Below is the full text of the letter from then AEG President Danielle Smith to then Energy Minister Sonya Savage concerning a proposed royalty credit for legally required environmental remediation.
Analysis of letter is below.
ALBERTA ENTERPRISE GROUP
11626-119 Street
Edmonton, AB T5G 2X7
July 29, 2021
Minister Sonya Savage
Minister of Energy
394 Legislature Building
10800-97 Avenue
Edmonton, AB T5K 2B6
Dear Minister Savage:
It was a pleasure meeting with you to discuss a pilot project this fall, to test out the RStar program as a new approach to address the issue of decommissioning and closing inactive wells.
I would like to summarize our conversation as you are working with your department officials to understand why this pilot project is so important to our members and the members of Sustaining Alberta’s Energy Network, which is an organization representing junior oil and Gas and energy service companies that has been championing the RStar program for nearly two years.
Historical context
In Alberta, we took the approach of “polluter pay” to deal with the issue of inactive and orphan wells which is a position we continue to support at the Alberta Enterprise Group. However, we also know that broad-based tax incentives have been a powerful method to incentivize the energy industry going back to the days of Peter Lougheed and Ralph Klein.
I hope we can all agree that the current government finds itself in a very difficult situation that has been inherited from decades of well-meaning policy decisions by previous administrations that have nonetheless resulted in unintended negative consequences. We recognize that your government did not create today’s problems, but we believe we have a solution that will help you to fix it.
In the past, the regulator agreed in good faith to allow companies to transfer assets and liabilities with the notion that the original company would not bear the liability for future cleanup. The regulator assumed in good faith that transferees would take responsibility for the cleanup, and that the assets and production would generate enough money to cover the cost of cleanup without the need for mandates. Meanwhile, energy companies believed they would be able to decommission and close wells and obtain a reclamation certificate in a timely fashion, which would not only allow them to reduce their liabilities and improve corporate health, but would also allow them to reduce operating costs for municipal property taxes and landowner lease payments as these sites were returned to the land owner or the Crown for other uses.
Unfortunately, none of this has occurred and a series of events has caused this model to break down.
Companies have not been able to obtain a reclamation certificate in a timely fashion. As a result, there has been no incentive to do surface reclamation or decommission low-producing wells. This has led to an unfortunate situation where companies remain obligated to pay landowner lease payments and municipal property taxes on properties that are not generating sufficient revenue. But because sites have not been returned to original use, landowners and municipalities have a reasonable expectation that they should continue to be paid. Now municipalities are owed an estimated $245 million in unpaid taxes, and landowners could be owed the same.
This has resulted in bad press and a lack of goodwill in rural alberta, which is reducing support for the energy sector and impacting the government’s popularity.
Meanwhile, for a period of time in the past 10 years, the regulator permitted well financed large companies to offload significant liabilities to small companies that have become overburdened with wellsite cleanup responsibilities that exceeded their ability to pay.
Plus, the Redwater decision put the liability for environmental cleanup ahead of other claims on a company’s assets. The practical effect of this is that any company with a Licensee Management Ratio (LMR) of less than 2 has found it impossible to arrange financing for new drilling programs that would yield new revenues in order to pay their obligations.
Finally, with the collapse of oil and natural gas prices in 2014, the revenue situation has become dark for the junior oil and gas sector. Since the UCP formed government, dozens of junior companies have gone bust and their assets and liabilities have been transferred to the industry funded Orphan Well Association. We understand this has caused the levy on companies to rise dramatically In at least one case, we were told one company’s levy went from $100k a year to $700k this year.
Default option if government does nothing
When we consider the number of struggling companies that have an LMR below 2, it represents $9 billion worth of liabilities. The July 2021 LMR summary is below (included in PDF embedder). Here is the link to AER’s LMR reports
Estimated Liabilities includes liabilities for ‘NEW’ wells and facilities as defined in Directive
006, which have not yet
The Alberta Liabilities Disclosure Project has recommended that the government assume the operations of low LMR companies and use their production to pay off their liabilities. We do not believe this will optimize the royalties and revenues to the people of Alberta, the owners of the resource. But if the government does nothing, we believe this will be the default result. Ultimately, junior oil and gas companies will continue to go out of business and, in the extreme, the Orphan Well Association will be left with billions of dollars of liability and have to rely on the large oil sands companies to pay increasingly high levies for the reclamation. This will do nothing to address the outstanding liability for municipal taxes or landowner leases. In fact, it will make the problem even worse.
In short, the default option benefits no one. The better solution is to create a pathway for junior oil and gas companies to clean up existing wellsite liabilities, improve corporate health, improve profitability and become compliant with all their financial obligations.
