Bankruptcy is not a license to ignore rules

[SharperDingaan]

Very deep ruling by the Supreme Court Of Canada, on the ranking of environmental responsibilities in a bankruptcy.

Basically, the cost of environmental clean-up ranks AHEAD of ALL other claims (including secured debt), AS WELL AS legal/adviser fees involved in the wind-up. And if asset sale proceeds are inadequate to fund the cost of the clean-up - the INDUSTRY is on the hook for the difference.

 

In effect, BY LAW, the first tranche of a company environmental clean-up is self-funded by the company, the second tranche is self funded by industry, and only the remainder is covered by you and I - the people. https://calgaryherald.com/commodities/energy/bankruptcy-is-not-a-license-to-ignore-rules-top-court-rules-old-wells-clean-up-comes-first-in-landmark-case/wcm/dad33064-ec42-421e-b019-04f5ac2abf29

 

Any kind of extractive industry (o/g, mining, forestry, fishing, etc), any kind of utility supplying an output at < full cost (not charging for polllution from nukes, CO2 from coal/gas power, potential catastrophic failure [Fukashima, PG&E], etc), and any kind of industry impairing the environment (cement manufacture, plastic container polution, etc.) are now explicitly (versus previously implicitly) liable. Pricing now includes full costing, it is a collective effort, and it finally pays to reduce pollution at source. Very, very smart.

 

For the Alberta Tarsands, it would essentially require, by law, ALL of Canada to collectively pay full cost for o/g, and in pollution controls to reduce that cost. Provinces no longer able to refuse transit, if it reduces the unit costs of o/g for all Canadians - either via higher throughputs, or higher prices for non Canadians. Today's roadblocks, suddenly collapse.

 

The new world - that we have all been waiting for.

We live in interesting times.

 

SD

 

 

 

 

 

 

 

[scorpioncapital]

I'm not sure this is quite so strict globally. Canada will suffer, what company wants to do business here with such deterrents?

 

[LC]

Creating prudent incentives within the industry, establishing a global precedent, and making an effort to quantify externalities? Canada, you've done it again!  ;D

[muscleman]

No wonder the oil industry is so pissed at Justin Trudeau. This ruling may also have big impact on the nuclear industry as well. Imagine a nuclear reactor blow up and the whole industry responsible for paying for the recovery? I can't even imagine how someone can completely clean up a nuclear blow up.

[John Hjorth]

Very intesting topic, Sharperdingaan, thank you for starting it,

 

Personally, I read it as a global icebreaker - a frontrunner, and thereby a place to start. The point here being that this should not only apply to businesses, but also to all legal entities [persons, [companies, firms, foundations, trusts & endowments doing business] etc.] with regard to reckless environmental behavior.

 

I.e. the problems related to what's going on at River Ganges involves all kind of sinners : businesses, individuals & the state, cities & municipalities etc. of India - them all being environmental sinners, based on short term based behavior etc.

[bizaro86]

This is interesting indeed. I think in the short run it will all but freeze the lending market for junior oil and gas companies in Canada. Hard to lend with undefined priority claims ahead of you.

 

In the long term I think one of the banks will build in house capacity to evaluate environmental liabilities and use it to take profitable market share.

 

This should have the consequence of pushing the industry toward higher rate individual wells, as the cleanup liability is less per $ of value extracted, and that is so obvious even the banks should realize it soon enough, and preferentially lend on those assets, lowering the cost of capital for those plays.

[Cardboard]

Another decision indicating that Canada is closed for business and its people will suffer.

 

Already, decommissioning liabilities are amongst highest in the world due to very strict rules. In the meantime the U.S. keeps on flaring natural gas and all over the world.

 

Now, by making this liability top priority vs other creditors including pension (I assume), then you have raised cost of capital for ALL the players instead of addressing an issue that is small in the grand scheme of things as most companies don't go bankrupt.

 

And when I read some empty statements such as these I can only shake my head:

 

"Creating prudent incentives within the industry, establishing a global precedent, and making an effort to quantify externalities? Canada, you've done it again!"

 

Nobody gives a shit about what Canada does. Not the U.S., not China, not Europe. Not even the Australians who were only too happy to see that girl from Saudi Arabia go to Canada after Trudeau and Freeland saw an opportunity to make the news.

 

The world will go on poluting and Canada in a few years from now will see a lot of unemployed. Just watch!

