Old or spent oil and gas wells have accrued across Alberta in the thousands. The environmental risk in the province is high and rising, and the financial liabilities are, too: Analysis by the C.D. Howe Institute in 2017 showed that the public cost could be in the billions of dollars if companies designated as “financially fragile” by the Alberta Energy Regulator (AER) simply abandoned their wells for taxpayers to clean up – an extreme scenario that is not beyond contemplation.
So amid reports about budget cuts, layoffs and alleged mismanagement on the part of the AER’s former CEO, the regulator has faced increasing pressure to change its one-size-fits-all rules, which use the valuations of operators’ assets to determine whether a company is financially fragile. This calculation may underestimate how many such companies there truly are in the face of fluctuating energy prices.
To misquote Tolstoy: happy oil and gas companies are all alike, but every unhappy oil and gas company is unhappy in its own way.
But the potential liabilities for the reclamation costs for both disused oil and gas wells and the oil sands will require that Alberta’s regulator more fundamentally adjust its approach. There is a better way beyond just reducing the reliance on arbitrary regulatory rules: allowing the private sector to step in to help achieve provincial cleanup goals and put an accurate price on the riskiness of companies.
The Supreme Court of Canada’s decision in Orphan Well Association v. Grant Thornton (also known as the Redwater case) last year effectively prevents trustees from “cream-skimming” good assets from bankrupt companies while leaving the public to hold the bag for remediation costs. As University of Calgary professor Fenner Stewart has argued, allowing bankrupt companies to avoid their environmental obligations would have undermined a long-established covenant for Alberta’s oil and gas sector. Nonetheless, the Court’s holding does not solve Alberta’s exposure to unfunded cleanup costs.
First, in the immediate term, the AER needs to be better attuned to the potential for pre-insolvency companies to “dump the dregs," by which an operator can return the best assets in an ongoing entity while transferring costly cleanup liabilities into fragile companies. For example, the trustee of the now-bankrupt Sequoia Resources alleges that another company transferred aging natural gas wells to Sequoia in a non-arm’s-length transaction that sunk the company and left the Alberta Energy Regulator with $225-million in cleanup costs. The regulator is also currently examining such a deal in which Shell would sell a significant number of sour gas wells in southern Alberta to a subsidiary of a much smaller Calgary-based company.
Second, to reduce the public exposure to liabilities, Alberta should gradually introduce additional bonding requirements that shift environmental liabilities to operators and their creditors. Such bonding requirements would also leverage the private market to assess and price the credit risk for particular operators. For example, any financial institution issuing a letter of credit for environmental liabilities would need to closely scrutinize the given company’s solvency. The government would merely need to require all companies have the third-party financial security available to clean up their wells. Private creditors would then price collateral according to the given company’s risk of insolvency and costs of cleanup.
The presently fragile state of Alberta’s exploration and production companies cannot be ignored. Although it resulted in the right decision, Redwater has reportedly further cooled creditors’ willingness to lend to junior oil and gas companies. While necessary, new bonding requirements should be phased in to avoid perversely tipping companies into insolvency. Nonetheless, Alberta must plot a clear path to address the looming risks and provide a schedule for ramping up operators’ obligation to post adequate financial security.
And then there’s the issue of the remediation of oil-sands mines. Indeed, the scale of fiscal burden from orphan oil and gas wells pales against Alberta’s potential long-term exposure to these costs. As of June, 2018, the Alberta Energy Regulator held $1.46-billion in financial security – $940-million of that on behalf of oil sands mines – against an estimated $31.4-billion liability for oil sands and coal mines. This liability would be equivalent to roughly 9 per cent of Alberta’s present GDP and more than half of the provincial government’s annual budget.
By requiring oil sands miners to provide collateral to cover their expected remediation costs, Alberta’s financial security program is a step in the right direction. However, the government policy on oil sands mines falls into the same trap of governments and regulators attempting to quantify something that private insurers can likely do better. In a report released in 2015, the province’s Auditor-General said that the government used the wrong asset calculations to reflect risk, underestimated the potential impact of future price declines, and did not vary the treatment of proven versus probable reserves. The private sector would have the highest incentive to get these numbers right to properly account for risk.
Given the scale of the potential liability, it is essential that Alberta ensure the adequacy of financial security for ultimate environmental cleanup and structure programs to promote progressive closure and prompt remediation. If the government does not fix the problem, taxpayers and financially healthy oil and gas companies will need to foot the cleanup bill. And then everyone would be unhappy in the same way.
Grant Bishop is associate director of research at the C.D. Howe Institute. Benjamin Dachis is director of public affairs at the C.D. Howe Institute.