The circle of (asset) life: AER implements new life cycle management directive
Published December 7, 2021
On December 1, 2021, the Alberta Energy Regulator (AER) finalized the long-awaited Directive 088: Licensee Life-Cycle Management (Directive 088), which is now in effect.
Directive 088 implements a number of important new requirements that licensees need to be aware of. Of particular note:
- the Licensee Capability Assessment (LCA), which replaced the Licensee Liability Rating (LLR) framework, is the foundational element of the new holistic licensee assessment;
- the Licensee Management Program provides the AER with a framework to monitor licensees across the energy development life cycle using the new holistic assessment;
- the Inventory Reduction Program sets mandatory licensee specific annual closure spending targets; and
- additional discretions with security deposit requirements have been introduced.
The AER first released the draft Licensee Life-Cycle Management Directive for comment mid-summer 2021. More information on the initial draft can be found in our previous article here. Since then, the AER has received feedback from the public and industry, leading to the adoption of Directive 088 in its current form. Regarding the adoption of Directive 088, the AER states that:
"Historically, liability has not been managed sufficiently to slow the growth of inactive sites, and requirements have been largely reactive – coming in at the end of development…The programs we are introducing now apply throughout the entire life cycle, which allows us to proactively identify potential issues, develop timely solutions, and increase closure work done at all stages of development."
Holistic licensee assessment
The AER is shifting away from point in time and formulaic assessments of licensees to assessing licensees as a whole. This holistic licensee assessment approach has been implemented with the intent of managing liability across the life-cycle of assets.
The LCA is at the heart of Directive 088, replacing the LLR framework for assessing the capabilities of licensees to meet their regulatory and liability obligations. The LCA forms part of this more holistic approach, which is intended to be flexible and subjective, with the AER having the discretion to determine what is relevant for each licensee (which is expected to evolve with time as the AER is able to "enhance business intelligence and access more structured data"). The AER may rely on any information provided to it by licensees, including all applications, amendments, reports, and other submissions including pursuant to Directive 067: Eligibility Requirements for Acquiring and Holding Energy Licenses and Approvals (Directive 067). More information regarding Directive 067 and its recent amendments can be found in our previous article here.
The following factors are specifically highlighted and will be considered by the AER as part of the LCA when assessing the risk posed by a licensee:
- Financial health: Assessment of, among other things, a licensee’s net profit margin, its ratio of current assets over current liabilities, and its ratio of cash flow from operations to debt.
- Liability risk: Estimated total magnitude of liability (active and inactive assets), including abandonment, remediation, and reclamation.
- Remaining lifespan of mineral resources: Remaining lifespan of mineral resources and infrastructure and the extent to which existing operations are expected to fund current and future liabilities.
- Operations: Management and maintenance of regulated infrastructure and sites, including compliance with operational requirements.
- Closure: Rate of closure activities and spending, and pace of inactive liability growth.
- Administration: Compliance with administrative regulatory requirements, including the management of debts, fees, and levies.
Further detail on these factors are provided in Manual 023: Licensee Life-Cycle Management (Manual 023). Based on a consideration of these criteria and others, a licensee is then assigned a corresponding risk of "financial distress", which rating will be classified as low, medium, or high.
The Licensee Management Program
Under the Licensee Management Program the AER will continuously monitor licensees through the life-cycle of a project. The AER will rely on the LCA, which will be used to build an overall licensee profile, to manage the Licensee Management Program and identify high risk licensees. This will allow the AER to proactively get involved with such licensees and employ various tools to ensure they are able to meet their regulatory and liability obligations. This could be as simple as educating a licensee on industry best practices or require regulatory action, including changing licence eligibility or requiring a licensee to provide a security deposit.
Inventory Reduction Program
Under the Inventory Reduction Program, the AER will publish industry-wide spending targets for abandonment and reclamation activities based on inactive liabilities and historical closure spending for the previous year. The current projections for those targets are:
- 2022 (Set): $422MM
- 2023 (Set): $443MM
- 2024 (Forecasted): $465MM
- 2025 (Forecasted): $489MM
- 2026 (Forecasted): $513MM
Based on industry-wide targets, licensees will then be assigned a mandatory licensee specific target based on the licensee's proportion of provincial inactive liabilities and the licensee's level of financial distress. Certain licensees (who meet an annually determined threshold) may elect to provide the AER with a security deposit in place of their closure spend target. Failure to meet mandatory closure spend targets or post a security deposit, if applicable, will result in a holistic reassessment of the licensee, and may require the licensee to provide the AER with a security deposit. Any outstanding amount on the licensee's closure spend target will be considered in assessing the amount of that security deposit. This is a noteworthy departure from the previous framework, which did not have strict deadlines or requirements for closure related work.
