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By David Yager
The province of Alberta has been in the oil and gas business for a long time. As have many major producing jurisdictions around the world.
Romania drilled its first oilwell at Baku in 1857. The Canadian Pacific Railway struck natural gas by accident while drilling for water near Medicine Hat in 1883. The East Texas oil gusher Spindletop blew out in 1901. Oil was discovered in Persia (now Iran) in 1908. The massive oil discoveries in Saudi Arabia occurred thirty years later, in 1938.
When it comes to hydrocarbons, society’s focus has always been on the future. Where will it come from? Will there be enough to keep up with a growing population? What will it cost?
The chaos created by Russia’s invasion of Ukraine has put security of supply back on the global agenda.
With climate change, the focus is still on the future. But it is about less oil, not more. For much of this century, the focus has been how to replace fossil fuels.
If we’re going to be allowed to stay in this business, then it must be decarbonized. But taking the “carbon” out of hydrocarbons is much easier to say than do.
The elephant in the room is how to materially reshape the industry’s future while simultaneously decommissioning the massive collection of legacy producing assets that helped fuel and build modern society.
A 2015 article in Science.org estimated that in the major producing regions of North America, over two million wells had already been drilled. Adding up surface facilities, access roads, storage sites, the total surface area impacted was over 30,000 square kilometers.
My own research concluded that in 2020 there were 2.7 million producing oil and gas wellbores globally. How many had been drilled but were no longer producing is harder to quantify. How many of those had been properly decommissioned and reclaimed (D&R) is unknown.
Then there’s the other assets including field processing plants and facilities, storage tanks and sites, subsurface storage caverns, refineries, distribution networks, offshore loading terminals, and tankers.
Plus hundreds of thousands of kilometers of pipelines and flowlines.
Globally, there are, or have been, over three million unique upstream oil and gas producing, processing and distribution assets created. As the world’s energy complex decarbonizes, these should be properly decommissioned to restore the land and protect the community.
Or end up abandoned and become somebody else’s problem because there was no industry left to clean them up.
Alberta has a disproportionate share of oil and gas producing assets relative to production because of larger numbers of low productivity wells.
According to public data, in 2021 there were 144,423 wells producing gas, conventional and heavy oil; about 47,000 gas processing assets and oil production batteries; 91,773 inactive wells; 80,992 abandoned wellbores without surface reclamation; eight oil sands mines; 25 thermal heavy oil recovery projects; eight heavy oil upgraders; four ethane plants; 26 petrochemical facilities; five oil refineries; nine operating coal mines; and over 440,000 km. of buried flowlines and pipelines.
That totals over 364,000 unique fossil fuel extraction and processing assets that, everyone assumes, will someday be decommissioned and reclaimed.
It is the legal obligation of the asset owner/developer to execute D&R to the current standards of the presiding jurisdiction. In Alberta, every balance sheet of the companies owning and operating these assets carries a D&R Asset Retirement Obligation (ARO).
Global D&R challenges are growing as the number of assets increases, costs rise as acceptable standards become more expensive and complex, and as more assets become uneconomic to commercially operate because of reservoir depletion, age, safety, or the energy transition to lower carbon energy sources.
The current goal of decarbonizing by replacing fossil fuels with lower carbon energy sources will significantly increase this obligation. The term coined by the financial community is “stranded assets.”
But “stranded assets” primarily refers to the economic value – a warning to investors to avoid this sector because of diminished future returns.
What this doesn’t fully anticipate is the massive D&R liabilities of an industry that will have continually reduced cash flow with which to clean up after itself.
“Stranded assets” anticipates zero value. ARO is about capital assets with negative value.
As so many of the world’s policy makers and energy transition advocates remain determined to starve the fossil fuel industry of cash flow, they really should think this through.
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The primary focus of decarbonization is the adoption of low carbon replacement energy sources, or reducing the carbon emissions of fossil fuels through various forms of emissions reduction including Carbon Capture Utilization and Storage (CCUS) and carbon taxes.
A new tool invented this century by “civil society” to accelerate decarbonization is the fossil fuel divestment movement and its more recent, broader and sophisticated derivative, ESG investing. This stands for Environmental, Social and Corporate Governance objectives. Decarbonization touches all three.
It started on university campuses, where it became morally reprehensible to own shares in companies producing oil, coal or natural gas. This expanded to debt financing and equity capital and now includes withdrawing liability and asset insurance.
There have been many concerns raised about the growing number of mature assets requiring D&R and whether or not industry provisions for future liabilities are adequate.
To its credit, the Alberta government has been proactive in several ways.
One is steadily increasing the minimum ARO expenditures by producers. The figure for 2023 is $700 million, the highest in history. It will rise again in 2024.
This is on top of winding down a $1 billion federally funded Site Reclamation Program that resulted in thousands of wellbore abandonments. The Orphan Well Association also received significant funding and has done a great job catching up with the thousands of wells it inherited due to insolvencies during a period when oil and prices collapsed and debt and equity financing for junior oil companies all but disappeared.
Regulators have tightened up financial requirements for companies wanting to drill new wells or purchase producing assets. More attention is paid today about the financial capability of developers and producers than ever before.
In the bigger picture, the pressure to decarbonize has relaxed somewhat. Since fossil fuel prices started rising and Russia invaded Ukraine, security of supply is again very important. This has tempered the determination to get out of the oil and gas business as quickly as possible, at least for now.
More pressing issues include energy shortages, rising costs, security of supply, and the failure of renewable energy sources like wind and solar to supply energy 24/7/365.
Decades of affordable energy-on-demand from powerful and reliable oil, gas and coal have created the expectation that when you flick the switch on the wall, the lights are supposed to turn on.
