The Alberta Energy Regulator’s (the “AER”) final phase of changes to the Licensee Liability Rating Program (the “LLR Program”) comes into effect on August 1, 2015. The AER’s Bulletin 2015-13 (found here) says that the implementation date was delayed from May 1 to August 1, 2015, to give licensees more time to understand the implications of, and prepare for, the Phase-3 program changes in light of current market conditions. The AER’s revision of the LLR Program was rolled in on May 1, 2013 in Bulletin 2013-09 (found here),with implementation phased over a three-year period effective in May of each year. This post reviews the LLR Program changes in the last two years, the final phase coming into force in August, and the implications of the revisions.

Background

The LLR Program revisions are reflected in the AER’s Directive 006: Licensee Liability Rating (LLR) Program and Licence Transfer Process (found here) and Directive 011: Licensee Liability Rating (LLR) Program: Updated Industry Parameters and Liability Costs (found here). These documents are used to calculate the actual amount of financial security owing by a licensee to the AER based on a ratio of the licensee’s assets to its liabilities. The revisions increased parameters and liability costs to address concerns that the previous LLR program significantly underestimated abandonment and reclamation liabilities of licensees. The goal was to increase the well abandonment liability costs and industry average netback to the 2012 values by May 1, 2015. Pursuant to the changes, if a licensee’s deemed liabilities in the program exceed its deemed assets in the programs plus any previously provided security deposits (including facility-specific security deposits), the licensee will have a Liability Management Rating (“LMR”) below 1.0 and will be required to provide the AER with a security deposit for the difference.

In 2013 and 2014, the deemed well abandonment liabilities and assets were updated each year by one-third of the 2012 values and the industry average netback, respectively. Industry average netback was decreased from a 5-year to a 3-year average. The present value and salvage (PVS) factor was changed from 0.75 for active wells and 0.50 for active facilities to 1.0 for all active wells and facilities. The facility abandonment cost parameter for each well equivalent was increased from $10,000 to $17,000 and reclamation costs increased by 25% for wells and facilities.

Phase-3 Changes

In Phase-3, the deemed well abandonment liabilities and assets will increase again by another one-third to bring them to their full 2012 values and industry average netback values, respectively. In Bulletin 2013-09 there was an option in Phase-3 to choose between the lower of the 2012 values and the updated 2015 values. This option was not repeated in Bulletin 2015-13.

After phase three, the liability costs and parameters will be updated in accordance with Directive 011. Throughout the implementation period, the orphan levy is calculated upon the previous year's liability costs and parameters. The 2016 orphan levy will be based upon the total three-year changes. After 2016, the orphan levy will be based on Directive 011 costs and parameters.

Implications

There is no doubt that the LLR changes have significant impact on the Alberta oil and gas industry. Some licensees, particularly in the present economic environment, are experiencing difficulties complying with the financial requirements of the LLR Program changes. To mitigate the negative impact, in Bulletin 2014-06 (found here), the AER introduced the LLR Program Management Plan (the “Plan”) in February 2014. The Plan allows licensees to pay the financial security they owe in increments, over a longer period of time, while improving their asset-to-liability ratio. The AER says that it adopts a gradual approach to implementing the financial security requirements and enforcement. The Plan is supposed to reduce the overall risk to industry and the Orphan Well Association (“OWA”). However, the Plan invites a higher level of scrutiny by the AER, of the licensee’s finances, reduction of liabilities, and improvement of LLR ratios. The licensee must agree to all requirements, and must submit an operating forecast of future cash flow as evidence of ability to meet the plan’s future security payments and abandonment and reclamation requirements within the specified timelines.

More than a year after the implementation of the Plan, Alan Tambosso, a merger and acquisition activity advisor in the industry, in an April 2015 Daily Oil Bulletin article entitled “The Impact of Changes to the AER's LMR System on M&A Activity” reported a negative impact on industry, particularly the junior sector. One of the main reasons was said to be the timing of the changes when the sector is starved of capital, with the result of unsustainable levels of debt, marginally economic production coupled with decreasing commodity prices, and steadily rising security deposit owing to the AER. Licensees with LMR ratios below 1.0 who fail to meet the LLR security deposit and the Plan’s requirements, where applicable, will be subject to enforcement actions possibly culminating in a shut-in order. An orphan designation by the AER and handover to the OWA for abandonment and reclamation may eventually follow, all of which would only exacerbate an often serious financial situation for the licensee. Meanwhile, the AER may not have obtained enough security deposit from the licensee under the Plan to cover the full abandonment and reclamation costs. It is noteworthy that since 2000, Alberta’s statutory criteria for designation of an orphan under the Oil and Gas Conservation Act, RSA 2000, c O-6, s. 70(2)(b) and (b.1) are not only inexistence or inability to locate but include lack of financial means.

The OWA says that in its 2013/2014 fiscal year it saw a jump in inventory of new orphan wells received from the AER due to the LLR Program changes and increases in industry bankruptcies and receiverships. The OWA funded over $14 million of orphan abandonment and reclamation work within this time period. The orphan funds are collected from industry through an annual Orphan Fund levy determined by OWA’s annual budget.

Conclusion

It appears that the LLR program changes have produced a cycle that makes orphans and increases the Orphan Fund levy for licensees who manage to weather the current market situation and stay at 1.0 LMR or above. Until a new solution to the cycle is determined, licensees will have to live with the challenges of maintaining an LMR of 1.0 as well as afford the annually increasing Orphan Fund levy. Risk management and survival strategies have become inevitable for licensees in the LLR program.