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AER refuses commercial allocation of regulatory liability for statutory non-conformance

Energy Bulletin
26.05.20
By Carolyn Wright, Evan W. Dixon, Tasha Wood and Brendan Downey

Pieridae's acquisition of the Foothills Assets

On October 17, 2019, Pieridae Energy Limited (Pieridae) announced that it had acquired all of Shell Canada Energy's (Shell) midstream and upstream properties and assets in the southern Alberta Foothills for $190 million (the Foothills Assets). As part of the deal, Pieridae also acquired three deep cut, sour gas processing plants––Jumping Pound, Caroline, and Waterton––with a combined capacity of approximately 750 MMcf per day, a 14% working interest in the Shantz sulfur forming plant, and approximately 1,700 kilometres of pipelines.

Within the first six months of 2019, the Foothills Assets had produced approximately 28,634 barrels of oil equivalent per day, consisting of approximately 119 MMcf per day of natural gas, 5,656 barrels per day of natural gas liquids, and 3,163 barrels per day of condensate and light oil. Based on these production levels, Pieridae's acquisition of the Foothills Assets from Shell secured most of the natural gas and initial processing capacity that Pieridae needs to supply the first train at its proposed Goldboro LNG export facility in Nova Scotia for at least twenty years.

Application to the AER

On December 4 and 10, 2019, Shell and Pieridae submitted applications (the EPEA Applications) under sections 66 and 70 of the Environmental Protection and Enhancement Act (the EPEA) to amend the existing EPEA approvals (the EPEA Approvals) for the Jumping Pound and Waterton sour gas processing facilities (the Sour Facilities). Section 70 of the EPEA empowers the "Director", on application by an approval holder, to amend, add, or remove terms or conditions from an approval. In particular, the EPEA Applications requested:

  • that the AER amend the EPEA Approvals to reflect the commercially agreed allocation of regulatory liability for the Sour Facilities as between Shell and Pieridae;
  • once amended, a transfer of the amended EPEA approvals (the Amended EPEA Approvals) from Shell to Pieridae; and
  • the issuance of new EPEA approvals to Shell for the operation and maintenance of certain components of a Containment and Monitoring System (CMS) operating at the Sour Facilities (the CMS Approvals).

Shell and Pieridae also submitted a number of related applications (the Related Applications), which asked the AER to consider and decide with the EPEA Applications, including applications under the Public Lands Act, Water Act, Pipeline Act, Oil and Gas Conservation Act, and Oil and Gas Conservation Rules. The Related Applications would have allowed Shell to transfer to Pieridae various Water Act licences and approvals, public land dispositions, landfills, schemes, large facility licenses, EPEA approvals, and well, facility, and pipeline licences in the Waterton, Jumping Pound, and Caroline areas. Together with the approval of the EPEA Applications, approval of the Related Applications would, from a regulatory perspective, complete the transfer of the Foothills Assets from Shell to Pieridae.

The EPEA Applications proposed to split the existing EPEA Approvals at the Sour Facilities into two separate and distinct approvals such that: (i) Shell would retain the regulatory responsibility under the CMS Approvals to remediate and reclaim the Sour Facilities, but only to the extent that those activities were connected to historical contamination attributable to certain specified substances; and (ii) Pieridae would assume all other obligations under the Amended EPEA Approvals.

In its decision issued on May 13, 2020, the AER denied the EPEA Applications, citing the creation of regulatory uncertainty and indicating that it considered the approach outlined in the EPEA Applications to be an attempt to circumvent statutory requirements under the EPEA by carving up and redistributing fundamental regulatory obligations in a manner that is not expressly provided for in the statutory scheme.

The AER provided the following reasons for its decision:

1. The liability allocation proposed in the Amended EPEA Approvals and CMS Approvals is contrary to fundamental principles in the EPEA and conflict with the overall statutory scheme

The AER's decision to refuse the EPEA Applications appears to have been motivated by its concern that approving the EPEA Applications could significantly dilute Shell's reclamation obligations under the EPEA as the polluter and responsible party for SulfinolTM, contrary to the polluter pays principle. As Shell is the current "operator" of the Sour Facilities, it is responsible for conserving and reclaiming the associated sites to the extent that they were impacted by its activities. Splitting out the reclamation obligations between the Amended EPEA Approvals and the CMS Approvals in the manner proposed would not be consistent with the principle that Shell should be responsible to pay for any contamination it caused, nor does it align with the statutory scheme.

