Environmental Liabilities- Regulators and Players

Originally posted 2 April 2018
Highlights:

• Alberta Energy Regulator and Licensee Liability Rating system
• Roles played Orphan Well Association and Surface Rights Board
• Nomenclature
• What are asset retirement obligations?

Albertarecessionwatch.com has been examining the scope of reclamation costs faced by the Alberta oil, gas and oil sands industries, and, ultimately, the Alberta government and taxpayers.  The Redwater Resources case,  Redwater  heard by the Supreme Court on 15 February is, arguably, the first salvo in what will be a long drawn out legal affair pitting environmental “interests” (NGOs, some governments, indigenous groups) against other governments, regulators, banks, and the energy industry.
There are a number of key players whose actions are critical to understanding the evolution of this conflict between “polluters” and those seeking a greener, carbon-free future.  Each group, it should be remembered, have vested interests to protect and promote.  No group is a “saint” in this evolving policy arena.  The Alberta Energy Regulator (AER) is the current organizational form that is responsible for regulating energy development in the public interest in Alberta Wiki AER.  It was forged in the late 2000s from the Energy Resources Conservation Board  and finally emerged in late 2012 as a product of the Responsible Energy Development Act.

The context for the change in the name and mandate of the energy regulator was a recognition by the governments of Ed Stelmach and Alison Redford that energy development was being slowed down by environmental concerns.  The AER became the “one window” on energy development including  the issuance of permits for water and other environmental permits.
According to Wiki:

AER chair, Gerry Protti was a former executive with Encana, the founding president of the Canadian Association of Petroleum Producers (CAPP), and a long-time lobbyist for the Energy Policy Institute of Canada. The appointment was met with calls for his resignation as he was seen to be biased in favour of industry. The organization’s governance structure, however, delegates decisions on contested applications and developments to the hearing commissioners, with the chair heading a board of directors tasked with setting performance expectations and approving regulatory change. Jim Ellis, a former deputy minister in environment and energy, was appointed as CEO by the Lieutenant Governor in Council.

While this restructuring, favourable to the energy industry, was taking place,  climate change debates were undermining the pipeline and oil and gas industries’ ability to gain “social license” in the form of approvals for major pipeline developments (e.g. Enbridge Pacific Gateway, TransCanada’s Keystone XL, Kinder Morgan TransMountain expansion, and subsequently TransCanada’s Energy East). Alberta politicians proclaimed the rigour of the environmental regime in Alberta in order to persuade federal and U.S. regulatory panels of the merits of allowing further shipment of Alberta bitumen to export markets.  In spite of lobbying by successive Alberta premiers and cabinet ministers in Washington and support from the Harper government, President Obama ultimately decided the case presented by Canada, Alberta and the State Department did not merit deploying his political capital at the end of his presidency.
Since the election of the NDP government, the AER has become somewhat less supportive of the industry it regulates. The AER has become more vigilant in its policing of the oilsands and oil and gas industry from an environmental perspective in spite of few significant changes in its staffing. Still, recently questions have been asked about the wisdom of AER’s enforcement of the Liability Management System.

According to the Regulator’s website

The AER works collaboratively with government and industry stakeholders to develop and implement appropriate liability management programs for all energy sectors regulated by the AER. The AER recognizes its responsibility to Albertans to protect the public from significant potential environmental issues and costs associated with abandonment and decommissioning of those sites that have been involved in petroleum resource recovery by ensuring licensees and owners are responsible for proper abandonment and decommissioning. (Emphasis added)

The Orphan Well Association (OWA) also operates at arms- length from the provincial government and its board is composed of representatives of the Canadian Association of Petroleum Producers,  the Explorers and Producers Association of Canada, and the AER as voting members. The Alberta Department of Environment and Parks has a non-voting member on the board. The organization administers a program to reclaim wells that have been orphaned by industry players that have gone bankrupt.  The OWA started operations in 2002 or about 50 years after extensive exploration, drilling, and production had commenced in the province.
According to the AER website

The annual orphan levy is based on the revenue requirements identified in the Alberta Orphan Oil and Gas Abandonment and Reclamation Association (Orphan Well Association) budget. A licensee’s annual levy is based on its proportionate share of sector liability as determined by the Licensee Liability Rating (LLR) program and the Oilfield Waste Liability (OWL) program.