Higher oil and gas prices have greatly improved producer cash flows. Wells economic to produce have been put back on production. Balance sheets have been strengthened.
While producers are enjoying vastly improved financial performance, all stakeholders must acknowledge that there remains significant competition for these funds.
Canadian producers are expected to reduce emissions by 42% by 2030 in order to meet federal emission reduction targets. This will cost tens of billions of dollars. The federal government has introduced tax incentives to de-risk investments and accelerate activity for CCUS and oil sands, and Alberta is considering participating.
But the focus is mainly oil sands. Full compliance industry-wide will require more billions of capital investment in activities and assets that generate no direct cash flow.
Unlike producing carbon-based energy which creates wealth, there’s no cash flow generated getting rid of carbon. This is financed from cash flow, tax deductions, carbon tax offsets, and society’s permission to stay in the oil and gas business. Capital providers won’t finance assets with no return.
Eventually, decarbonization will become just another operating cost. Which is fine. Industry has a long, innovative and successful history of making its operations cleaner and more environmentally benign.
But non-compliance will create more assets requiring D&R if they are rendered uneconomic to produce. This will depend upon how emission reduction targets are measured and enforced.
At the same time, producers are dealing with capital restraints in the form of restricted access to insurance, debt and equity capital.
And multiple levels of society with their hand out demanding more cash from producers for various reasons. This includes so-called “windfall” profits taxes in various jurisdictions.
As a result the “reinvestment ratio” – the amount of free cash flow reinvested in future production through capital expenditures – is the lowest in history. Producers have been repairing their balance sheets by paying down debt and anticipating possibly having to sustain their companies only on cash flow from existing production, or becoming self-insured for the first time.
Commodity prices in North America are starting 2023 much lower than the highest levels in 2022. As this column is written, WTI is down nearly US$50 a barrel from its peak in June of last year. While AECO spot gas at $3/GJ is great compared to past years, it still half of its highest price in the second quarter of 2022.
ARC Energy Research Institute forecasts for 2022 and 2023, while preliminary, indicate a material correction year-over-year.
For 2022 ARC estimates the value of all production was $227 billion generating after-tax cash low of $121 billion.
But if producers were reluctant to make major long term spending commitments based on 2022 commodity prices, that was certainly the right decision.
Because ARC’s revenue estimate for 2023 is down to $185 billion, and after-tax cash flow $44 billion lower at $77 billion.
$44 billion is a lot of money. Competition for that cash is intense. Future costs will rise because of decarbonization investments.
Meanwhile, the cost of everything else is rising as witnessed by the ballooning costs of the Trans Mountain and Coastal GasLink pipelines. It is unlikely there will be any capital asset construction discounts when big CCUS investments begin.
At the same time, legacy costs are rising because of a growing ARO base and increasingly expensive D&R obligations for older and more complex assets.
The perfect scenario is impossible. This is where fossil fuel producers continue to power the world until they are no longer required; pay tens of billions in taxes and royalties as long as possible; reduce emissions; then go out of business in an orderly fashion while miraculously cleaning up after themselves as they shut the doors.
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It is the expectation of the province, producers and Albertans that all 360,000+ legacy assets will be properly decommissioned.
But there are multiple unanticipated forces at play.
Historically, the focus has been on aggressive but orderly development with the understanding that everything will be cleaned up at some point.
But the primary focus of today’s energy policies is the future, not the past. Further, they are directionally biased towards going out of the fossil fuel business, not expanding it.
Meanwhile, just staying in the business will cost more.
This has changed the channel for major legacy producing jurisdictions like Alberta in more ways that is publicly acknowledged.
Another factor is that changing D&R standards over time have greatly increased ARO costs. Past wells that were drilled and assets that were constructed that fully complied with the regulations of the day must now meet standards that did not exist when the assets were created.
Had the new regulations been in place when the assets were created, things would have been done differently. Or perhaps not done at all.
For more complex mature assets, significant unknowns hamper accelerated D&R activity; total cost, completion date and if and when a reclamation certificate will ever be issued.
Nobody paid much attention for decades. Because of the world’s growing population, expanding energy needs, and oil shortages and energy crisis of periods like the 1970s, this issue was rarely considered by policy makers of the day.
However, in 2023 the responsible approach for continued leadership on resource stewardship is to focus on the past as well as the future.
Chanting “polluter must pay” solves nothing. Staying in the oil business of the future while dealing with the oil business of the past is a new policy challenge that Alberta has not appropriately addressed.
Nor has any other oil and gas producing jurisdiction in the world.
The solution is new, better and cheaper tools in the D&R toolbox. The problem is that new ways of doing the old job better require activity in the space for testing and proof of concept.
And few, if any, licensees are willing to take short term commercial risks on new methods. Years of tough times and continued competition for cash flow has reduced the number of “first movers” when it comes to supporting new tools and technologies for the long-term reduction of asset retirement costs.
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Alberta’s oil and gas industry is a crossroads.
Besides the aforementioned issues, municipalities still want their property taxes; surface rights holders demand their lease payments; consumers want lower prices; investors want higher returns today because of uncertainty over the industry’s long-term future; the economy wants more jobs and investment; and a growing world wants increased oil and gas production if for no other reason than to further isolate Russia.
To properly do everything 21st century society demands, the oil and gas industry needs more money, not less.
Alternatively, the expectations among those dispensing advice about what the oil business should do next must be materially diminished.
You read it here first.
David Yager is a Calgary oil service executive, energy policy analyst, oil and gas writer, and author of From Miracle to Menace – Alberta, A Carbon Story.
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