In the AER's view, there were significant operational and regulatory challenges associated with the arrangement proposed in the EPEA Applications that would blur the scope of liability for both Shell and Pieridae. First, the extent of the contamination at the Sour Facilities was not well known and, according to the AER, was not well described in the EPEA Applications. The most recent Site Specific Liability Assessments also revealed significant gaps in Shell's information regarding the contamination. It was therefore not clear how Shell would be able to identify and remediate only historical SulfinolTM contamination, nor was it clear how Pieridae would be able to identify and remediate contamination—including subsequent SulfinolTM contamination—attributable to other substances and activities at the same sites.

The second challenge arises from the fact that the proposed CMS Approvals, limited to the reclamation of historical contamination attributable to particular substances, would conflict with statutory reclamation requirements. Though the AER did not fully explain its reasoning in this regard, its conclusion was likely based on the following:

  • As required by the EPEA, the CMS Approvals would cover the entirety of the sites on which the Sour Facilities are located, not just the areas where Shell will operate the CMS.
  • Unlike the obligation to clean up site contamination under "Part 5 – Release of Substances" of the EPEA (which may be limited to the clean up of a particular substance or contaminant, historical or not), an operator's reclamation obligations under "Part 6 – Conservation and Reclamation" apply to the reclamation of the entire site covered by the applicable approval and do not contemplate that such reclamation obligations can be limited to particular substances on or in specific areas of the site.

The tension is that, according to the proposed terms of the CMS Approvals, Shell's reclamation obligations would be limited in scope (both by area and by substance), but the legal requirements that attach to the CMS Approvals would not be similarly limited.

Due to these conflicts between (i) the terms of the parties' commercial agreement, (ii) the proposed terms of the Amended EPEA Approvals and the CMS Approvals, and (iii) the ordinary operation of the EPEA, the AER was not willing to approve the EPEA Applications.

2. The EPEA requires joint and several liability for clean-up

As noted, the EPEA Applications would lead to a split of liability for reclamation obligations related to the Sour Facilities. Not only does this approach appear to not conform to the EPEA, it is also inconsistent with the principle of joint and several liability underlying the EPEA. In the AER's view, approving the EPEA Applications would limit the effectiveness of any future enforcement actions that may become necessary.

For example, under section 215 of the EPEA, "where an enforcement order is issued to more than one person, all persons named in the order are jointly responsible for carrying out the terms of the order and are jointly and severally liable for payment of the costs of doing so." From an enforcement perspective, it would be imprudent for the AER to create a situation where any future enforcement orders that it may issue to Shell and/or Pieridae to reclaim the Sour Facilities would be inconsistent with the terms of the Amended EPEA Approvals (to the extent that Pieridae may be required to address historical contamination) and the CMS Approvals (to the extent that Shell may be required to address post-effective date and non-SulfinolTM contamination).

3. Obligations without corresponding benefits disincentivize regulatory compliance

The proposed CMS Approvals would have left Shell only with obligations related to historical SulfinolTM contamination, without the ongoing benefits associated with the EPEA Approvals (i.e., the right to produce and process natural gas). This approach limits the number of meaningful enforcement tools available to the AER. For example, Shell would be unaffected if the AER cancelled or suspended the CMS Approvals due to Shell's non-compliance because such an order would only require Shell to stop remediation and reclamation activities. Ordinarily, such an order would also prevent Shell from obtaining the benefit of processing and production activities carried out under the applicable approvals. By reallocating the benefits and burdens of the approvals as requested in the EPEA Applications, however, the regulatory usefulness of enforcement orders for non-compliance would be diminished.

