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High-profile environmental liability cases and recent bankruptcies have resulted in a higher awareness of asset retirement obligations (ARO) among banks and investors. It’s not enough to examine the potential profit of an acquisition or investment opportunity. The potential liability must also be known before an investment decision is made, as it can be the difference between an incredible bargain and an albatross asset.
The Problem
Banks, investment firms, law firms, and any third party tasked with evaluating potential transactions and assessing producers looking for capital need a trustworthy, independent tool to evaluate liabilities. Internal ARO calculations provided by borrowers might not be reliable. Numbers provided by the Alberta Energy Regulator (AER) are often incomplete and are no longer publicly available. Third party evaluators need a standardized way of calculating ARO, with a process that provides complete data in a consistent way for each evaluation they do.
Investment capital for oil and gas has never been tighter. With margins this thin, it’s essential that lenders and evaluators have the tools they need to properly assess the liability risk posed by each potential investment.
The Company
Company X (we’ll refer to them as simply the “Bank”) is a high-profile investment bank, with a significant portfolio in the oil and gas industry. The Bank has two main needs for accurate ARO data. First, they assist their clients with advice and funding for acquisition and divesture work. Second, they provide funding for their clients for operations and need to do due diligence on these companies to reduce risk.
The Solution
For years, the Bank had to rely on and trust data from their clients or their clients’ target A&D opportunity. In this case, the Bank had a client attempting to purchase an entire small natural gas producer and needed advice and funding. Looking at the natural gas producer’s reserve numbers, the Bank felt confident as they had been evaluated by a third-party engineering firm known for its integrity in their evaluations.
However, the natural gas producer’s future liability evaluation had no such scrutiny and was based on their own assumptions and cost model. This left both the buyer and the Bank wondering how to properly evaluate this increasingly important number that could be the difference between a good purchase or not.
In the past, the Bank could look to the regulator to get a sense of what this liability might be, but even that was often an incomplete picture. This look over-the-fence by the regulator could be faulty, if, for example, it did not include obligations on non-operated working interest liabilities, or if working interest was significantly different than 100%. Regardless, that over-the-fence look provided by the regulator no longer exists today.
The Bank required a more reliable resource for quick evaluations – one that could speed up the process for their clients looking to capitalize on a good deal.
The Bank turned to XI’s ARO Manager to provide a standard way to assess liabilities for this type of situation, one they could use for several different companies. Rather than relying on data provided by applicants or the AER, they invested in an independent tool that makes ARO assessments reliable and easy.
Figure 1 – Projects based on target companies are easy to create in ARO Manager.
Using ARO Manager, the Bank was able to generate their own numbers immediately when approached with an evaluation for their client. They were able to pull all the selling producer’s wells, facilities, and pipelines directly into the product and view it against either XI’s industry standard vetted cost model, the government’s cost model, or their client’s own cost model in order to get three pictures of the obligations. This gave them a much stronger sense of true liability. The Bank decided to refer to XI’s cost model to remove bias and ARO calculation practices that might be questionable, ensuring their ARO calculations were on par with any other client evaluations.
Figure 2 – Easily compare project liability payment projections.
With ARO Manager, the Bank saw a full working interest calculation of the target company’s liability. They then applied their own discount and inflation rate to uncover when the liabilities would come due and what that would do to the overall Net Present Value of the purchase. Further, since it also calculated the RLI of the wells, the liability schedule was produced in seconds as opposed to the days or weeks it would have taken previously in the data room.
The Result
As a result of the evaluation capabilities provided by ARO Manager, the Bank was able to clearly evaluate the future profitability of this deal. While the reserve numbers provided by the engineering firm were solid, when the deemed liabilities were factored in, the purchase was no longer as enticing. The Bank used this assessment to advise their client to not pursue this particular asset, saving them from assuming $48 million in discounted liabilities ($62M undiscounted) on a $31 million asset.
Figure 3 – Examining the ARO of a potential purchase revealed a distressed asset, leading the bank to advise against the purchase.
Instead, the Bank recommended their client use their capital on a second-choice opportunity, as their independent ARO assessment indicated a healthier liability balance sheet with a liability schedule that fit better to their client’s roadmap. This other opportunity was rated slightly lower from a reserves-standpoint by third-party engineering firm but became the much better opportunity when liabilities were evaluated by the Bank using ARO Manager. In this deal, ARO obligations were evaluated to be $2.7 million discounted, or $4 million undiscounted, but the projected value of the assets was $24 million, significantly reducing the risk of the purchase.
Figure 4 – The ARO of another potential purchase revealed it to be the better asset, with much less liability in comparison to the asset’s value.
By using ARO Manager, the Bank was able to make unbiased, educated decisions on their lending practices, which, in turn, helped their client better understand their return on investment. They were able to do this through:
- A standard assessment tool with an industry-standard cost model, ensuring all their ARO calculations are on par with each other.
- Full working interest calculation estimates for each property they examined.
- Instantly-produced liability schedules that helped them see how the assets fit their client’s timelines.
- Reports and summaries that gave them easy access to all the ARO data they required.
- The ability to compare liabilities for multiple companies quickly to better understand risk upfront.
Learn more about the industry’s leading ARO management tool
XI Technologies, the maker of AssetBook – the WCSB’s most powerful and complete web-based application for informed decision making, competitive analysis, A&D scoping, asset planning, and business development – has developed the industry’s first web-based software tools for LLR analysis and ARO cost management and tracking. To learn more, visit our website or contact us to request a demo.
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