Word to the Wise: Why LMR values aren’t a good indicator of a company’s liabilities

January 14, 2020

Here’s why the LMR information you used to get from the AER wasn’t telling the whole picture.

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In XI’s final article of 2019, it was pointed out that the Alberta Energy Regulator (AER) has stopped providing monthly detailed liability management rating (LMR) reports on all assets in the province. Information that was previously made available to help producers and banks evaluate potential acquisitions and borrowers is no longer being provided by the AER.

When XI reached out to the AER about this change, one reason offered was that the AER believed that the LMR value alone isn’t a good indicator of a company’s financial health, and as a result, they are broadening their assessment processes and focusing their resources on those means (the other reason given was budgetary). This article will look at some of the ways in which LMR values fail to accurately assess a company’s true financial liability obligation. LMR can both overstate or understate this obligation.

Figure 1 – There are five significant factors that cause LMR to inaccurately assess a company’s liabilities when it comes to abandonment and reclamation estimates.

When estimating the potential end of life costs for an asset, there are five key evaluation factors that the LMR model does not account for, and these can have a significant material impact on the total end of life liability obligation calculations.

Working interest

The LMR formula currently applies 100 percent of deemed liabilities to the Licensee without taking into consideration the working interest values for wells with multiple owners. It simply applies all liability to the Licensee and zero liability to non-operating partners.

Abandonment

Using the deemed liabilities prescribed in the LMR can result in an understatement of abandonment costs for sour wells and older (pre-1985) wells, as well as an overstatement on downhole abandoned wells requiring only cut-and-cap and shallow gas wells.

Over-licensed facilities

The licensing requirements of Directive 056 create an incentive to license facilities to their maximum size potential. LMR assigns deemed liability values according to how facilities are licensed. If a facility is licensed to one size, but built to a smaller size, the deemed liability values may exceed the actual retirement cost of the facility.

Reclamation costs

LMR is not designed to account for contamination, including both the assessment and remediation of impacted materials. Other influencing factors include large pads and revised vegetation standards introduced in the mid-1990s.

Scheduling and discounting of liabilities

LMR does not consider discounting and the application of present value will reduce liabilities in comparison to LMR. However, the introduction of new legislation, such as the Inactive Well Compliance Program (IWCP), limits the window within which companies must abandon inactive wells. This effectively changed many older, long-term liabilities into short-term liabilities, increasing the present value of these liabilities.

For a more detailed look at how the AER calculation of liabilities fails to provide a complete picture for evaluations, particularly in comparison to more robust ARO calculation provided by XI Technologies, click here to download an ePaper on LLR vs ARO.

For more information on this change to liability data delivery, or to discover how AssetSuite can help you manage your liability analysis, contact XI Sales.