Word to the Wise: How the scheduling and discounting of liabilities affects end of life cost estimates

August 20, 2019

Our final blog in this five part series of LLR vs ARO looks at the impact of scheduling and discounting.

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For the past month, our Wednesday Word to the Wise series has focused on various reasons why the AER’S LLR deemed liability values may not provide an accurate assessment of the actual end of life costs of an oil and gas asset. This week we present our final article on the subject, examining how the scheduling and discounting of liabilities are not reflected in LLR. This and other shortcomings of the LLR formula are demonstrated in our case study LLR vs ARO: The Cost of Uncertainty.

Sometimes we feel that we’re presenting all doom and gloom when discussing the difference between LLR and an ARO calculation, but here is where we catch a break. Alberta’s current LLR calculation does not discount deemed liability values to account for present value and the application of present value will reduce liabilities in comparison to LLR. With LLR, all liabilities are assumed to come due tomorrow, which impacts how ARO is booked into transactions and the present value of liability.

Many of the assets in the Western Canadian Sedimentary Basin will continue for many years and companies will extend this life even further with drilling, re-entry and other activities. Therefore, assigning present day liabilities will give us a skewed assessment of value. Discounting the associated liabilities to properly reflect their lifespan can have a significant financial impact on the overall dollar figure and it also allows us to compare multiple assets with different lifespans.

We can clearly see this illustrated in the table below, where we look at an example of a company with oil rich assets sitting at approximately 2100 boe/day. In this example, the LLR total liability is sitting at $21,147,795, but their discounted ARO liability calculated by XI’s ARO Manager is only $15,320,127. This is a difference of 28%, which can have a material impact on how their corporate health is assessed. XI uses very conservative decline analysis for these assets, so this liability could justifiably be pushed out further again, decreasing the effective liability amount in the process.

Discrepancies LLR-Based Estimation of Liabilities ARO-Based Estimation of Liabilities Difference
Scheduling & Discounting $21,147,795 $15,320,127 -$5,827,668


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