Therefore the better the LLR, the lower the fees paid into the fund. Conversely the poorer the rating, the higher the fees.  This structure works to incent good behaviour but when oil prices fall dramatically as they did in 2015, this creates enormous pressure on both the weakest firms and the regulator.
As of 28 February, the OWA’s website states there are 1851 wells for abandonment and 1038 wells for reclamation, along with 639 reclaimed sites. Orphan Well Association Homepage Of the 1851 abandoned orphan wells Redwater Energy Corporation accounts for 50.  The well data provided through the OWA from the AER_Licence_Details_Report illustrates the length of time these wells have been out of operation.  For instance, the “last volumetric activity date” for  a suspended well in Excelsior (north of Namao), licensed to Artisan Energy Corporation, was in 1985.  Another well in Basal Belly River also licensed by Artisan was abandoned in 1982.
Additionally there are 2349 orphan pipeline segments for “abandonment” and 1333 segments for “suspension.”  Of the suspended  pipeline segments over 1100 are as a result of the failure of Lexin Resources and the remainder those of  LR Processing.  Erstwhile owners of abandoned pipeline segments include  Alston Energy Inc. (48 segments), BNP Resources Inc.,  Canadian Coyote Energy Ltd.(130),  Canadian Oil & Gas  International Inc. (123), Fairwest Energy Corporation (82),  Midlake Oil & Gas Ltd (110), Neo Exploration Inc. (162),  Redwater Energy Corp. (33), Sekur Energy Management Corp. (112),  Shoreline Energy Corp.  (102),  the unfortunately named Stealth Ventures Inc (112),  Sydco Energy (100), and Tuscany Energy Ltd (116) being the largest companies abandoning pipelines.

Nomenclature

The Association classifies the clean-up by using specific terms such as abandonment, suspension, and reclamation. Well abandonment is the proper plugging down hole and the wellhead removal at the surface of a well.  The process is classified under the following categories:  downhole work, remedial repairs, groundwater protection, and surface abandonment.  The main objectives are to protect groundwater, prevent gas leakage, and address soil contamination.
Reclamation involves ” activities that return the land to its equivalent land use capability. Such activities include can include subsoil replacement, contouring, de‐compaction, re‐establishment of drainage, topsoil replacement and re‐vegetation of disturbed land. Activities also include weed control, vegetation monitoring, detailed site assessment of the soils and vegetation, and the preparation of applications for Reclamation Certificates when reclamation has been completed. ”
Remediation or decontamination is the term used to describe activities that include the investigation and removal of contaminant impacts to soil and groundwater as per current AEP regulatory guidelines.
As with the AER, the OWA is meticulous in recording the information pertaining to these wells. The OWA has a list in alphabetical order of defunct companies that is 7 pages long containing the expenditures by the OWA on both abandonment and reclamation.  There are about 400 named companies or individuals that have left the industry with its environmental liabilities to remediate.
It is understandable that, with the financial difficulties facing the industry, OWA board and staff would be overwhelmed. This note on OWA’s website shows the demands placed on the organization’s resources:

Due to the increase in defunct company files that are being sent to the OWA, the OWA is establishing a process for receiving defunct company files.
The OWA requires files to be sorted in the boxes and the boxes clearly labelled with contents by well files, surface land files and engineering/pipeline/environment files. Please do not send mineral lease files, correspondence files or contract files. A list of the box contents is requested whenever it is available.
Parties delivering file boxes are responsible for the arrangements and costs of delivery and must contact the OWA first to make arrangements for the OWA to receive them.
Once arrangements are made to receive file boxes, they can be brought to the loading dock of Centennial Place, West Tower, where an OWA representative will meet the courier to facilitate delivery of the files to the OWA storage area in the building. The loading dock is accessed from 4th Street SW between 2nd and 3rd Avenues.

There is no shortage of data available to the public on the nature of the activity aimed at cleaning up the environment after oil and gas activity has become uneconomic. The difficulty for the outside observer is how to form an opinion as to the process by which the oil and gas industry, including regulators, allowed vast amounts of capital (equipment, pipelines, well bores, etc.) to lay abandoned once uneconomic. Has there been an underlying process by which larger enterprises sell to smaller players, who then sell to smaller players, who then become bankrupt at the point of abandonment? How, if this hypothetical process has unfolded over the past two decades have government regulators failed to recognize the process, and failed to act?
Could part of the problem be with government requirements in the Remediation Certificate Regulation 2009_154  Section 3(2) of this regulation spells out over three and a half pages the information required to be submitted. Although there may be sufficient reason to require all 42 information items, acknowledgements and certification, for even a medium-sized company the task is daunting. If government thinks these requirements will be met for 300,000 wells they are delusional.