 

Cardboard

[John Hjorth]

This is interesting indeed. I think in the short run it will all but freeze the lending market for junior oil and gas companies in Canada. Hard to lend with undefined priority claims ahead of you.

 

In the long term I think one of the banks will build in house capacity to evaluate environmental liabilities and use it to take profitable market share.

 

This should have the consequence of pushing the industry toward higher rate individual wells, as the cleanup liability is less per $ of value extracted, and that is so obvious even the banks should realize it soon enough, and preferentially lend on those assets, lowering the cost of capital for those plays.

 

Yes, new green grass for insurance & reinsurance - over time, world wide.

[SharperDingaan]

Everyone is free to buy their raw materials elsewhere, but can only do so as long as 'elsewhere' has the excess capacity. 'Elsewhere' also has to have the deposits that can be produced for less than it would cost to buy Canadian, AND the same (or lower) political/regulatory risk. Tar Sands, Hydro, etc remains very attactive.

 

The 'open for business' argument thinks it OK to rape and pillage - so long as you create jobs. The arseholes and abuses that this generates, are just another cost of doing business; and if it damages the environment, who really gives a sh1t - as everyone else is doing it. If we don't do it, somebody elsewhere will, & we're just unemployed.

 

We used to think that drunk driving, 2nd hand smoke, wife beating, and suppressing women was 'OK' as well. And in the early 2000's we also thought predatory mortgage lending was OK - right before it blew up the financial system; oops!  Like it or not we've moved on, we don't have to do something just because everyone else is, and 'rape and pillage' is just not acceptable any more.

 

So next time you meet a politician, put him/her on the spot, and see how well 'they' can lie out of both sides of their mouth! 

 

SD

 

 

 

 

 

[EliG]

And if asset sale proceeds are inadequate to fund the cost of the clean-up - the INDUSTRY is on the hook for the difference.

 

Citation needed. Please provide a reference that corroborates your claim.

 

FWIW, I read a few articles about the decision. None of them mentioned this (supposedly earth shuttering) aspect of the court ruling.

 

In fact, based on my quick read, the reality could be the opposite of what you claimed.

 

Currently, when a bankrupt Alberta company walks away from a well, The Orphan Well Association ends up being responsible for the cleanup. The Association is funded by the energy industry. The court decision makes it less likely that abandoned wells will be dumped in OWA's lap.

 

Alberta oil industry appears to be happy about the decision:

 

The Orphan Well Association should be “a last resort,” said Brad Herald, Canadian Association of Petroleum Producers vice-president Western Canada, in a release, adding the industry group was pleased with the decision.

 

“CAPP has argued on behalf of industry that when a company declares bankruptcy, the value of any assets should go to abandonment and reclamations costs first,” he said.

 

https://calgaryherald.com/commodities/energy/bankruptcy-is-not-a-license-to-ignore-rules-top-court-rules-old-wells-clean-up-comes-first-in-landmark-case/wcm/dad33064-ec42-421e-b019-04f5ac2abf29

 

 

 

 

[Cigarbutt]

^Even if individual firm reckless behavior cannot be ruled out, the growing number of abandoned wells is mostly due to a very difficult realized price environment since 2015.

 

The bankruptcy processes that resulted from the above effectively transferred the environment liabilities from the "polluter", skipping the lender, to the OWA which has required, on top on industry contribution, some form of government support (temporary). The OWA has produced a letter yesterday (see link provided by EliG).

 

Bankruptcy is used to maximize recovery and to offer coordination guidelines. The SC ruling IMO simply helps to correct the relative temporary displacement that has occurred. Temporarily, the lender will pay if oil prices stay low but lenders have also intrinsic mechanisms to pass costs to the various customers they serve. Energy ($) can neither be created nor destroyed, but it can move around.

 

Along the same lines, if externalities become incorporated in regulated utilities' cost+reasonable return model, it's not the utility's return that will change.

 

Here's a nice summary of the split decision:

https://www.osler.com/en/resources/regulations/2019/supreme-court-of-canada-decision-in-redwater-early-implications

 

[bizaro86]

#eliG I agree this removes the environmental costs from industry.

 

Previously the order was:

Individual company equity holders -->industry

 

Now it will be

 

Individual company equity --> individual company debt owners --> industry

 

The big companies (the ones who control CAPP) love this. They pay most of the orphan well levies, which have been rising dramatically. So this will save them money.  They also have much better access to both debt and equity capital than juniors.

