Originally posted 4 February 2019
On 31 January 2019, the Supreme Court of Canada handed down its decision in the Redwater Resources (Redwater Energy Corporation) case. SCC Decision The decision, by a 5-2 majority, was written by Chief Justice Richard Wagner (concurring Abella, Brown, Gascon, Karakatsanis). The 183 page judgment included a 70- page dissent by Madame Justice Suzanne Côté (concurred in by Justice Michael Moldaver). The majority opinion relied heavily upon the earlier dissent from former Alberta Court of Appeal Justice, Madame Sheilah Martin (who joined the High Court last year). ACA Decision
Côté
The decision affirmed the right (and strategy) of the Alberta Energy Regulator (AER) to deny a Receiver, acting for a creditor, the ability to “disclaim” assets. In the Redwater case, these assets were 84 wells, 7 facilities, and 36 pipelines. 72 of these “assets” were non-producing. Grant Thornton LLP, the Receiver acting for its client, ATB Financial, sought to take ownership of only the productive assets in order to sell these assets to repay the creditor. The job of a Receiver and Trustee of a bankrupt firm is to maximize the recovery for creditors. Part of the question at issue was whether the AER was acting as a creditor.
The AER has extensive powers under Alberta legislation to regulate the oil and gas industry from “cradle to grave.” AER has put in place a sophisticated system designed ultimately to protect the public and most notably, landowners where drilling and production activity occur. The goal is to ensure that private interests exploiting the resource return it to its original state. The AER’s power to issues licenses also meant the agency had the power to approve the transfers of licenses.
Implications
The most significant impact of the decision will be on the corporations involved in both the energy and mining sector who borrow from financial institutions or from the capital markets. Since the lenders can no longer rely on their Receiver’s capacity to disclaim assets, which are in fact environmental liabilities, lenders must re-adjust their lending policies.
For lenders who have a number of small companies in receivership, money extracted by Receivers had been placed in trust pending the outcome of the appeal. This money will now go to the AER, not to creditors. This means that for Redwater, ATB will have to write off any value that it placed on the loan to that company. As ATB may be a significant lender to smaller oil and gas firms, its loan write-offs could be substantial. Unfortunately ATB does not report a sectoral breakdown of its commercial loans, the Alberta government and the public do not yet know what the immediate financial ramifications may be. There may be some disclosure of the impact of the Court’s decision when the Province releases its Third Quarter Update at the end of February.
Turning to other lenders, the Canadian majors have approximately $40 billion in oil and gas or energy loans at the end of October. It is difficult to know how much lending there is to Canadian resident firms, a good proxy is National Bank with a $2.5 billion in oil and gas loans. Assuming the other majors each have Canadian portfolios slightly larger than National’s, it would be fair to say that the combined Canadian loans to Canada’s oil and gas and oilsands’ sectors are about $20 billion. This level of loans is a very small percentage of each bank’s capital and bank write-downs will not be material. In this respect, National Bank might be an exception. When banks report their earnings for their first quarter (to January 31) there may be some mention in the management discussion and analysis portion of their reports.
In relation to overall energy lending, word on the street is that the Canadian banks have been pulling in their horns in lending to smaller players since the downturn in 2014-15. Canadian Western Bank has maintained a low level exposure to the oilpatch. At the end of October CWB had only $129 million in outstanding loans, or four per cent of its total loans.
Lending policies must change
Credit departments at the major lenders will be scrutinizing their credit policies to oil producers. Lenders take security on all the assets of a producer and then discount the value of the proven energy reserves and equipment. Credit reviews are done usually at least once a year. One element is the “pricing deck” used to evaluate reserves. These pricing decks are normally taken either from external forecasters such as Sproule Associates or from their Economics departments.
A key part of the security taken is the AER license that gives the producer the right to develop and extract the resource. But as this case has shown, credit departments also must take into account the environmental obligations the licensee has undertaken as a condition of the license. Consequently, the amount of money that will be lent will diminish because loan amount must take into account the liabilities assumed by the producer and the creditor.
In addition, credit committees will also need to consider the pricing on loans. In hindsight, lenders were not pricing loans appropriately given the latent environmental risks. Borrowing will become more expensive, especially for smaller explorers. Depending on the wording of loan documents, it remains to be seen how quickly borrowers can expect to face higher rates. This will undoubtedly place smaller firms in a more precarious situation. Some commercial loans may be “call” or “demand” loans which give the lender the ability to act quickly if they so choose.
With oil and gas prices still low, once demand for repayment is given, the likelihood of finding another amenable lender is low. Perhaps the Business Development Bank will become more active in supporting these companies. Regardless, the AER liability management rating system (LMR) may also force companies to put up more security for environmental liabilities. It is unlikely any creditors would provide any support on this front given the recent judgment.
Still borrowers may have some negotiating room with the lenders. If the borrower is insolvent, would it make sense to hire a costly Receiver where the remediation costs of non-producing wells exceed the value of the producing wells? Would it make sense for the lender to enter into forbearance agreements while the oil producer prunes its operating costs to the bone while both the debtor and creditor pray for higher oil prices?
Source: CBC.ca
The decision has important ramifications for the oilsands’ producers. The AER imposes reclamation responsibilities on these producers as well. There are four main areas of remediation: 1) the mines; 2) production facilities; 3) in situ facilities; and 4) tailings ponds. A recent assessment by the Vice-President of Liability for the AER suggested that the oilsands’ reclamation costs could be in the neighbourhood of $100 billion. Although this figure was quickly disavowed by the Regulator, several facts should be considered in the context of financing requirements of the major operators: Husky, CNRL, Suncor, Imperial Oil, and Cenovus.
Firstly, these five companies had short-term and long-term debt outstanding (30 September 2019) of approximately $56 billion. These companies also recorded equity of $141 billion. But leverage at CNRL (59 %) and Cenovus (53 %) is notably higher than Imperial (21 %), Suncor (36 %), and Husky (27 %). Unfortunately these players do not report “asset retirement obligations” consistently. They each use terms like “decommissioning expenses” or “provisions” to describe environmental liabilities. The collective number of these “provisions” was about $16 billion. This number is probably consistent with the official AER number of total liabilities of about $57 billion.
Financing the reclamation of these vast lakes will become more critical and will play a role in the AER’s decisions on requiring more security to be posted on future oilsands projects.
Abpolecon will explore these issues in future posts.
Related posts
Redwater Resources Supreme Court Hearing Part 1
Redwater Resources Supreme Court Part 2
Redwater Resources Supreme Court Part 3
Update on Land Lease Delinquencies
Redwater court decisions side with lenders
Docket 37627 Orphan Well Association et al. v. Grant Thornton, et al. (Redwater Resources contd)