Environmental, Indigenous and Natural Resources Blog

In response to the Alberta Court of Queen's Bench decision in Redwater Energy Corporation (Re), 2016 ABQB 278, the Alberta Energy Regulator ("AER") has issued Bulletin 2016-16 (the "Bulletin") to minimize the risk to Albertans.

In Redwater the Court held that a trustee in bankruptcy has the right to disclaim unproductive oil and gas assets, including those subject to abandonment orders. This creates a risk that if the Orphan Well Association is unable to fund the increase in abandonment and reclamation liabilities from disclaimed assets, the obligation to do so will borne by Alberta taxpayers.

The Redwater case is under appeal. The Bulletin has been issued pending the earlier of the appeal decision in Redwater or the implementation of appropriate regulatory measures.  The Bulletin provides that effective immediately:

1. The AER will consider and process all applications for licence eligibility under Directive 067: Applying for Approval to Hold EUB Licences as nonroutine and may exercise its discretion to refuse an application or impose terms and conditions on a licence eligibility approval if appropriate in the circumstances.
2. For holders of existing but previously unused licence eligibility approvals, prior to approval of any application (including licence transfer applications), the AER may require evidence that there have been no material changes since approving the licence eligibility. This may include evidence that the holder continues to maintain adequate insurance and that the directors, officers, and/or shareholders are substantially the same as when licence eligibility was originally granted.
3. As a condition of transferring existing AER licences, approvals, and permits, the AER will require all transferees to demonstrate that they have a liability management ratio (LMR) of 2.0 or higher immediately following the transfer.

Previously, a post transfer LMR of 1.0 was required under the Licensee Liability Rating Program. The AER acknowledges that the requirement of an LMR of 2.0 or higher is a significant change and that "these measures may inconvenience some stakeholders." This is an understatement.

What are the ramifications of this policy?

• It is likely that a reduction in eligible purchasers will result in fewer acquisition and divestiture ("A&D") transactions being able to proceed, given that only 28% of licensees currently have an LMR of 2.0 or greater (219 of 788 licensees) (according to the AER Liability Management Programs Results Report dated June 4, 2016). In contrast, 54% of licensees currently have an LMR of 1.0 or greater (426 of 788 licensees);
• We may see more negotiations providing for the purchaser to post security to offset any LMR shortfall reducing the purchase price for the assets and creating a further barrier to A&D activity;
• The injection of new capital into the industry could be deterred by this dramatic and immediate increase in the LMR threshold;
• There is a retrospective effect to this change given that many deals will have been in planning stages for months. Those transactions in particular that were slated for a second quarter closing may now be derailed with very little to no notice. Further, the Bulletin does not address whether closed deals with pending transfers are affected by this new policy; and
• Perhaps corporate acquisitions rather than asset deals will be an alternative that is considered when dealing with asset transactions that would otherwise result in an LMR rating below 2.0.

The Bulletin does not explain why the AER has chosen an LMR of 2.0 as the new standard for transfers. At a time when the oil and gas industry is already suffering from a prolonged period of low commodity prices, a supply glut, increased taxes and a new carbon emissions regime, this additional hurdle to completing transactions may be unduly restrictive.

The Bulletin indicates that this change will only affect those wishing to acquire AER licensed assets so current licensees with an LMR rating under 2.0 not contemplating any transactions should not be directly affected by this change. In addition, the Bulletin indicates that these are temporary measures and that it will work with industry, other stakeholders and the Government to develop broader and more permanent regulatory measures to ensure that environmental obligations are met by industry. However, this does beg the question of whether increased LMR requirements for all licensees are forthcoming.

Hopefully a full and meaningful consultation with industry does occur and a balance is achieved that will allow the industry to recover and grow while ensuring that abandonment and reclamation obligations are met by industry and not passed on to the Alberta taxpayers.