Alberta Energy Regulators (AER), formerlyÂ Energy Resources Conservation Board (ERCB), implemented a revised Licensee Liability Ratings (LLR) program effective May 1, 2013. These changes resulted from extensive consultation with industry and were supported by Canadian Association of Petroleum Producers (CAPP) and the Explorers and Producers Association of Canada (EPAC). The LLR program applies to all upstream oil and gas wells, facilities and pipelines.
The LLR program was developed to prevent Alberta taxpayers from assuming liability for suspension, abandonment, and remediation and reclamation costs from defunct licensees. Currently there are over 60,000 inactive wells in Alberta and this number will increase significantly as the resource depletes.
Some of the pressure to reform came from Albertaâ€™s Auditor General, industry, land ownersÂ (a large portion of it being the Crown) and environmentalists. The program is designed to be phased in over a three year period â€“ May 2013, May 2014 and May 2015.
In essence, the LLR is a ratio of the licenseeâ€™s deemed assets value to its deemed liabilities. ItÂ is based on certain parameters set by the AER under Directive 006 and Directive 011. Liability Management Rating (LMR) is a ratio of a licenseeâ€™s eligible deemed asset in the LLR factoring in Large Facility Liability Management Program (LFP) and Oilfield Waste Liability Program (OWL) to the licenseeâ€™s deemed liabilities.
The Licensee is required to maintain a monthly ratio of 1.0 or greater, failing which; a security payment is required to be deposited with AER. Failure to comply with the LLR program can result in application of a non-compliance fee or suspension of operations.
Â THE MICRO-JUNIORS ARE DISAPPEARING
“Many of us recall when the family farmer could make a living farming a relatively small section of land. If we fast forward to today, it is obvious the vast majority of these small farms have disappeared. They are no longer economically viable. This scenario is now playing out within the micro-junior oil firms. The squeeze is on and many will not survive unless they adapt to the new reality. Economy of scale is critical.”
The LLR directive requires every licensee to maintain a monthly LMR of 1.0 or greater.
These changes, as applied to calculating the LMR, will result in significant increases in security deposits payable to AER by companies having a LMR of less than 1.0. In particular it may cause significant hardship to junior oil and gas companies that are trying to either develop their assets or increase production.
Companies with a lower LMR can improve their ratio by increasing production through acquisition, reactivating wells or drilling new ones. Another way of improving LMR is by reducing liabilities throughÂ abandoning and reclaiming non-producing wells and facilities. Both of these initiatives require capital.
The AER estimates the number of companies in breach of LLR will increase from 88 to 248 within the three year phase in timelines and the amount of deposits with AER will increase from $13 million to $297 million. This will affect micro-juniors if they donâ€™t have access to capital to take remedial measures to increase their LMR.
The micro-juniors will be devastated the most if they donâ€™t pay attention to the impact of depleting resource to increasing liability costs in determining their LLR.
Another significant impact of the LLR applies to transference of well licenses. The transferor and transferee are each required to have a LLR of 1.0 or more before the transfer of license is approved by AER. Any party having a LLR of less then 1.0 will be required to post a security deposit prior to transference being approved.
The formula for calculating the LMR will change over the three-year phase-in plan as follows:
â€¢ Deemed well abandonment liability value will increase annually by one-third the 2012 values in May 2013, May 2014 and May 2015.
â€¢ Deemed assets value will increase annually by one-third of 2012 industry average netback values in May 2013, May 2014 and May 2015.
â€¢ Present Value and Salvage (PVS) factor changed to 1.0 for all active wells and facilities from current 0.75 as of May 2013.
â€¢ Facility abandonment and cost parameter for each well equivalent will change from $10,000.00 to $17,000.00 as of May 2014.
â€¢ Reclamation costs will increase by 25% for wells and facilities as of May 2014.
In 2007 there were 94 publicly listed junior oil and gas companies in Western Canada. By 2013 that number had dropped to 49. Similarly private juniors are also being squeezed out of the market due to the added LLR burden on their cash flow outlook. A recent Niven Fischer study predicts some 500 companies could have LMR of 1.0 or less by 2015.
â€¢ Pay the required deposits
â€¢ Present a plan to the AER to get back on side
â€¢ Or, turn over the keys
This LLR trap, however bleak, also provides great opportunities to companies that develop strategies to take advantage of firms with low LMR. Some of these opportunities include:
â€¢ Capital: Companies with access to capital will be better positioned to take advantage of assets on the market as a result of low LMR. Some companies will be forced to shed low LMR assets to improve their LMR. Others will have to sell high LMR assets to raise capital for security deposits to AER or use capital for abandonment or drilling program.
â€¢ Acquisition and Mergers: Companies with higher LMR will be in a stronger position to negotiate acquisition or mergers with companies that struggle with low LMR.
â€¢ Farm-in: CompaniesÂ with high LMR will be in a stronger position to negotiate farm-in agreements, in particular the royalty rates.