Hard Times Revisited
Times are not good in the oil patch. Readers are directed to a December 28th article in the Bismarck Tribune entitled “Pretty terrible year” for background on the current industrywide depression. This economic environment will also influence production activities in Harding and Fall River County in South Dakota. As oil and gas producer bankruptcy filing rates increase, the risk that these companies cannot support possible end-of-project closing costs increases. End-of-project is a description for the decommissioning and reclamation phase of a well. “Plugging” a well is also a part of the decommissioning process.
Public data shows that as of November 2020, 45 exploration and production (E&P) firms filed for bankruptcy. In 2018, 28 E&P firms filed for bankruptcy and in 2019, 42 E&P firms filed for bankruptcy. The rate at which these firms are taking the cure is rising. Rystad Energy, an energy industry consultant, predicts 54 new E&P bankruptcies for 2021 assuming a West Texas Intermediate average of $40 per barrel continues. The numbers show a need for increased attention to how producers provide end-of-project financial assurance.
To be fair, Forbes magazine disagrees with my economic assessment. The magazine argues that no large structural shift exists across energy markets. And it is true that the production numbers have not dropped radically. In 2020 crude output dropped 7% and marketed gas 4%. Nevertheless, there will be more well closures; such is the nature of the economy. It is the well closures about which we lend our scrutiny in this column.
In North Dakota the cost to plug “producing wells” is expensive. A producing well is an unplugged well with a last production (LP) date within the past two years and average daily oil and gas production equal to or greater than 15 barrels of oil or 90 Mcf of natural gas. Carbon Tracker, an industry blog, calculates it would cost $2,985,000 to plug these North Dakota wells. Who would bear the brunt of decommissioning costs? Is there a better way to address end-of-project closure costs?
I have seen all sides of this end-of-project issue. I have advised natural resource developers, challenged, and opposed natural resource projects, and previously held a neutral position as it were when I sat as a U. S. Bankruptcy Trustee handling commercial liquidation. I look at the decommissioning issue from “both sides now” as the song goes.
The end-of-project issue for a well is not difficult to understand. When companies get a permit to drill, they file or pay a set amount of money often referred to as a surety. This amount is intended to cover the cost of decommissioning, plugging and reclaiming the well. If the company plugs and reclaims the well itself the deposited surety is returned. If the company does not, or cannot, plug and reclaim the well for whatever reason (there are several), the state or feds use the surety to do the work. Unfortunately, the process does not work well; Between 1997 and 2014 it cost the State of Wyoming $11 million in total to plug orphaned wells, only $3 million was covered by the end-of-project sureties. Clearly surety amounts are set too low.
Government agencies, staff and their boards set the surety amounts. It is unusual however for even a large natural resource regulatory agency to have competence in these financial matters. A recent report by the U.S. Government Accountability Office found that state agencies struggle mightily with this issue. Not to be left out, the feds are equally bereft of good planning when a federal agency oversees the setting of surety amounts.
End-of-project decommissioning is an issue likely to increase. But governments are not always well endowed with the requisite skills at setting surety amounts. I suggest better agency scrutiny as well as transparent access to the government’s process in setting adequate financial terms are essential. Thoughtful rules of the road at the initial stages of any project will help address the problems of possible project abandonment, closure, and decommissioning.
My recommendation: regulators should evaluate, in writing, all financial assurance proposals using a non-party (an outside consultant) with recognized experience in this field. A completed report and recommendation by an outside consultant should set the amount before granting a permit or license. The costs incurred by the regulator in hiring the independent outside consultant would be paid by the developer as a part of the permit filing fees.