Licensees may also elect to commit to a voluntary spend target that is greater than its mandatory target. Participating in the voluntary spend program may entitle licensees to receive a maximum three-year extension for expired Crown mineral lease wells and extend deadlines for the removal of surface equipment and other materials associated with cut and capped wells.
Licence transfers and security deposits
Industry has experienced increased transactional uncertainty in recent years with lengthy approval timeframes for licence transfers and the AER signaling its move away from reliance strictly on calculable LLR program numbers for transferor and transferee. Directive 088 now clarifies that licence transfer applications will include an assessment of the entire asset package being transferred, and will trigger a holistic assessment of both transferor and transferee. The AER's assessment will include assessment of Directive 067 section 4.5 "Unreasonable Risk Factors", key LCA factors (including financial health, magnitude of liability and remaining lifespan of the resource), and any other factors the AER determines appropriate in the circumstance. As part of a licence transfer application, the AER will use the holistic assessment of the licensees to determine whether, and in what amount, security deposits will be required by either transferor or transferee. Directive 088 does not provide direction as to an expected timeline for the comprehensive AER assessment process prompted by a licence transfer, nor has the AER confirmed whether it would adhere to the timelines that licensees had previously come to expect for public notice periods or assessments.
Directive 088 specifically states that licences with a licence status of reclamation certified or reclamation exempt are eligible to be transferred, and further, Directive 088 appears to indicate that the transfer of such licences may be required. Directive 088 indicates that the AER may reject a licence transfer application for failure to include licences of assets which are reclamation certified or reclamation exempt; however no further guidance or details are provided. This is a clear departure from earlier versions of Directive 006: Licensee Liability Rating (LLR) Program, which stipulated that licences transfers were not permitted for reclamation certified or reclamation exempt licences.
In addition to requiring a security deposit as a condition of a licence transfer application, the AER also has broad authority to require security deposits at any time. Security deposit determinations outside of the licence transfer context are also made with consideration of the result of a given licensee's holistic assessment, with a focus on certain of the LCA factors (being financial health, liability risk, remaining lifespan and closure). Calculation of a security deposit may involve consideration of the value of liability calculated in accordance with Directive 011: Licensee Liability Rating (LLR) Program: Updated Industry Parameters and Liability Costs (Directive 011), the value of site-specific liability under Directive 001: Requirements for Site-Specific Liability Assessments in Support of the ERCB's Liability Management Programs (Directive 001), present value future cash flows based on reserves and economic analysis, and any other values deemed appropriate by the AER. Directive 088 caps security deposits at "the licensee's total liabilities, including the cost of providing care and custody and the cost to permanently end operations, which includes the abandonment and reclamation of the site". Given the potential value of this calculation, having a maximum amount is likely not a helpful reference for licensees.
We note that the holistic assessment in Directive 088 has replaced the LLR program with respect to licence transfers and security deposits under Directive 006; however, the liability management ratings under the LLR program will remain in effect for Directive 001, Directive 011, Directive 024 and Directive 075 until a broadened scope of Directive 088 is phased in over time.
In the past, the AER has permitted existing transfer applications to be grandfathered in the midst of regulatory amendments; however, AER Bulletin 2021-45, which details the implementation of Directive 088, indicates that "any applications for transfer of licences submitted to the AER but not yet dispositioned as of December 1, 2021, will be closed and returned, and companies may reapply under the new requirements" (emphasis added). The AER will directly notify affected parties.
Implications: another step in Alberta’s Liability Management Framework
Directive 088 represents another step in Alberta’s major overhaul of the regulatory regime that manages oil and gas liabilities and significantly changes the AER's approach to managing the orphaned well inventory in Alberta. The ultimate goal of this overhaul is to reduce the number of orphaned wells and to prevent future growth of the orphaned well inventory—while still encouraging responsible energy development.
The introduction of the LCA, and the ability of the AER to trigger a holistic assessment, places increased reporting and disclosure obligations on licensees (and emphasizes the importance of accurate and timely reporting). Timing and certainty are key in transactional licence transfers. Some degree of uncertainty is inevitable with Directive 088’s holistic approach to assessment, and is in contrast with the more formulaic LLR approach that the AER previously relied on. Uncertainty surrounding the LCA is further underscored by the fact that Directive 088 broadly considers a number of factors, but does not give guidance on the specific weight afforded to each of those factors, or set the expected timeline associated with a holistic assessment.
The new tools given to the AER in Directive 088 aim to help the regulator more easily identify and manage at-risk licensees. Though Directive 088 does impose additional burdens on the industry, it remains to be seen whether the right balance has been struck, and whether these changes will help to manage Alberta's rapidly growing inactive well inventory.
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