We believe the RStar program can address all of these issues. Unlike a direct grant program, it will require no direct outlay of cash from the government, it will be applied fairly across all licensees and it will potentially allow new financing for wellsite reclamation on the basis of being an ESG investment.
Sproule Consultants has calculated that if the government provided $20 billion in RStar credits, the dual activity of decommissioning and closure, combined with new drilling activity would generate 366,000 jobs and all the attendant personal income tax revenue with that, $8.54 billion in new royalty revenues and $2.66 billion dollars in new tax revenue, and create $76.7 billion in new GDP.
As it is designed as a credit against royalties from new production, the Alberta Government could implement the program without the need for federal approval. We think there is a matter of some urgency to get a replacement for the federal Site Rehabilitation Program (SRP), so we do not lose the momentum on cleanup or the expertise and efficiency that has developed over the last year of the program among the companies that provide these services.
In addition, we fear that because we have not addressed the issue of closure and timely issuance of reclamation certificates, we have observed that most companies are focusing on down hole abandonment of the” easy wells”- some of which would be profitable with oil and gas prices as they are today- and the surface reclamation remains incomplete.
Rather than have $1 billion in direct grants administered the same way as SRP with the same issues, we think RStar offers a fair way to address the Issues of legacy wellsite cleanup, incentivize surface reclamation, and restore the health of the junior oil and gas sector.
RStar Pilot Project proposal
I am grateful that you have a great to consider a pilot project in the fall to test out the RStar concept.
First some background. The CStar credit Is a drilling credit that allows a company to pay a 5% royalty until they have recovered the cost of drilling. The RStar credit would be structured to piggyback on the program for ease of administration: A company will be able to apply the credit to new production to extend the 5% royalty rate until they have paid off the cost of the RStar reclamation.
We think the most efficient way to implement the program would be to offer 10 RSTAR credits to every licensee with active production and with an LMR above zero (456 licensees), with the proviso that they must fully decommission and close a site, and that it only apply to sites that were drilled prior to 1990, with a strong preference for the most environmentally damaged sites
The value of the RStar credit would vary, as it would be the amount it costs to fully decommission and close the site. It will range in value depending on the complexity of the site cleanup, but realistically (as we are focusing on the worst sites), it may range from $75,000 to $1 million or more per credit. We are conscious of the fact that some of these sites may have an actual liability much greater than the deemed liability. We believe the regulator can you use the existing Specific Site Liability Assessment (SSLA) program to reassess the liability so that a company is further incentivized to take care of the worst site first.
With 456 eligible licenses, this would allow for as many as 4,560 of the worst sites in the province to be fully remediated. If each well costs an average of $150,000 to clean up, this would be the equivalent of $684 million in RStar cleanup credits. As previously mentioned, there would be no direct outlay of grants by the provincial government, but companies would be allowed to extend their 5% CStar drilling credit with an RStar credit until they recover the cost of reclamation.
If you think this is too large for a pilot project, it could be scaled to a size you think is manageable by the department. For instance, you can pilot the program with just one or two RStar credits per licensee, but we think it is important that all licensees be offered an opportunity to participate. For the 240 companies that have a LMR of 0, you could allow viable companies to receive an RStar credit to harvest one of their wellsite liabilities, perhaps at two times the value, as an additional pilot project to create another mechanism for industry to address this $600 unfunded liability problem.
The key to the success of the RStar program will be creating a process that results in closure and a rapid reduction in associated liabilities and operating costs.
We would like to propose a six-step process:
- Identification of reclamation site. The licensee identifies the wellsite they would like to reclaim for the RStar credit and the department approves it on the basis of deemed liability, or the licensee asks for a SSLA reassessment for a more accurate valuation.
- Downhole abandonment occurs. The department issues an abandonment confirmation and issues an RStar credit for the amount. the portion of the liability is reduced immediately.
- Surface reclamation occurs. The Department issues an interim reclamation certificate and issues an RStar credit for the amount. this portion of the liability is reduced immediately. Municipal property taxes are reduced by 50%. landowner lease payments continue.
- Vegetation management occurs. the Department issues a final Reclamation certificate and issues an RStar credit for the final amount. all liability for the site is extinguished. Municipal property taxes and. Landowner lease payments end.
- Transfer of fully reclaimed sites to Orphan Well Association stewardship. once the final reclamation certificate has been issued, sites will be transferred to the Orphan Well Association and insured in the event a small percentage of them need to be Revisited in future.
- RStar credit is redeemed. The licensee either identifies the site they would like the RStar credits to apply to or identifies a licensee to sell the RStar credit so it can be utilized, and the department approves it.
