Word to the Wise: How third parties evaluate ARO to assess risk on potential investments

January 12, 2021

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A lot of focus in liability management is centred on those who hold the liability: producers, working interest partners, and the Orphan Well Association. These are the parties who will have the liability costs on their books and will deal with abandoning and reclaiming the assets in time.

But there are other parties that are also involved in decision-making based on ARO, ones that primary liability holders regularly work with: banks, investment firms, law firms, and any third party tasked with evaluating potential transactions and assessing producers looking for capital. High-profile environmental liability cases and recent bankruptcies have resulted in a higher awareness of asset retirement obligations (ARO) among these third parties. It’s not enough to examine the potential profit of an acquisition or investment opportunity. The potential liability must also be known before an investment decision is made, as it can be the difference between an incredible bargain and an albatross asset.

It’s helpful to examine what these third parties need to assess ARO. If you are a third party, you need to know your options and the potential pitfalls of certain solutions. If you’re a producer looking to work with one of these third parties, you want to ensure your ARO calculations either match their assessments or allow you to explain the differential.

Gaps in ARO evaluations

Traditionally, these third-party evaluators relied on liability calculations provided by the Alberta Energy Regulator (AER). Third parties could get liability information via liability management rating (LMR) reports to get an at-a-glance look at potential acquisitions. As liability management rose in importance, many banks and investors started to recognize the limitations of the LMR numbers in accurately judging liability based on several missing pieces of data (see our case study LLR vs ARO: The Cost of Uncertainty for details on these limitations).

Despite the limitations of LMR, some third-party evaluators continued to rely on it as an independent, summary evaluation, until the AER stopped providing its report on all companies at the end of 2019. Without this report, they needed to find an alternate source of data for quick evaluations.

Internal ARO calculations provided by borrowers or listing agents might not be reliable. Even if they are reliable, they usually employ personalized cost models based on internal numbers that aren’t useful for apples-to-apples comparisons for the third-party. Third parties want their own calculations, using standardized cost models that can carry over to each evaluation they do.

For third party practitioners, this means finding their own data solutions to replace what they used to get from the AER. This is particularly necessary when evaluating assets that have yet to be listed, a practice growing in importance in our current A&D landscape. For asset-holders, it means that they need to understand that the third parties evaluating them won’t be relying on their own internal numbers. This means that they either need to have tools that allow for an independent evaluation of their numbers to get a sense of how others assess their liability or be prepared to explain why their numbers differ from those evaluations.

To achieve this, you need to ensure that your ARO processes provide:

  • Publicly available data for all assets, internal and external.
  • Standardized industry-trusted cost models to ensure all ARO calculations are on par with each other.
  • The ability to compare liabilities for multiple companies quickly to better understand risk upfront.

AssetBook ARO Manager by XI Technologies is one such tool, used by the majority of banks in the Western Canadian Sedimentary Basin. It provides third party evaluators with a robust, customizable cost model developed through a culmination of government resources, expert opinion, and industry data and provides ARO liability estimates for every company, well, facility, and pipeline in the WCSB. To read about how one bank used ARO Manager to help a client evaluate potential opportunities, click here.

If you’d like to get a more detailed look on how ARO Manager can satisfy needs of third-party evaluators and those working with them, contact us today to book a demo.