers with shut-in wells could be federal funding of a well-abandonment program. In March, the Petroleum Services Association of Canada (PSAC) asked the federal government for $500 million to abandon some of Alberta’s 75,000 suspended wells. CEO of PSAC Mark Salkeld says, “While we absolutely agree well decommissioning is the responsibility of the licensee, economic circumstances and steadily increasing costs due to ever-improving regulations are causing this work to be delayed or postponed and regular activity has almost come to a standstill.” Ottawa, however, didn’t include such a provision in the federal budget announced in March, but it could consider it for future budgets.

These solutions come too late for Ray Desaulniers, owner of Welleco Ventures a junior oil producer, who says he’s being driven into bankruptcy by red tape. He says after three months of shutting in production—not the 12 months that the Alberta Energy spokesperson said is given before serving a mineral rights cancellation notice—he was served with the Section 18 notice. Welleco Ventures had planned to lower its operating costs by putting waste water into a nearby CNRL disposal well, instead of trucking it out. This would have made the well profitable again and allowed its restart. In December, CNRL decided it would transfer the disposal well, “but it was too late. We had been shut in for close to a year and our LLR assigned by the AER was not in compliance so they would not approve the transfer. To be in compliance I would have to come up with abandonment costs of two wells plus the well from CNRL. It is impossible to raise,” he says.

Although, an abandonment would improve the LLR of his two wells, should they no longer be viable assets, it’s a cost Desaulniers could not swallow at the time.

“If I were a farmer losing everything and was being forced into bankruptcy by a Government policy I guarantee there would be demonstrations in front of the legislature. At this point I’m nearing bankruptcy—the province has bankrupted me,” Desaulniers says. Alberta Energy, which implements policies set by the previous government, wouldn’t comment on this particular case.

Sidloski says, “If AER didn’t make companies put up these bonds the government would be left holding the bag. It’s tough to get it right. The AER says it operates under the mandate to protect industry, and ultimately government, from assuming abandonment and reclamation costs.” Desaulniers says, “All that is needed is a relaxation of layers of overregulation, a break on all levels of governments for lease, access, property taxes, royalties for the low producing wells. We also need a completely different system for regulating small producers.”

Gary Leach, the president of the Explorers and Producers Association of Canada (EPAC), says, “There will always be situations at the margin where the Liability Management Program is unable to deliver an optimal solution for all affected parties.” The design of the program is not static and these problem situations offer ideas for improvement—it’s updated regularly. Ideas to improve the program, including assessing the impacts of the current deep economic downturn, are the subject of ongoing dialog between EPAC, CAPP, the AER and the Orphan Well Association, he says. The Alberta program has been copied very closely in both B.C. and Saskatchewan. “There is no U.S. jurisdiction, to our knowledge, which offers anything comparable to the comprehensive scope of the Alberta program,” Leach says.

Finding a Good Home

Some of Alberta’s abandoned wells are long-lost orphans, whose owners left them decades ago. They are looked after by the Orphan Well Association (OWA), an industry-funded, non-profit organization unique to Alberta. It manages the abandonment of wells and answers to the AER, which collects the Orphan Fund Levy from oil firms. Its remit spans into another century. Two years after Adolf Hitler came to power Tenwell Gas & Oil drilled its only well in Vermillion, Alberta, abandoning it three years before WWII ended. In 2014, the OWA installed a soil gas management system to stop its methane leaks.

But some of the province’s 170,000 abandoned wells became orphaned more recently as the crisis hit home. In 2014/15, the OWA managed over $16 million of orphan abandonment and reclamation work as the number of orphan wells needing abandonment soared 700 percent to 591 from the year before, partly due to bankruptcies. Brad Herald, who’s also an OWA director, says, “We are on course to have an extra 180 wells this year, which is up significantly from last year, and there are big receiverships pending, including Spyglass, which may add more.” OWA’s mandate is to work with liabilities not assets. LIF Director Deirdre Macht says, “There are 230 companies at zero for their LLR (below threshold)—if they roll into OWA, which we call ‘the morgue,’ they’re done.”

Herald, however, says just because a company goes into receivership doesn’t mean all its wells end up abandoned as things can sell in receivership for 25 cents on the original dollar—the assets are repriced so OWA doesn’t see these wells. Low oil prices also drive up the number of abandoned wells as falling contractor prices allow more wells to be abandoned for less money, he says.

Inventory of all wells drilled in Alberta

12-junior-bankruptcy-infographic

Well Abandonment

“The most expensive part of abandoning a well is returning the surface lease back to the way you found it before drilling started,” says retired rig manager Dan Claypool. “In a remote location, a long road that was used for 50 years could have gravel driven ten feet into the ground by heavy trucks.” Digging that up is why some abandonments cost up to $300,000, he says. Surface abandonment also includes removing the wellhead.

Full abandonment includes both surface and downhole work. Zone abandonment means formally abandoning a producing zone and going up-hole to produce above it. A bridge plug—a packer—saddles across the well to take pressure off the wellhead. The cement plug above the producing zone and casing perforations protects the bridge plug. A corrosion inhibitor is added to the water that fills up the bore below the plug.

Well abandonment is covered by AER’s Directive 020 Well Abandonment Guide.

Typical steps to abandon a well also include checking the cement outside the casing, using a cement log bond. If groundwater protection is required or if the well is leaking (normally methane), remedial repairs are also needed.

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