 

The small companies are less excited. They don't pay much for orphan well levies anyway, so making them smaller doesn't move the needle. But they don't have access to the bond market or earnings-based lending. And now reserve based lenders will tighten their purse strings dramatically as they are effectively subordinated behind environmental liabilities. Given an individual well can range dramatically in liability, that puts them behind an uncertain value. (I once had to hire a scuba certified guy who also had alberta wellhead insurance to suspend a well that was underwater (ducks unlimited created a new wetland...). We could only find one guy who met the criteria to do the work, and from his pricing he realized that he had a 'moat' in the business of underwater well remediation....)

 

I'm in favor of this as an Alberta resident/taxpayer, I think it's the right thing to do. But it will cause a lot of pain in the junior sector, and that's a group that has had a lot of external pain inflicted on them the last few years... The management class of these companies tend to be well off (==overpaid?) and are often politically active/donors. So they have clout here in AB. (Supreme court doesn't care about that, obviously...)

[SharperDingaan]

Agreed the OWA has been the long-standing INDUSTRY response to well abandonment.

But it has always functioned as an after-the-fact PR salve. Throw in a few bucks to demonstrate we're attempting to clean up the mess, in return for letting us continue. No real before-the-fact attempt to actually fix the problem.

 

Now the emphasis is before-the-fact, and those responsible for a large part of it, being made to pay for it. Yes it wil making starting up harder, and pull the plug on failing firms earlier than might otherwise have occurred; but that's not a bad-thing. Making it harder to abuse, and doing so PRO-ACTIVELY, is in everybody's long term interests. We're done with hostaging employees.

 

Ultimately it's really a muscular behind the barn 're-adjustment'.

Elder siblings informing/enforcing the 'new order' on the younger 'hard of hearing', in partial recompense for having to bear the majority of the current shut-in. Hard to argue against.

 

Canadian o/g has the OWA, Canadian auto-insurance has the Facility Association, but a great many other industries have nothing.

While being more responsive than others is great PR, when the bar is so low ... the industry is just evidencing that it's a salve. No real intent to change.

 

If the industry really wants to move forward, it has to clean up its act.

If you keep drawing 'roughing' penalties, eventually you just get thrown out of the game.

 

SD

 

[Cigarbutt]

The junior oil and gas sector is a magnified boom and bust cyclical industry.

 

Since 2015, the market environment has shown that many focused only on the boom side (bloated and too well paid execs at the top, excessive leverage and poor/unsustainable capital allocation model) but let's say you're a typical player in the field (reasonable), what do you try to do during the bust? You try to stretch the payables, stretch the lenders and you try to stretch the environmental liabilities.

 

In 2015 and 2016, there were a few instances where Receivers would come in and flesh out the good assets and throw away the inactive (which really "deserved" to be abandoned) wells into the public backed-stopped hands. At the time, this did not smell right.

 

So, who's at fault? I would say many parties but IMO especially the regulator (AER) and if you read the SC decision between the lines, the wise suggest to observe the rules AND to re-write some rules. I think it's not the job of the regulator to "help" the industry during downturns. When looking at what has been happening in the last few years, the AER has underestimated abandonment costs and overestimated the potential recovery of inactive wells. Firms that reached bankruptcy and price discovery levels were sometimes characterized by a very unusual switch of potentially "productive" assets becoming environmental liabilities.

 

Despite the above comments about the judicial aspect, if the regulator brings the LMR ratio and its management to appropriate and conservative levels and if you believe, as I do, that the Canadian oil and gas sector has a role to play in the global energy transition, nothing (not even the Supreme Court) prevents the politicians (federal and provincial) from "investing" in an infrastructure-related program for environmental remediation or even a "job stimulus" program to help the industry if the downturn persists or worsens.

 

The oil industry has to become a better (and less adversarial) political player.

[bizaro86]

I think the AER will leave the requirement that companies can't make acquisitions unless they have an LMR greater than 2.

 

That would stop the traditional big company plans of dealing with liabilities by selling a package of assets with NPV slightly greater than zero (because environmental liabilities approx equal value) to a junior who milks it along cheaply. That worked fine in a rising price environment, but poorly in an extended downturn. It will also stop the garbage barge issue (ie Lexin) which is a huge part of the current problem.

[SharperDingaan]

Two brief adds to this, before moving on.