Surface Rights Board 

According to its website, the Alberta Surface Rights Board ” is a quasi-judicial tribunal that grants right of entry and assists landowners/occupants and operators resolve disputes about compensation when operators require access to private land or occupied crown land to develop subsurface resources such as oil, gas, and coal or to build and operate pipelines and power transmission lines.”

The core of the SRB’s powers is found in section 12 of the Surface Rights Act which sets out rights of entry for “operators.” Operators are individuals or corporations with mineral rights or pipeline or transmission companies. Operators do not have aright of entry unless they have the permission of the owner or  granted the right to entry by an order of the SRB. A more recent change also enables the board to make an order allowing the operator required to remediate land under the  Environmental Protection and Enhancement Act to enter the land where consent has not be obtained from the owner.
Since the downturn in oil prices commencing in2014, the number of applications for right of entry gone down significantly as would be expected as the appetite for drilling declined. At the same time, the number of application seeking compensation review rose in 2015 by about 50 per cent, dropped in 2016 and then rose again in 2017.  Damage dispute applications have risen steadily since 2014, growing from 12 to 48 by 2017.  Recovery of rental applications have also skyrocketed from 505 in 2014 to 2570 in 2016, declining to 1934 in 2017. The data speaks to the heavy demands placed on another regulatory agency responsible for responding to the demands of land owners hurt by the failure of oil and gas producers to honour their existing obligations. These are costs that have been left to taxpayers by our devotion to the rule of law.  All these quasi-judicial regulatory agencies or associations begat by government are costly. Procedural fairness and the right to be heard are important barriers to ensure powerful state or corporate actors do not run roughshod over the less powerful.
Still one has to ask why the government, which owns the resource, is unable to exploit its resource sustainably, responsibly either directly or through appointed agents compelled to carry out what the laws require?

Asset Retirement Obligations

Albertarecessiohnwatch.com contacted three large Alberta-based oil producers: Suncor, Canadian Natural Resources Limited (CNRL), and Husky Energy to ascertain their disclosure of environmental liabilities in their annual financial reports.
Suncor 
According to note 4 of Suncor’s annual financial disclosure  (audited financial statements):
“The company recognizes liabilities for the future decommissioning and restoration of Exploration and Evaluation assets and Property, Plant and Equipment. Management applies judgment in assessing the existence and extent as well as the expected method of reclamation of the company’s  decommissioning and restoration obligations at the end of each reporting period. Management also uses judgment to determine whether the nature of the activities performed is related to decommissioning and restoration activities or normal operating activities. In addition, these provisions are based on estimated costs, which take into account the anticipated method and extent of restoration, technological advances, possible future use of the site, reclamation projects and processes and the water treatment facility. Actual costs are uncertain and estimates can vary as a result of changes to relevant laws and regulations related to the use of certain technologies, the emergence of new technology, operating experience, prices and closure plans. The estimated timing of future decommissioning and restoration may change due to certain factors, including reserves life. Changes to estimates related to future expected costs, discount rates, inflation assumptions, and timing may have a material impact on the amounts presented.”
The description above is of one of the “significant accounting estimates and judgments.”  So how significant is this are these estimates and judgements to Canada’s largest integrated petroleum company?  On the statement of comprehensive income, Depreciation, depletion, amortization and impairment accounted for the fourth largest expense of $5.6 billion of $26.3 billion in expenses. Notes 11 and 18 provide further detail on this line item.  Note 11 deals with Asset Impairment and Derecognition which are not relevant to our examination of environmental liabilities.  Note 18 reviews the property, plant and equipment (PPE) of the company showing additions to PPE, depreciation, disposals, and changes in decommissioning and restoration. In 2016 a deduction of $47 million was taken and in 2017 a “gain” of $845 million was recorded.  These numbers are really not material to the enterprise’s balance sheet which shows $73.4 billion in PPE at the end of December 2017.  Thus in the past two years decommissioning and restoration expenses have decreased by about $800 million, a remarkable feat given the continued expansion of the oil sands mines and related PPE.
When examining the balance sheet,  the entry “Provisions” stands at a significant $7.2 billion as a liability of the company. Of that number, fully $7  billion or 97 per cent of the provision is for decommissioning and restoration.  The table in the report illustrates the complexity of the calculations, estimates, and judgments involved in determining a value. The key factors or variables considered are:

1. determination of liabilities incurred and settled in the fiscal year;
2. changes in technology;
3. changes in regulatory requirements;
4. changes to the estimates;
5. changes to the discount rate; and
6. asset acquisitions. (page 135 of Annual Report)

In order to arrive at the value, the liabilities of decommissioning and restoration which are not immediately decommissioned or restored, are valued by discounting the expected expenditures using a stated discount rate. When discount rates fall the future liability rises substantially; when they rise the liability falls as do pension liabilities. These future payments to address decommissioning and restoration provisions “occur on an ongoing basis and will continue over the lives of the operating assets, which can exceed 50 years.”  The undiscounted value of Suncor’s liabilities were about $12.2 billion. The current portion of the provision was $722 million in 2017 down from $781 million in 2016.
Husky labels their decommissioning expenses “asset retirement obligations” (AROs) which stood at $2.5 billion, of which $274 million is  included in current liabilities.  Like Suncor, Husky estimates the costs of environmental remediation over a low period of time and establishes an annual expenditure budget to address AROs. These expenditures reduce or “settle” the ARO liability but each year new calculations must be done to factor in changing developments such as asset acquisitions or changes in discount rates.  Husky uses “credit-adjusted risk-free rates of 2.9 to 4.9 per cent with a 2 per cent inflation assumption. Husky’s ARO has fallen from $3 billion at the end of 2015 to $2.5 billion at December 2017 “primarily due to the disposition of select legacy Western Canada crude oil and natural gas assets in 2017 and 2016.”  Husky also discloses that the total unadjusted (undiscounted liability was $9.7 billion down from $11.4 billion in 2016.
The company also reported that it had deposited $192 million into a restricted cash account of which $95 million related to its Wenchang field.

Licensee Liability Rating

There are no references at all to Alberta’s licensee liability rating (LLR) system in the audited financial statements of the three large energy companies.
In the case of specific deposits for asset retirement or reclamation obligations, Husky discloses in Note 7 that  “provisions of the regulations of the People’s Republic of China,” require Husky “to deposit funds into separate accounts restricted to the funding of future asset retirement obligations in offshore China.” In the case of Suncor and CNRL no mention is made of any deposit requirement or restrictions on cash for reclamation costs.

Environmental Risk Management (EnRM)

Although risk management is generally related to operational and financial risks,  for energy companies EnRM is an increasing focus of senior management. A key facet of EnRM for CNRL is “working with legislators and regulators to ensure that any new or revised policies, legislation or regulations properly reflect a balanced approach to sustainable development.”  The company’s  comprehensive environmental risk management focuses its “energy efficiency, air emissions management, released water quality, reduced fresh water use and the minimization of the impact on the landscape to preserve high value diversity. Each quarter the board of directors reviews the organizations Environmental Management Plan.

In the case of Suncor, a key risk factor cited is environmental in the context of its operations. Its Management, Discussion and Analysis report highlights the many regulatory schemes the company operates under including land tenure, royalties, fish, wildlife, occupational health and safety, environmental protection, greenhouse gas emissions, reclamation and abandonment of fields and mine sites.  The company notes that failure to comply may result in the payment of fines, penalties, production restraints, and reputational damage. A full-page in the MDA is devoted to tailings management, Alberta’s land use framework, Species at Risk Act, Air quality management, and Alberta wetland.  Such disclosures are necessary under securities laws as a central tenet in securities law is plain. full and true disclosure.
In Husky’s presentation, environmental risk is broken down into government regulation, environmental regulation, and climate change regulation. The process of general Government regulation is described thus:

As these governments continually balance competing demands from different interest groups and stakeholders, the Company recognizes that the magnitude of regulatory risks has the potential to change over time. Changes in government policy,
legislation or regulation could impact the Company’s existing and planned projects as well as impose costs of compliance and increase capital expenditures and operating expenses.

Environmental regulation “may result in stricter standards and enforcement, larger fines and liabilities, increased compliance costs and approval delays for critical licences and permits, which could have a material adverse effect on the Company’s results of operations, financial condition and business strategy through increased capital and operating costs.”
A full-page devoted to Climate Change Regulation where regulations may become more onerous over time as governments implement policies to further reduce greenhouse gases (“GHG”) emissions.” The report notes the various climate change plans developed by provincial and federal governments and various U.S. governments.

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