Canada: Ripple Effect Continues: AER Issues Bulletin 2016-16 In Wake Of Redwater

On Monday, June 20, 2016, the Alberta Energy Regulator (AER) issued Bulletin 2016-16 (Bulletin) detailing its interim regulatory response to the Alberta Court of Queen's Bench decision in Re Redwater Energy Corporation (Redwater).

As detailed in a previous post, the Redwater decision allows a trustee to disclaim certain assets (and their associated abandonment and reclamation obligations) under the provisions of the federal Bankruptcy and Insolvency Act (BIA).  In doing so, such a trustee will not be liable as a licensee under the provincial oil and gas regulatory regime in relation to the renounced assets.  Further, the trustee is not required to assume any liabilities, and will not be bound by any abandonment orders issued by the AER relating to renounced assets, in seeking approval of the sales process to sell assets remaining under its possession and control.

With respect to the AER's Licensee Liability Rating Program ( LLR Program), the result of Redwater is that the AER cannot consider the disclaimed assets in calculating a company's Licensee Liability Rating ( LLR) for the purpose of approving or refusing a transfer of licences to a purchaser who is subject to a BIA bankruptcy or receivership.  Generally, these impacts all resonate from the court's finding that the provisions of the provincial legislation governing the actions of licensees of oil and gas assets do not apply to receivers and trustees in bankruptcy of insolvent companies insofar as they conflict with the BIA, as the federal legislation is paramount.

Bulletin 2016-16

The Bulletin confirms that the AER and Orphan Well Association (OWA) have appealed Redwater, and announces three interim regulatory measures to be effective immediately.  According to the AER, the following measures are temporary, pending the earlier of the Redwater litigation or the implementation of appropriate regulatory measures:

1.            Licence Eligibility Approvals

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.            Material Changes in Licence Eligibility

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 the directors, officers and/or shareholders are substantially the same as when licence eligibility was originally granted.

3.            Post-Transfer LLR of 2.0 or Higher

As a condition of transfer of existing licences, approvals, and permits, the AER will require all transferees to demonstrate they will have a LLR of 2.0 or higher immediately following the transfer.

Earlier this year, the AER had issued Bulletin 2016-10 to "remind" licensees and their directors and officers "of their statutory responsibilities when ceasing operations because of insolvency or for any other reason."  Bulletin 2016-10 specifically noted licensees' responsibility to obtain AER approval to transfer licences, approvals, or permits to an eligible party with an LLR of at least 1.0 post-transfer, which was increased to a LLR of 2.0 in the new Bulletin.

AER's Justification for the Bulletin

The Bulletin could have significant and far-reaching impacts to the oil and gas industry and Alberta's economy, including preventing new licensee entrants, reducing competition for leases, properties and assets, and creating a chilling effect on investment interest.  Notwithstanding these impacts, it is our understanding that the AER felt it was necessary to quickly formulate an interim response to Redwater and as such issued the Bulletin without extensive consultation.

In justifying its regulatory measures, the AER stated the following within the Bulletin:

  • The changes are interim measures to minimize risks to Albertans and the AER intends to work with industry and other stakeholders and the Government of Alberta to develop broader and more permanent regulatory measures in accordance with government policy in response to Redwater.
  • While the AER recognizes that these measures will inconvenience some stakeholders, they are necessary to ensure the continued protection of Albertans and confidence in both the regulatory system and AER licensees; and
  • The post-acquisition minimum LLR of 2.0 was justified on the following basis: (i) it only applies to licensees wishing to acquire AER-licensed assets; (ii) it is required because the AER has observed licensees maintaining a LLR at the minimum level (i.e. 1.0) and purchasing assets, only to find themselves in financial difficulty shortly after the acquisition; and (iii) licensees have a number of ways to achieve a LLR of 2.0 or higher, including posting security, addressing existing abandonment obligations, or transferring additional assets.

What's Next?

While ensuring that abandonment and reclamation obligations are borne by industry is within the public interest, unilateral strategies and policy changes will only compound the crippling effects on the Canadian oil and gas industry caused by current economic conditions and global oversupply and competition.  The AER appears to have recognized this in the Bulletin by committing to work with industry, stakeholders and the Government of Alberta in developing broader, more permanent regulatory measures in accordance with government policy.

The magnitude of the abandonment and reclamation liabilities in Alberta must be viewed in context in order to fully understand the size and scope of the issue.  The liabilities are magnified through the lens of the AER's LLR Program, which looks primarily at the licensee/operator of the assets rather than all of the working interest participants.  In contrast, although the licensee/operator is the only party subject to the AER's LLR Program, the OGCA and operating procedures provide that abandonment and reclamation obligations are shared by all working interest participants.  The vast majority of working interest participants in the province are solvent, viable companies with the financial capacity to fund their abandonment and reclamation obligations.

When viewed in light of the number of parties to whom responsibility can be cast, the magnitude of the risks is not nearly as large as originally perceived.  Changes to the LLR Program for the purposes of casting a wider net would provide a more accurate assessment of the actual risks and liabilities for Albertans.

However, the Canadian oil and gas industry is currently under significant financial hardship, as evidenced by tens of thousands of job terminations, termination of billions in capital spending, 10% rig utilization, and 25% office vacancy rates.  Among other challenges, low commodity prices, lack of access to international markets, competing international resource developments, and new carbon emissions regimes all contribute to a very tough economic environment.  Nonetheless, the oil and gas industry remains a substantial part of the Canadian economy, and it is the backbone of the provincial economy.

In this current period of restricted cash flow, piling additional obligations and financial hardship solely on licensees/operators for abandonment and reclamation liabilities risks the long-term viability of the industry in Western Canada.  While industry must help the AER and provincial government solve the problem of abandonment and reclamation liabilities, an important point that seems to be missing from the debate is that the best way of funding those liabilities is ensuring the continuation of a healthy and robust industry.  Measures to increase the burden on industry for the purpose of addressing abandonment and reclamation liabilities today and in the future must be weighed carefully against ensuring a return to a more robust provincial economy, which benefits all Albertans.

Further, increasing the LLR for transfers to 2.0 while existing licensees must only meet an LLR of 1.0 raises a number of questions, including related to fairness.  While requiring transferees to meet a LLR of 2.0 or greater, the Bulletin does not impose a similar obligation on transferors – presumably there is an equal risk that a transferor's LLR can dip to 1.0?  Further, we speculate whether, in order to meet the required threshold, the higher LLR for transferees could lead to the disclaimer of more borderline economic, but currently inactive, wells.  What happens if a transferee's LLR dips below 2.0 post-acquisition – would it be required to take steps to maintain a LLR of 2.0 or greater, or is 1.0 sufficient (as it is for other licensees)?

Clearly the AER and industry ought to be working together to find a long-term and viable solution to the funding and retirement of abandonment and reclamation liabilities.  In fact, we understand that discussions of this nature have begun among the AER, the Explorers and Producers Association of Canada (EPAC), the Canadian Association of Petroleum Producers (CAPP) and potentially others.

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