Law of Un­in­tended Con­se­quences

How to nav­i­gate the world of Al­berta’s chang­ing Li­a­bil­ity Man­age­ment Rat­ing

Alberta Oil - - SMART MONEY -


from what has been one of the worst down­turns in en­ergy in a gen­er­a­tion, one thing has been abun­dantly clear to us: Gov­ern­ments and reg­u­la­tors do not seem to have par­tic­u­larly aus­pi­cious tim­ing with re­spect to chang­ing the rules of the game. Nowhere is this more ev­i­dent than with re­spect to the oil patch in Al­berta. On the heels of an ill-timed roy­alty re­view, the prov­ince has en­acted new rules with re­spect to the treat­ment of li­a­bil­i­ties that re­late to the aban­don­ment and recla­ma­tion of wells.

By way of back­ground, ear­lier this year, a prece­dent-set­ting bank­ruptcy case pit­ted the prov­ince against cred­i­tors. At issue was where a pro­ducer’s obli­ga­tion to clean up an old well ranked rel­a­tive to the obli­ga­tions of banks and lenders. In the in­sol­vency of Red­wa­ter En­ergy, the Al­berta En­ergy Reg­u­la­tor (AER) asked for a rul­ing that would pri­or­i­tize that any money raised through the sale of the com­pany’s as­sets be used first to de­com­mis­sion its roughly 70 in­ac­tive wells. The crux of the case seemed to be cen­tred around whether or not the prov­ince should be on the hook for these obli­ga­tions. Un­for­tu­nately for the prov­ince, the court ruled in fa­vor of the cred­i­tor, thus al­low­ing fi­nan­cial in­sti­tu­tions to re­cu­per­ate out­stand­ing debts ahead of any decom­mis­sion­ing ac­tiv­i­ties. As such, those as­sets would fall un­der the re­spon­si­bil­ity of the Or­phan Well As­so­ci­a­tion (OWA), which is not par­tic­u­larly well-funded, and will be even less so if there is a wave of bank­rupt­cies yet to come.

In re­sponse to the rul­ing, the AER has rolled out more strin­gent fi­nan­cial re­quire­ments for com­pa­nies look­ing to trans­act in oil and gas as­sets. Pre­vi­ously, pro­duc­ers were re­quired to post se­cu­rity if their Li­a­bil­ity Man­age­ment Rat­ing (LMR) fell be­low 1.0 as part of a stan­dard­ized for­mula. The new reg­u­la­tory mea­sure re­quires that pur­chasers of AER-li­cenced as­sets have an LMR of 2.0 or greater, pro forma pro­posed ac­qui­si­tions. The im­pli­ca­tion is that po­ten­tially ac­quis­i­tive com­pa­nies like Pine Cliff En­ergy and Car­di­nal En­ergy may have dif­fi­culty ex­e­cut­ing their busi­ness strate­gies, es­pe­cially since both have his­tor­i­cally re­lied on ac­qui­si­tions to grow. By en­act­ing these changes, the prov­ince is ob­vi­ously try­ing to pro­tect tax­pay­ers from li­a­bil­ity for the large num­bers of aban­doned and yet-to-be-re­claimed wells.

Ap­prox­i­mately 72 per­cent of li­censes in the prov­ince cur­rently have an LMR less than the crit­i­cal 2.0 thresh­old. De­spite an av­er­age LMR of 3.7 prov­ince-wide, the im­pli­ca­tion is clear that the gov­ern­ment has thrown a wrench into the in­dus­try’s abil­ity to trans­act dur­ing the down­turn. Penn West Petroleum’s CEO re­cently said he be­lieves there are 500 or so com­pa­nies that are now ef­fec­tively frozen out of the as­set trans­fer mar­ket.

A sig­nif­i­cant part of the solution to the in­dus­try’s woes seems to be the abil­ity of pro­duc­ers to trans­act. As­sets from weaker hands need to be trans­acted into the hands of stronger, bet­ter cap­i­tal­ized com­pa­nies. Im­ped­i­ments to the heal­ing process are al­most cer­tain to in­crease bank­rupt­cies and im­pair the abil­ity of some com­pa­nies to emerge from this com­modi­ties rout any stronger—if at all. The cu­ri­ous irony is that this has the po­ten­tial con­se­quence of ac­cel­er­at­ing bank­rupt­cies, and could even see an in­flux of wells en­ter the or­phan well fund. In the ab­sence of a softening of this AER stance, in­vestors might want to in­crease their weight­ing to de­fen­sive en­ti­ties with strong balance sheets, ac­cess to cap­i­tal and LMR ra­tios above 2.0—or per­haps even look out­side of Al­berta.

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