 

The best solution for everyone is a self-regulated industry, with the lightest 'regulatory touch' possible. We already have something like this in Canada that works very well - the Canadian Banking Industry. Replace 'bank act' with a 'resource act', 'bank charter' with 'resource permit', and 'law' with 'OSFI Guideline'. Free to compete as you wish within the Guidelines, blunt political discussion behind closed doors, and industry decisions - made by industry.

 

Pipelines are really national assets, and would be better served; were they built by Canada, and leased back to industry. Nationalized rights of way and construction to get it done, industry to operate it, and 'over-ride' control if the lessee fails to deliver. In rail use, this would include double/triple tracking portions of the east-west rail tracks, engines and crews; leasing them back, and ending congestion. Certainty, and the end of fiefdoms ransoming citizens.

 

Obviously not popular, but if you want to make 'real' change ......

 

SD

 

[Cardboard]

"We used to think that drunk driving, 2nd hand smoke, wife beating, and suppressing women was 'OK' as well. "

 

Maybe it has been for you but, it never has been for me. So slapping your wife was ok with you SD?

 

Regarding this whole discussion, there is no environmental liability not being met. It is only a matter of who ends up paying? I continue to stand by my point that Canada has amongst strictest rules in the world and they are being followed.

 

The issue here is a tiny minority or a company that fails AND where the assets being purchased in the liquidation process are not worth enough to cover both first creditors and environmental liabilities.

 

By the way, it is again our so called perfect group of 6 big banks (per SD's admiration for the Canadian Banking Industry) who help to lever these things then, push their way around everybody at first sign of trouble to defend their obligations and throw these companies into receivership without any consideration for proper restructuring.

 

"I think the AER will leave the requirement that companies can't make acquisitions unless they have an LMR greater than 2."

 

Even in a bankruptcy, environmental liabilities follow in their entirety with the assets and purchaser is subject to these rules to ensure they are solvent. The Redwater example is a special case where the banks were once again able to push their way around by creating good company and bad company and prompted the regulator to modify its rules.

 

Environmental liabilities is an on-going cost of the business met over decades or financially similar to a very very long term lease. To call this first lien or above everything else is not right and will only increase cost of capital for all players even if perfectly sound once again because big banks will use this as an excuse to charge more. It should be the responsibility of the regulator who bless all these activities: acquisitions, new wells, etc. to ensure that the operator is financially sound when they deliver these permits. If not, what are they doing exactly?

 

Cardboard

[SharperDingaan]

That tiny minority poisons the well for everyone else, and while that may have been seen as acceptable at one time; the times have moved on. Hence the reference to drunk driving, 2nd hand smoke, wife beating, etc.

 

Agreed environmental liability is an ongoing cost of business. You can either 'pay as you go', or provision for it - and rank that provision ahead of all obligations in a bankruptcy. You don't get to diminish/escape it by simply declaring bankruptcy, the times have changed.  Greater certainty, and a lower cost of doing business.

 

Everybody hates their banker, their regulator, and God damn that CPR!  ;)

It gives everyone someone else but themselves to blame, and helps politicians capture votes. Of course there is no possibility that either you, or your industry, were a sh1t credit at the time you applied - and the banker was just being prudent? They didn't have to lend to you, and apparently you ALSO couldn't get ANYONE ELSE to lend to as well? Your banker was right!

 

Sure, regulators and central bankers aren't perefect, they're human.

And we all accept the cost of that, when we collectively pay to clean up the impairment that the minority left behind. Apparently we can't change the rules of the game, that permit the extraction of those resources that we all collectively own?

 

Different strokes.

 

SD

 

 

 

 

 

[RichardGibbons]

Regarding this whole discussion, there is no environmental liability not being met. It is only a matter of who ends up paying? I continue to stand by my point that Canada has amongst strictest rules in the world and they are being followed.

 

So, according to this article, in the three western provinces, there were about 85K abandoned wells, and another 122K inactive sites.

 

About 85% of the abandoned wells are in Alberta, and more than 50% have had nothing done to them for a decade, and the ratio is only a bit better for BC and Sask.

