In the first part of 2013, the Energy Resources Conservation Board (ERCB) made significant changes to its abandonment liability program and licence transfer process. These changes were implemented on May 1, 2013 under Directive 006: Licensee Liability Rating (LLR) Program and Licence Transfer Process (Directive 6) and effected important changes to the LLR Program (the Program). Effective June 17, 2013, the Energy Resources Conservation Board (ERCB) was succeeded by the Alberta Energy Regulator (AER). As part of this succession, references throughout the directives refer to the ERCB and no changes have been made to any of these directives to reflect that the AER is now responsible for all such directives.
Directive 6 requires oil and gas operators in Alberta to pay higher security deposits to maintain the required LLR with the AER. As a result, 248 licensees will now be required to post financial security totalling C$297-million, a substantial increase from the 88 licensees that have posted security deposits of approximately C$13-million to date.
The changes will be implemented over a three-year period. While this provides certain licensees some time to ensure compliance, the changes raise significant concerns for junior oil and gas companies being required to provide increased security deposits with limited ability to plan or prepare for this increased obligation.
In addition to explaining how these changes will require increased payments under the Program, this bulletin will also discuss the effect of the Program on an insolvent company and how the requirement to post additional security under the Program may be treated in any proceeding that may be commenced by an insolvent entity.
As discussed further below, while the AER may be prevented from demanding immediate payment from a company that is the subject of certain court-supervised insolvency proceedings, the AER may prevent the transfer of licences held by licensees that do not meet the new LLR requirements. Accordingly, companies that do not comply with the new Program may be prevented from transferring assets as part of a sales process carried out under a court-supervised insolvency proceeding.
LICENSEE LIABILITY RATING PROGRAM
The Program is designed to prevent Alberta taxpayers from incurring costs to suspend, abandon, remediate, and reclaim a well, facility, or pipeline.
The Liability Management Rating (LMR) is the ratio of a licensee's eligible deemed assets in the LLR, Large Facility Liability Management Program (LFP), and Oilfield Waste Liability Program (OWL) to its deemed liabilities in these programs. Any security deposit provided to the AER as a result of the operation of these programs is considered in determining a licensee's "security-adjusted" LMR. The LMR assessment is designed to assess a licensee's ability to address its suspension, abandonment, remediation and reclamation liabilities. This assessment is conducted monthly and on receipt of a licence transfer application in which the licensee is the transferor or transferee.
If a licensee's deemed liability in these three programs exceeds its deemed assets in these programs, plus any previously provided security deposits (including facility-specific security deposits), it has a security adjusted LMR below 1.0 and is required to provide the AER with a security deposit for the difference.
If a licensee fails to post security, as required, then the AER may take a number of steps to enforce these provisions, which are described in further detail below.
According to the AER, changes are now being made to the LLR Program because of concerns that abandonment and reclamation liabilities have been significantly underestimated.
Some of the important changes include:
- A 25% increase to well and facility reclamation costs
- An increase to facility abandonment cost parameters for each well equivalent from C$10,000 to C$17,000
- A decrease in the industry average netback from a five-year to a three-year average
- A change to the present value and salvage factor, increasing to 1.0 for all active facilities from the current 0.75 for active wells and 0.50 for active facilities.
Overall, these changes will result in a significant increase to the amount Alberta oil and gas companies are required to post as security under the Program and may cause significant hardship to many junior companies trying to develop their assets and increase production from certain portions of their assets.
NON-COMPLIANCE WITH LLR PROGRAM
In accordance with Directive 19: AER Compliance Assurance, if a licensee fails to comply with the requirements of the LLR Program, it could be subject to various AER enforcement provisions, including:
- Non-compliance fees
- Partial or full suspension of operations
- Suspension and/or cancellation of permit, licence or approval
- Issuance of an Order, which is a legal document that formally orders a specific action or prohibition, including facility closures or abandonments.
In the context of transferring well licences, non-compliance can be especially problematic as both the transferor and transferee must have a LLR rating of at least 1.0 before the transfer can be approved. If either party is below 1.0, the AER will require a security deposit from the party whose rating is less than 1.0. Should no deposit be made within a 30-day period, the AER will cancel the transfer application and the licence will remain with the transferor.
