SHALLOW GAS
– City could debt-finance well shut-ins
City hall officials will recommend debt-financing to pay for abandoning most of the city’s low-production gas wells over the next three years, the News has learned.
Last fall, the 110-year-old petroleum production company announced it could no longer sustain deeply depressed prices for natural gas and would close in and reclaim about 2,000 moneylosing wells in its 2,500-well portfolio.
At that time the cost of the three-year program to complete the work was estimated at $90 million — seemingly to be paid out of from $150 million in reserve funds for that purpose that the city set aside with AIMCo several years ago.
However, with the cash locked into long-term investments, but needed sooner than expected, administrators will recommend accessing favourable credit markets and underwriting debt with the cash holdings.
“We will be laying out the entire 10-year plan, and we expect at least a portion — the first tranche (of abandonments) will be financed by borrowing,” said energy and utilities commissioner Brad Maynes.
“Our cost to capital is very low, and the arbitrage (of managing debt to investment income) can be very advantageous.”
Full details will be outlined in a presentation to city council’s Monday meeting. That meeting is physically closed to the public and media, though proceedings will be broadcast on the city’s website and on local cable station Shaw-TV (cable 10).
Speaking on a separate matter this week, Mayor Ted Clugston said that while many cities are pulling back on spending, Medicine Hat would push ahead with its municipal capital program and “absolutely” the abandonment program, since the wells are operating at a loss.
“It’s like pulling an abscessed tooth,” said Clugston. “The sooner the better.”
According to the city’s yearend financial report for 2019, also to be presented Monday, the gas production business lost $31 million last year and needed cash from the city’s gas depletion reserve fund to keep operating.
That brought the balance — once near $200 million — to zero after years of using money originally meant to buy new gas fields to offset tax increases as budgeters work to erase a deficit.
But operating costs in the production business were also trimmed by $1 million thanks to early stages of the abandonment program that will also require substantial budget amendments that could be introduced on Monday.
There may also be some policy change regarding the city’s internal rules on debt load targets. With about $400 million in debt currently, the city is at about half its mandated limit, which is set by the province.
As well, some special provincial order might be required to accomplish new borrowing. Cities are limited to borrow only for construction that results in a physical asset, whereas closing a wells is the opposite, even if it reduces liability.
Medicine Hat is currently lumped in with major cities in terms of borrowing and investment regulations due to its relatively large holdings and utility operations.
Managing debt against borrowing cost could provide a benefit, since interest rates already at or near historic lows with the potential to drop further as central banks look to spur a post-COVID economic recovery.
The local process could also be akin to a traditional “sinking fund,” whereby the city would hold cash assets and collect a rate of return, while borrowing and then repaying the debt.
By managing money out of the long-term fund, the city would retain the difference between the rate of return and the interest expense which is typically locked-in for municipal borrowing.
Depending on yearly returns the gain could be substantial, but could also wind up in negative territory in case of major market reversal.
The AIMCo investments, including a portion of the city’s separate Heritage Savings Fund, grew by 14.5 per cent in 2019, according to the city’s recently released annual report. But, it lost 2.3 per cent in 2018, following a 7 per cent return the year before. Analysis of the most recent major market correction this spring is not available.
The rate annualized over three years is about 6 per cent, near the city’s stated target of inflation plus 4 per cent.