 

So, how do you explain the discrepancy between these numbers, and your "there is no environmental liability not being met" and "Canada having some of the strictest rules"?  Is the Globe and Mail misrepresenting something about the situation?  Is it just you twisting words to lie about the situation?  (e.g. "There is a clear plan for dealing with the abandoned wells--it's on the calendar for June 17, 2174")

[Cigarbutt]

The number of orphaned wells has gone up tremendously in the last 5 years and there are reasons for this rise (mostly smaller and weaker players) but there was already an underlying industry-wide upward trend for "inactive" wells before 2015, most of which had very little chance of going back into production, even with very optimistic "projections".

 

There is a lot of talk about shared benefits which should be proportional to potentially shared liabilities. At a time when the industry needs to improve the public perception and at a time where pipelines going through someone else's lands are necessary to get its extracted product to the end consumer, I think that oil and gas market participants should not simply bet on a rebound but should take a pro-active stance with elected officials and regulators in order to show a balanced concern for the environmental liabilities.

 

The environmental liabilities could be backed by partial bonding and, to avoid having a specific timeline on the growing number of "inactive" wells, should push for a mandated insurance program to be used in the interim. I'd say this would be a +NPV project when all costs and benefits are considered.

 

[John Hjorth]

I've been reading the O&G topics here on CoBF for many years, keeping my mouth totally shut. Here I ask a few basic questions, -I hope you'll pardon me, and also answer me:

 

1. What does it mean "to abandon a well"? [is it just removing the superstructure above ground, or what?, - how about i.e. properly sealing?]

2. Is there a stated, written & approved upon [by regulatory body, or perhaps by lawmakers] standard for "abandoning a well"?

3. Is there follow-up, control & approval about bullet #2?

[Cigarbutt]

I've been reading the O&G topics here on CoBF for many years, keeping my mouth totally shut. Here I ask a few basic questions, -I hope you'll pardon me, and also answer me:

 

1. What does it mean "to abandon a well"? [is it just removing the superstructure above ground, or what?, - how about i.e. properly sealing?]

2. Is there a stated, written & approved upon [by regulatory body, or perhaps by lawmakers] standard for "abandoning a well"?

3. Is there follow-up, control & approval about bullet #2?

There, everything you ever wanted to know about well classification. :)

https://www.canadasnaturalgas.ca/en/environmental-action/land/liability

https://www.aer.ca/regulating-development/project-closure/suspension-and-abandonment/how-are-wells-abandoned

 

Interesting to remember that the remediation problem would disappear from the radar if oil prices would go up. IMO, the regulators wanted to help but are now behind the ball. You've probably heard of the path to insolvency, gradually then suddenly. The problem with bizaro's comment to require firms to maintain a LMR ratio above 2 is that, at this point, requiring weak firms to provide regulatory capital may push some into insolvency, further compounding the problem. It seems to be easier to avoid a mess than to disentangle from one.

[John Hjorth]

Thank you for taking your time explaining it to me, so to say "on the rim", Cigarbutt!,

 

It makes sense to me, as an ignorant layman in the field, despite years of reading here on CoBF. -What a game! - It reads like "Klondike anno 2019"... - Now I'll just keep my mouth shut going forward and continue reading.

[bizaro86]

I've been reading the O&G topics here on CoBF for many years, keeping my mouth totally shut. Here I ask a few basic questions, -I hope you'll pardon me, and also answer me:

 

1. What does it mean "to abandon a well"? [is it just removing the superstructure above ground, or what?, - how about i.e. properly sealing?]

2. Is there a stated, written & approved upon [by regulatory body, or perhaps by lawmakers] standard for "abandoning a well"?

3. Is there follow-up, control & approval about bullet #2?

 

1. Those links cover it well. Abandonment requires all zones to be isolated from each other, generally with a bridge plug covered with a layer of cement. The lowest area with groundwater is also isolated. To cut and cap, the well is cut off below the surface, and covered with a vented cap, then with dirt.

 

You didn't ask, but after all wells/facilities on a lease are abandoned, the lease is reclaimed. That requires the operator to put the land back to condition comparable to its original condition. For this reason, oilsands projects collect seeds and plant matter when they are building. That way they can plant the exact same species as were there originally. The cost of remediation often exceeds the cost of abandonment (sometimes greatly).

 

2. Yes. It's long and technical, but basically you have to demonstrate (via pressure data) that each zone is isolated from the others.

 

3. Yes. There is required data to be submitted to the regulator to get an abandonment complete. Also, the operator remains liable for future issues from the abandonment in perpetuity.

[John Hjorth]

Thank you, bizaro.