What happens to chain of title during insolvencies?

August 9, 2018

Guest Blog by Mike Newton

Are oil and gas companies responsible for the end of life liabilities of assets they divest if the acquiring company goes bankrupt? This question has been reverberating throughout the oil and gas industry since the Redwater case first went to trial and with subsequent high-profile bankruptcies in Alberta. The fear is that companies will sell an asset to another entity that eventually goes bankrupt, and the Alberta Energy Regulator (AER) and Orphan Well Association (OWA) will come knocking on the door to recover costs for the end of life liabilities. A little-known precedent agreed to in the early 1990s between industry and government appeared to have shielded industry from lookbacks, but the recent announcement that PricewaterhouseCoopers Inc. (PWC), acting as Trustee of Sequoia Resources Corp. (Sequoia), is pursuing Perpetual Energy Inc. (Perpetual) in the Alberta Court of Queen’s Bench for asset retirement obligations (ARO) has sent a renewed shockwave of unease throughout the industry.

John Nichol presented a paper at the CADE/CAODC Spring Drilling Conference in April 1991 titled Orphan Wells: Who is Responsible – For How Long and At What Cost? that describes the process undertaken to create the OWA and establish the current chain of title precedent. In the mid-1980s, industry and government (ERCB, Alberta Environment, Alberta Energy) each contributed $1.5 million to form the precursor to the OWA to manage orphaned wells. As the number of orphan wells began to increase in the late 1980s, industry and the government composed a joint task force that evaluated long term management options. The objective of the task force was to find a balance between protecting the public and not imposing unnecessary costs on industry, which culminated in the position that those who benefitted from the well should pay. The immediate outlook from the government was to follow the chain of title from licensee and receiver through to working interest participants, previous licensees and mineral rights owners. Industry expressed their concern over this proposed length of chain of title, and instead, recommended that chain of title be limited to current licensee, working interest participants and receivers in return for industry agreeing to fund 100% of the OWA. Further, government agreed to limit security requirements relating to licence transfers if industry agreed that the OWA would fund all orphaned wells that resulted from transactions.

Looking at current legislation, the Oil and Gas Conservation Act under sections 31 and 31.1 does provide the AER with a limited ability to hold divesting parties responsible for end of life obligations in very particular situations. Specifically, working interest participants who divest their interest in non-economic or shut-in assets can be held responsible if the purchaser fails to pay their proportionate share of suspension, abandonment and reclamation costs, so long as certain conditions are met. Directive 024 also references limited lookback authority (i.e. 24 months) for the large facility liability management program, but there has been no judicial consideration of this section to our knowledge.

The recent shockwave, however, revolves around Section 96 of the Bankruptcy and Insolvency Act (Act) and PWC’s assertion that ARO and future environmental liabilities can be used as consideration when deeming assets transferred undervalue. As per the Act “On application by the trustee, a court may declare that a transfer at undervalue is void as against…or order that a party to the transfer or any other person who is privy to the transfer, or all of those persons, pay to the estate the difference between the value of the consideration received by the debtor and the value of the consideration given by the debtor…” In the case, PWC asserts that Sequoia was insolvent at the time of transfer due to, among other things, the gross misevaluation of the ARO associated with the assets included in the transaction with Perpetual. All said, oil and gas producers who were formerly thought to be shielded from end-of-life obligations once an asset was divested are anxiously awaiting the decision in this case. It can be assumed that other similar cases will be brought forth to the Courts and the precedent will have resounding impacts for the oil and gas industry.

In light of this new case, it is more important than ever for all parties involved in transactions to properly assess ARO and develop execution strategies to retire these obligations in a way that balances corporate business priorities with long-term sustainability and the public interest. Over the past few years, I have been pleased to work with XI Technologies to develop a standardized ARO cost model and software tools to help companies do just that.

Related Reading: Download XI’s ePaper, “LLR vs ARO: The Cost of Uncertainty

About the Author
Mike Newton is with 360 Energy Liability Management, where he helps both divesting and acquiring companies in the liability assessment and management process. Mike is also a key consultant to XI Technologies in developing the LLR and ARO Cost Model within AssetBook. He has more than six years’ experience specializing in LLR and environmental issues within the western Canadian oil and gas sector and has also completed an extensive 4-year project gathering LLR, ARO and other industry data across the WCSB. Mike can be reached by phone at 587-999-5648 or email mnewton@360elm.com.

About XI’s ARO Manager
The AssetBook ARO Manager is the first and only standardized tool for estimating and monitoring asset retirement obligations in Western Canada’s oil and gas sector. More than just an ARO calculator, it can be utilized to monitor and optimize liabilities over the entire life cycle of an asset. From Land, to Business Development, to Operations, Risk Management and Finance, E&P leaders across the organization can use AssetBook ARO Manager to:

  • perform scenario analysis to see the impact of an A&D transaction on a corporate position
  • analyze scenarios using any combination of properties in XI’s AssetBook
  • upload proprietary corporate ARO data for more detailed analysis and tracking
  • save your work for future reference and updating

For more information about AssetBook ARO Manager, or to request an introductory demo, call XI Technologies at 403-296-0964, or contact us.