The Colorado Oil and Gas Conservation Commission (COGCC), now with paid directors, has put out its Financial Assurance Rulemaking draft on how the fossil fuel industry will cover the cost of closing down their wells. The current system’s total closing costs are $10,000 per well with a maximum cost per company at $100,000.
The Commission finds that the average cost of plugging, abandoning, remediating, and reclaiming orphan wells, wells with no viable owner, is about $78,000/well, with the actual costs ranging from $25,500 to $144,300. The goal of the Financial Assurance Rulemaking is to correct the dollar undercount so Coloradans don’t get stuck with a big bill currently attached to orphan wells.
Well sites are evaluated for financial assurance based on their production. Active wells are in one bucket, wells producing below 5 barrels/day are in another bucket, and wells producing below one barrel/day are in a third bucket.
As is evident, wells go through a production cycle. The current oil well valuing system does not adequately include the final cost of closing down well sites. That is, banks and other energy financing entities have a time horizon for oil and gas credit shorter than the complete lifetime of wells. Banks may finance drilling on a three to five year loan or line of credit, get paid back in that timeframe, and walk away with their profit before the well’s production is extinguished. That leaves that final bit of a well’s lifespan unfinanced, and that’s part of the orphan well problem.
Oil and gas is a boom/bust industry. Not long ago, oil was priced below profitability. Today, the market has rebounded so it’s making money. But with the pressure of climate change and energy competition from renewables, the fate of oil and gas over the long term is dark with prices volatile.
The COGCC decides what financial instruments can serve to cover companies’ financial assurance bills. Cash bonds work. Companies put in $78,000/well in cash bonds to cover their closing costs. The bonds are not considered collateral to ensure in bankruptcy proceedings that the money goes where it’s supposed to.
Another form of financial assurance is a letter of credit. Banks offer letters of credit to clients so they can draw on funds when they need them. As a financial assurance, the quality of the credit issuer is as important as the quality of the borrower. It’s unclear how the COGCC determines whether the credit issuer is a sound entity. Some may recall the credit problems of banks in Colorado in the late 1980s and early 90s related to bad oil and gas loans. Not only did the producers go down, so did the banks.
Surety bonds are also acceptable to the COGCC. The oil and gas company pays a third party a fee and the third party guarantees that whatever the company is supposed to do under the surety gets done. As with a letter of credit, the surety bond company is a third party, so the quality of the bond is tied to the quality of the purchaser and the surety bond insurance provider.
Another form of financing for abandoned wells is a sink fund in which the oil and gas companies make annual payments that are then used to offset the final well site closing costs. What’s unclear is what happens if the sink fund dollars are insufficient to cover well closing costs.
Here are some obvious issues. There are two types of drilling: vertical and horizontal. It’s uncertain as to whether the $78,000 average well closing price tag is adequate to cover the expenses of closing horizontal well sites.
The only completely secure form of financial assurance is cash bond for each well. The COGCC, in accepting assurance other than cash bond, is put in the position of credit analyzer in determining the relative risk to the public of being on the hook to close wells.
The simplest answer to these issues is to require full cash bond. That requirement would put some in the drilling business in a very tight spot. So, is accepting more risk an acceptable option or should the state ensure that whoever drills here has enough money to cover the full cost of their business both at the front end and the back end?