Alberta’s good faith rules hit firms hard
Junior producers feeling crunch
In its zeal to demonstrate good environmental and fiscal practices, the Alberta government may be pushing out of business already struggling oil and gas junior producers.
Last May the province significantly jacked up security deposits for oil and gas operators to cover the cost of restoring land affected by wells, facilities and pipelines in case they go out of business.
A fund that held $13-million from 88 Alberta companies was expanded to hold to $297-million from 248 companies. The province has been demanding the new money from operators who, according to its own complex formula, have liabilities that exceed assets.
It’s junior producers that are taking the hit. Already barely staying afloat as a result of natural gas prices declining 80% since 2008, they are being asked to pay money they don’t have, said Dale Brand, chief operating officer of Midlake Oil & Gas Ltd., a private Calgarybased company that produces about 420 barrels of oil equivalent a day from 200 wells.
“As a junior, we are coming off a period of sustained low gas prices, our cash reserves are gone, our bank lines are gone, and all of a sudden they demand a $1-million payment, and they say, do it now,” Brand said in an interview.
“The impact to the small oil and gas companies is immediate and absolutely terrible,” added Rick Nixon, CEO of Midlake. “There are a lot junior oil and gas companies that won’t survive, because the bank won’t lend them the money. The juniors are less than 6% of the problem, but they are pushing them into bankruptcy.”
To compound the problem, the new rules are depressing the market for oil and gas assets as both buyers and sellers weigh the implications, said Kim Davies, vicepresident of business development at Atoll Financial Group in Calgary.
As is often the case, the change came with good intentions. The Licensee Liability Rating (LLR) program was designed to prevent Alberta taxpayers from being on the hook for the costs of cleanup after oil development.
Pressure came from environmentalists, land owners, the province’s auditor general and even industry, which criticized the Alberta Energy Regulator for underestimating abandonment liabilities.
Midlake’s Nixon complains the charges have the feel of a cash grab to pay for expanded regulation to respond to the public’s unreal expectations that all risk be taken out of oil and gas development.
While large companies, which tend to be focused on oil production, have the cash to absorb the new costs, the changes couldn’t have come at a worst time for junior producers.
Years of depressed gas prices, uncertainty over oil pipeline capacity, increased anti-energy activism, and unsupportive markets have shrunk the junior sector to half its size from the middle of the last decade. There are 49 remaining public juniors in the Western Canadian basin with production of 500 to 10,000 barrels of oil equivalent per day, down from 94 in 2007, according to data compiled by investor relations firm Bryan Mills Iradesso.
In a newsletter to clients, David Yager, leader of the oilfield services group at MNP LLP in Calgary, said the new costs have the effect of kicking juniors when they are down.
“The LLR is in some ways a solvency test for licensees to ensure the government doesn’t get stuck with a bunch of ownerless wellbores,” he writes. “It ensures companies are solvent and that the Crown has enough cash to abandon and clean up old wells if the current licensee goes broke.
“But for Alberta’s black-and-blue junior gas producers, the formula is calculated in a manner such that if you’re not broke yet, you will be shortly.”
Kelly Bourassa, an insolvency lawyer at Blake, Cassels & Graydon LLP in Calgary, said the new rules are causing a cash flow crunch for junior companies, although it’s early days to tell whether it will mean a big push into bankruptcy since they are just now beginning to realize the impact.
She said her law firm represented one company, Tallgrass Energy Corp., which filed for receivership last summer and cited the increased deposits as one of the reasons.
A spokesman for Alberta Energy Minister Ken Hughes said he is looking into the issue.
Midlake was meeting its liability obligations under the old parameters, but was short under the new parameters, which found its liabilities exceeded its assets by about $1 million.
Soon after the new assessment, Midlake received a demand for payment through a cash deposit or a letter of credit. The company was told that failure to comply would result in loss of its licences and being forced to abandon its wells.
Meanwhile, the company said it’s not allowed to buy or sell anything until it pays the money.
Nixon said if the province doesn’t reassess the changes, it will end up with the opposite of what it was trying to achieve — a lot of abandoned wells as companies turn over their properties, instead of juniors which, while struggling, are still paying taxes, fees, maintaining their facilities and contributing to the economy.