It’s springtime – greening grass, new leaves, robins, the Masters… and the Orphan Well Fund annual levy.
The latter won’t strike fear in most of you, but those who are awaiting it don’t feel very good. This year’s levy against producers is a very substantial $135 million up from $72 million the year prior.
The orphan well levy is an attempt to clean up the historical mess caused by (in no particular order) severe commodity price collapses, capital flight due to industry antagonism, sometimes-sketchy operators, poor market access for commodities, and standards that have changed over time.
It is the Alberta Energy Regulator (AER’s) way of taking care of orphans whose parents died in oil price crashes or fled the country under cover of night once they’d realized what they’d bought. Those shenanigans may be over (or closely watched anyway) but the gruesome legacy lives on.
This isn’t a history of how it came to be, others have done a great job of that (Dave Yager, for example). I haven’t the abilities to re-till that soil. In fact, I can’t think of anything energy-related that I’d like to write about less than the abandonment situation. It’s an unbearably significant problem with a lot of nuance and challenge that only experts understand.
But some ideas are being bandied about, and I’m not sure they’re optimal. They might be, but I’m not really sure what they are… I hear it is R*, and then I hear it is R* modified, and then I hear it is not really R* anymore (R* being the idea of granting royalty relief towards future wells for dollars spent abandoning wells, plus or minus some TBD features, from what I hear).
I don’t really know what the government is up to, but here’s an idea in case anyone is listening to new ideas. It doesn’t involve the angle that gets up people’s noses like R* does – the offering of future royalty relief – and it creates an incentive exactly when it is most needed.
First, some context around how the situation will actually be conquered. It may seem self-evident, but it is still worth bringing to mind that in times of low oil/gas prices, producers cut expenditures to the bone.
Abandonment/reclamation programs are no different. When cash flow heads to zero, meeting the minimum acceptable abandonment spending is all that can be hoped for. That’s how it goes in an industry that has to keep running (or at least jogging) to keep production flat.
In times of low commodity prices, the abandonment problem becomes amplified, because companies go out of business, and then a bunch of wells end up in the Orphan Well Association (from their website, “the OWA’s job is to close wells, facilities and pipelines that do not have a solvent and responsible owner to protect people and the environment, and remove the potential risk of unfunded liability.”).
Any real progress in getting ahead of the abandonment curve can therefore only happen in times of high commodity prices, when producers have enough cash flow to repay debt, maintain production levels, and remain healthy. Seems like a relatively simple formula – accelerate abandonment activity when cash flow is high.
But there’s a new sheriff in town, one that has different demands. These days, producers are expected to return cash to shareholders via dividends, special dividends, and share buybacks. This demand exists for a number of reasons: historically, producers have chewed up capital at a voracious pace to grow production, and now investors want a return on that investment.
For another reason, there is the lingering fear that governments are about to fatally wound oil and gas producers in one way or another, and therefore investors want to extract as much capital as possible in case that happens.
Therein likes a big problem, as far as all those forlorn derelict wells go – in the current era, high commodity prices are triggering huge outflows to investors, which makes complete sense given how global power centers want to throttle hydrocarbons out of existence in all defiance of reality
But given that capital outflow, how can we hope to get ahead of the future abandonment challenges? Prices will fluctuate, and fields will be depleted, and here we go again.
There is a clear path forward. Consider first what high commodity prices do for producers’ taxation situation. For many years, producers spent far more than their cash flow (borrowing plus capital raises), which generated huge tax pools with which investors could shelter income for years.
But with recent high commodity prices, many companies are becoming taxable, for the first time in memory.
Therefore, companies are quite thrilled to find anything that can help lower the tax bill, as are most humans.
Now, it is clear no one wants to see hydrocarbon companies shirk their duties and offload costs and problems to taxpayers. But with all the uncertainty and animosity towards the industry becoming so ingrained (‘just transition’ employment legislation, a glaring case in point), now that producers’ pockets are stuffed with cash, the overwhelming game plan is just to return it to shareholders.
We’re setting ourselves up for more headaches and drama when the next major price collapse happens – no guarantee of that, but one would have to be crazy to think it impossible.
Here’s a way to break the log jam.