In addition, the AER also noted that an enforcement order issued to Shell would have an unwanted negative effect on Pieridae, given their overlapping and concurrent production and processing operations. While this is undoubtedly true, it is unusual that the AER would second-guess Pieridae's consideration of and willingness to assume this risk when it negotiated the liability split contemplated in the EPEA Applications.

4. It is inefficient to administer approvals with separate partial regulatory obligations

In accordance with section 2(1)(a) of the Responsible Energy Development Act (the REDA), the AER has a mandate "to provide for the efficient, safe, orderly and environmentally responsible development of energy resources in Alberta." One single approval already exists to cover all operational and reclamation responsibilities for each Sour Facility, and it would not be efficient or orderly for the AER to now split responsibility between separate operators for the same sites and activities.

Overall, the AER noted that the EPEA Applications would create too many contradictions with the REDA and the EPEA and would significantly increase regulatory, operational, compliance, and enforcement challenges. Effectively managing and enforcing different reclamation obligations between different approval holders would be inefficient and extremely burdensome for the AER. As a result, it refused to grant the EPEA Applications and also refused to grant the Related Applications. However, Shell and Pieridae still have the right to submit further applications independently of the refused Applications.

5. The fact that applicants may have reached a particular commercial arrangement is not sufficient to guarantee AER approval if it does not align with the regulatory regime

It is important to note that the allocation of liability that Shell and Pieridae proposed in the EPEA Applications was not financial, but regulatory in nature. In commercial agreements, transacting parties typically negotiate a particular allocation of financial liability for regulatory obligations. Here, however, the parties asked the AER to carve up the statutory reclamation obligations by amending and transferring the Amended EPEA Approvals relating to the Sour Facilities to Pieridae and issuing new CMS Approvals to Shell.

In its reasons, the AER indicated that the mere fact that parties have entered a particular business arrangement regarding regulatory liability is not a compelling reason for the AER grant an approval that may depart from what the statutory scheme clearly allows for. While this is speculation on our part, it is possible that the AER may not have had the same concerns if the proposed allocation of liability did not require the amendment of the EPEA Approvals and instead contemplated some sort of financial indemnification or letter of credit from Shell backstopping reclamation costs associated with Shell's historical activities.

The five points identified above suggest that the AER was concerned about Pieridae's ability to assume and discharge its statutory obligations, a concern shared by several of the parties that submitted statements of concern as part of the AER's review of the EPEA Applications. This is not surprising as the abandonment of oil and gas infrastructure in Alberta has become a topic of increasing public awareness. The following quotation from the AER's decision echoes these concerns and summarizes the AER's position in this regard:

the parties are requesting that the AER move away from a situation of regulatory certainty regarding operational and closure obligations for the sites (where Shell is the person responsible for all pollution and ultimately for reclamation of the sites), and approve a far less certain situation, where the parties will have separate and partial regulatory obligations regarding different aspects of operations, remediation, monitoring and reclamation of the sites.

Pieridae's response

Pieridae has issued a statement expressing disappointment in the AER's decision and reiterating that Shell and Pieridae are evaluating options with respect to the EPEA Applications and the Related Applications and will continue to seek clarity from the AER to find a path forward. Pieridae stated that it remains confident that the two companies will be able to find a solution which addresses the concerns of the AER.

Key considerations

  • While the allocation of financial responsibility for regulatory obligations is common in commercial agreements, the AER will not permit a re-allocation of regulatory responsibility between transacting parties where the re-allocation does not reflect the structure of the statutory scheme and could result in ineffective enforcement.
  • The principles of polluter pays, joint and several liability, and regulatory efficiency continue to be important and will influence the AER's interpretation of the statutory scheme.
  • The AER's decision regarding the EPEA Applications was informed by a technical legal interpretation of the EPEA and the REDA. But there were a number of unstated background considerations that may have informed its reasoning, including: the size and unknown financial capability of Pieridae, as well as its ability to meet its ongoing regulatory obligations; the uncertain economic climate and demand forecast for natural gas; and the pending final investment decision regarding the Goldboro LNG export facility.
  • The AER continues to have broad authority to interpret its home legislation and administer the development of the Alberta energy industry in accordance with its statutory mandate.