The AER may also grant extensions for any non-compliance with the LLR Program in order to allow companies additional time to comply with new requirements. Any such extension generally results in no escalation within the AER's enforcement process and can provide companies with additional time to make appropriate arrangements to satisfy their obligations under the Program.
The recent revisions to the Program have increased burdens on junior oil and gas companies who were previously very close to or below a 1.0 LMR assessment. The options for such companies to try and satisfy their obligations to the AER are to post the required security (which can be a short-term strain on cash flow), increase their production (and thus their deemed assets) or commence the abandonment and reclamation of certain wells. All of these options may represent a significant financial cost, especially for a company that is unable to properly budget for these increased expenditures and which may now face significant challenges in raising the necessary equity or financing to satisfy such obligations.
LLR AND INSOLVENCY
If an oil and gas company is unable to meet its financial liabilities as they become due, including its obligations under the Program, it may voluntarily or involuntarily become the subject of insolvency proceedings under the Companies' Creditors Arrangement Act (CCAA) or the Bankruptcy and Insolvency Act.
Should the AER pursue the payment of a security deposit of a company subject to proceedings commenced under the CCAA, the wording of section 11.1 of the CCAA limits the ability of the AER to demand payment from the debtor company. Section 11.1(2) says that the stay of proceedings against the debtor company provided by section 11.02 does not affect "a regulatory body's investigation in respect of the debtor company or an action, suit or proceeding that is taken in respect of the company by or before a regulatory body, other than the enforcement of a payment ordered by the regulatory body or the court". This language in the section suggests that if the requirement to post security with the AER under the LLR program is found to be the enforcement of a payment ordered by the regulatory body, then the AER would be stayed from demanding payment from the debtor company. The language in section 11.1 of the CCAA is also closely replicated in paragraph 14 of the Alberta Model Template CCAA Initial Order.
Similarly, in the context of receivership proceedings, paragraph 9 of the Alberta Model Template Receivership Order states that the stay of rights and remedies against the debtor or receiver does not exempt the debtor or the receiver from compliance with statutory or regulatory provisions relating to health, safety or the environment. As discussed further below, it is somewhat unclear whether a court would decide that this section exempts the AER from the stay of proceedings in a receivership proceeding with respect to requiring posting of security to satisfy obligations of the debtor company under the Program.
While it appears the courts have not considered whether the language "enforcement of a payment ordered by the regulatory body" in section 11.1(2) of the CCAA includes security deposits under the Program, there is some case law regarding a regulatory body's attempts to enforce a payment obligation. For example, in Northstar Aerospace Inc. Re, Morawetz J. held at para. 60:
"[T]he moment that [the debtor] is 'required' to undertake such an activity, it is 'required' to expend monies in response to actions being taken by the MOE. In my view, any financial activity that [the debtor] is required to undertake is stayed by the provisions of the Initial Order."
Similarly, courts in both British Columbia and Quebec have held that regulatory orders against CCAA debtors that were financial or monetary in nature were subject to the stay of proceedings (see Lemare Holdings Ltd. and Re AbitibiBowater Inc.). Considering that the payment of a security deposit under the Program is similar, as it is a payment that is also required by a regulatory body, we are of the view that the court would most likely decide the AER is subject to the stay of proceedings provided by section 11.02 of the CCAA.
Although less clear, it appears more than likely that paragraph 9 of the Alberta Model Template Receivership Order would also stay the AER in the context of a receivership proceeding. It is less clear in the context of a receivership proceeding since the language in the Alberta Model Template Receivership Order does not explicitly say that the enforcement of a payment ordered by a regulatory body is included in the requirement for the debtor and receiver to comply with regulatory provisions relating to health, safety or the environment.
Nonetheless, while there does not appear to be case law or a regulatory decision specifically dealing with this issue, we expect that debtor licensees and receivers of debtor licensees would be required to comply with AER guidelines in the same manner as discussed above (i.e., post security to retain a LMR rating of 1.0) for the AER to approve a transfer of licences held by the debtor licensee. Accordingly, upon a sale or restructuring of a debtor company that required the transfer of licences held by the debtor licensee being carried out as part of an insolvency proceeding, then the AER may be able to limit a debtor licensee or a receiver's ability to deal with the debtor's licences, unless the debtor or proposed purchaser complies with the LMR rating requirements and posts any applicable security with the AER.