Create a ‘future abandonment fund’, established by the AER/OWA, that would be funded via contributions from producers. Make those donations fully tax deductible in the year incurred, in the amount put into the fund. Any money put into the fund would be earmarked towards the producer’s wells, to be used when the wells are ready to be abandoned, and the producer would no longer have access to that cash.
There is no ‘subsidy’, no ‘give-away’, other than that companies get to write off the amounts in the year they give up control of them rather than when they abandon the well. But if they lose access to the cash forever, it would be hard for even Ottawa decision-makers to hate the idea.
Over time, the money would grow as it could be invested in something super safe like government bonds (haha). The time frame until many of today’s current producing wells face abandonment can be decades, which is a lot of time for compounding to work its magic.
Speaking of today’s current producing wells, that brings up another aspect of the whole problem we need to consider – the inventory of failed wells in the orphan well fund, and the inventory that might end up there one day.
Wells get dumped into the orphan well pool when, for instance, a company goes bankrupt. The problem is, the whole mess gets dumped in, sometimes thousands of wells. Not all should be there.
There is an effort to find homes for wells in the fund, but many do not escape, and face the executioner – abandonment. The fund then does the responsible thing, and sets about cleaning them up.
But is that really the right path? Consider that there are many thousands of low rate wells in the province, or provinces, that have been producing for decades and may keep producing for decades more. They become uneconomic when commodity prices collapse, which is when companies go bankrupt.
Once those wells are abandoned, however, they won’t be brought back, because the cost to recomplete a low-rate well that has been abandoned would not make sense under any realistic pricing scenario. Yet the well may be capable of more decades of low-rate production, and those wells in combination are important.
They provide low decline, stable production that adds up to a significant amount through sheer number alone.
The orphan well fund is forced to deal with these, to keep numbers manageable and the story on the positive side.
But what if the future abandonment fund was up and running, and well enough funded so all of today’s producing wells, even if they were shut in during times of low prices, there might be an option to keep some of them in inventory for when prices recover?
The whole topic of abandonment liabilities is not an absolute but a function of commodity prices. The world is being driven to energy scarcity by the starvation of capital – either through conscious actors like ‘divest fossil fuels’ or by subconscious degradation by indifferent politicians or by return-cash-to-shareholders’ demands.
Since global demand for both oil and natural gas continues to rise – despite the loud fantasies of those who wish to see the opposite – there is every reason to believe that hydrocarbons are going to become a lot more valuable in the future.
Should that assumption come to pass, then maybe today’s low-rate well that generates a monthly operating income of, say, $1,500 per month, or far less when AECO prices crap out yet again, and is thus a potential candidate for the dumpster, would look a whole lot better if producers one day started receiving even a third of global LNG prices.
Is it not in the interests of the province’s citizens to see that resource continue to either keep feeding government coffers – oil and gas resources belong to the province and its people – or at least not have it permanently impaired through abandonment, even if a small and inconsequential (in isolation) well?
A huge fund that is ready to deal with these as time arises would be a far better mechanism than what we have now. The OWA picks up the garbage when “wells, facilities, and pipelines that do not have a solvent and responsible owner”, which is maybe all we can do with yesterday’s disasters.
But we should make sure that the problem doesn’t multiply when the next downturn strikes. If tens of billions exit the industry in the form of dividends in the next decade, and then there is a subsequent downturn-driven wave of new orphan assets, there won’t be many friends in the house.
Next up should be a hard look at reclamation requirements; oil/gas well sites have almost absurd levels of compliance. Per the AER’s website: “Even after we issue a reclamation certificate, a company remains responsible for surface issues related to reclamation, such as topography, vegetation, soil texture, and drainage, for 25 years…” Imagine getting a full reclamation certificate but being held responsible for changes in vegetation on that site for 25 years. But that’s another beast entirely.
A dedicated, untouchable (by producers) pool of money, funded by tax-deductible producer/infrastructure owner contributions, would be one small step for mankind, and one giant step for the overall health of the industry. I am fully aware also that some clever policy wonk out there may find a good reason to shoot holes in this idea, but c’est la vie. Anyone with an idea should speak up.
Energy dialogue should be exciting and positive – if you’re going to wade into the current energy mess, might as well enjoy it. Pick up “The End of Fossil Fuel Insanity” at Amazon.ca, Indigo.ca, or Amazon.com. Thanks!
Read more insightful analysis from Terry Etam here, or email Terry here.