At a time when the Bureau of Safety and Environmental Enforcement’s (“BSEE”) Well Control Rule has shifted focus away from its sister agency’s regulatory maneuvering, the Bureau of Ocean Energy Management (“BOEM”) is changing the way it approaches securitizing decommissioning obligations – a shift with the potential to change the face of the Outer Continental Shelf (“OCS”).

Industries, like ecosystems, thrive on symbiotic relationships. Even companies that compete for resources need each other to ensure the health of the industry as a whole. While BOEM’s anticipated new requirements for supplemental financial security may not affect majors directly, they do affect the smaller players, and the loss of those smaller players will ultimately affect the health of the OCS economic ecosystem.

BOEM’s proposed changes to its Notice to Lessees No. 2008-N07, which spells out BOEM’s supplemental bonding requirements, are discussed in an October 5, 2015, North America Shale Blog post. These changes – which we expect BOEM to issue before the summer – ignore the contracts put in place by private parties relying on BOEM’s current bonding practices (often between majors and independents), thus putting additional and unnecessary financial pressure on independents.

Historical structuring of purchase and sale agreements

Federal regulations allocate responsibility for residual liabilities flowing from OCS leases, such as removing platforms and plugging wells after lease obligations end. As a general rule, co-lessees are jointly and severally liable for fulfilling leasehold obligations.1 Since 1997, this rule as applied to residual decommissioning liabilities also extends to former lessees.2

Upon BOEM’s approval of a transfer of record title interest in an OCS lease, federal regulation allocates residual liabilities between the assignor and assignee depending on when they accrued. The assignor is liable for all obligations that accrue under the lease before the date that BOEM approves the request for assignment of the record title interest in the lease, and the assignee and each subsequent assignee are liable for all obligations that accrue under the lease after the date that BOEM approves the governing assignment.3 The regulations further provide that the agency’s approval of the assignment does not relieve the assignor of “accrued” lease obligations that the assignee or subsequent assignee fails to perform.4 This includes decommissioning obligations, which are deemed to have accrued at the time any platform was emplaced or any well drilled.5 Thus, when a current lessee defaults on its decommissioning obligations, BSEE looks back through the chain of title to find a solvent responsible party.

Addressing this federal regulatory scheme of residual liability has been a critical component of contract negotiations among buyers and sellers of OCS assets.6 For example, the seller of OCS properties will obtain an indemnity agreement from the buyer and usually also seek some form of security for the obligations of the buyer under the indemnity and other contract provisions which obligate the buyer to properly abandon the properties sold. The seller will attempt to negotiate the value of the security so that it matches the seller’s potential exposure. The joint operating agreement (“JOA”) is another point at which parties allocate risk for abandonment liabilities among themselves. The JOA has been used to require that each co-lessee be responsible for its pro rata share of any security required by BOEM.

In many cases, BOEM’s new bonding requirements will overlap these existing private arrangements. Despite the reality that the marketplace has already found ways to ensure that decommissioning obligations will be funded, BOEM continues to indicate that it is unwilling to give a lessee credit for existing security arrangements unless the security may be called upon by BOEM directly. In other words, if BOEM does not appear on the surety as an insured party, the lessee will have to provide additional security to BOEM in order to satisfy its financial assurance obligations. This very likely will result in decommissioning obligations being doubly secured – first by virtue of a private contract, and second by virtue of financial assurance held by the federal government. This unnecessarily ties up capital that could be beneficially invested in exploration and production.

In addition, BOEM’s proposed changes will increase the number of companies subject to bonding and the amount of such bonds, which in turn affect available capital and squeeze the surety market. Majors, which carry more weight with surety providers, may inadvertently raise the rates for smaller producers – compounding the difficulty some of these companies face in putting up multiple layers of security. The combination of the need to provide multiple parties with financial security and the increased costs associated with obtaining such security will likely discourage new companies from entering the OCS and may drive out a handful that are already there.

The loss of independents in the OCS will impact the majors’ offshore future

The contribution of independents in the OCS is well-documented.7 Majors rely on independents to purchase assets that for them qualify as underperforming. Who will acquire these assets if independents are driven from the market by unduly burdensome bonding obligations?

While BSEE’s Well Control Rule deserves the scrutiny it is receiving, BOEM’s supplemental bonding proposals also deserve a long, hard look by all OCS operators, independents and majors alike.