I have met with Environment Minister Jason Nixon to discuss how we can assist in aiding the collaboration between departments. I told him I suggested to you a round table discussion to talk through the wellsite issues with a variety of stakeholders. Minister Nixon suggested a ministerial task force might be helpful in coordinating an approach between Energy, Environment and Municipal Affairs in working through the details of implementing a pilot project.
We would be happy to work with you to discuss how this might be implemented in a way that reduces the regulatory burden on energy companies as well as limits the cost of administration on the Alberta Energy Regulator, in whatever capacity you deem most helpful. Tristan Goodman of the Explorers and Producers Association of Canada has also kindly offered to assist in this regard if you require expertise from an industry partner who has a deep understanding of the processes and capacities at the AER.
I truly believe the RStar program pilot program will prove to be a success, and could form the basis for a long-term program to incentivize legacy wellsite reclamation, stimulate new drilling and restore the vibrancy of our Junior oil and gas sector.
I look forward to hearing from you on how you would like to proceed.
Very kind regards,
Signed by Danielle Smith, President
Alberta Enterprise Group
cc Honorable Jason Nixon, Environment Minister
Analysis
The RStar program already builds on a generous drilling incentive program, the so-called CStar program. It is directed at the “worst” well sites. It is also directed at the least financially viable firms those 462 forms referred to in the July 2021 letter. As at 3 December 2022, the AER reports that there were 440 companies with $7.5-billion in liabilities with an LMR below 2.0, including 214 at zero.
It seems incredulous that an avowed believer in market solutions would write a letter on behalf of over 400 “walking dead” oil and gas drillers for what can only be described as a corporate handout. This “solution” assumes the taxpayers will “loan” or “front” the money for years- “it’s not a grant- it’s a credit.” The real goal is to make companies profitable again to allow them to meet their legal obligations to the Alberta regulator, landowners, municipalities, and the environment.
This letter which could be called brazen has rightly stirred considerable criticisms. Less commented on are the implications of the Redwater decision. The LMR ratio is 0.0 for over 200 companies. What does this mean? As Smith notes in her letter such companies could “become compliant with all their financial obligations.” This would include paying interest and principal to lenders who have already taken a provision or write-off on these walking dead companies. Instead lenders will take their write-offs because they do not wish to foreclose on these companies because they would become liable for the environmental liabilities. This is an unsatisfactory situation for the industry to be in. Conventional production is only about ten pre cent of oil production now in Alberta although they still pay significant royalties to the Crown they are financially bankrupt when environmental liabilities are taken into account.
| The LMR rating is calculated under AER Directive Number 006 which was amended in December 2021. It “is the ratio of a licensee’s eligible deemed assets in the LLR, LFP, and Oilfield Waste Liability (OWL) programs to its deemed liabilities in these programs. |
The RStar is packaged as an opportunity for the worse delinquents to municipalities and landowners to be resuscitated by government funds.
An interesting facet of this friendly dialogue between the AER and energy department is the reference to the Alberta Liabilities Disclosure Project study reported in the media which was released about one month prior to this letter. The ALDP proposal would
-
Create an independent non-profit Reclamation Trust would wind down end-of-life companies and use their remaining revenue to fund the cleanup of their wells.
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Introduce an industry-wide levy to recoup public bailouts for cleanup, as recently implemented in Australia;
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Update the (federal) Bankruptcy and Insolvency Act to stop companies from downloading cleanup liabilities on small companies for as little as $1;
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Ensure the industry pays the full cost of its annual levy to the Orphan Well Association (OWA) as already required by law, and repays public loans to the OWA;
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Alberta’s secretive, industry-run OWA should also be subject to Alberta’s Access to Information laws to “open their books” to the public, and appoint members of the public to its Board;
Create a public ‘licensee registry’ for every well in Alberta, so that cleanup costs can be traced back and equitably distributed amongst past companies that profited from it. And then the AER needs to actually use its power to look back to previous beneficiaries for cleanup costs.
Thus the AEG proposal countered directly the polluter- pay approach of the ALDP. Meanwhile lending institutions continue to forego legal action and without either the Orphan Well Association or the Alberta Energy Regulator forcing these companies into bankruptcy and the lenders to satisfy the obligations, it seems that the RStar will only allow companies which should be placed into bankruptcy to continue limping along.
Given the controversial nature of the RStar proposal as an unapologetic attempt by the small producers to create the illusion that these companies can actually be trusted to fulfil their obligations and contribute a huge amount of GDP (Sproule) it seems highly unlikely this gift will be produced before the election. Should the UCP win, it is a foregone conclusion that a publicly funded bailout of weak oil and gas producers would be implemented.
Acknowledgement
I am grateful to Regan Boychuk for providing me with a copy of the letter.
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