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A bonding question
AOGCC hears testimony on proposed major increase to the bonding of wells
Alan Bailey Petroleum News
In the latest step in the lengthy process of reviewing the surety bonding requirements for operators of oil and gas wells in Alaska, on Oct. 16 the Alaska Oil and Gas Conservation Commission held a public hearing on its latest proposal for bonding changes. The purpose of a surety bond, which an operator has to post prior to drilling a well, is to indemnify the state against the financial liability for effectively plugging the well, when the well is eventually abandoned. Without effective plugging, typically by injecting cement into the well, the well will become an environmental and safety hazard. But, depending on the characteristics of the well, the plugging operation can be very expensive.
Current state statutes require the commission to mandate bonding of not less than $100,000 for a single well and not less than $200,000 for blanket coverage of all of an operator’s wells in the state. In the past the commission has only required bonding at those minimum levels, other than in situations where there have been regulatory violations.
Commission increasingly concerned Major oil companies generally have the financial capability to deal with well plugging and abandonment costs. But, with increasing numbers of smaller companies entering the Alaska oil and gas scene, the commission has become concerned about the adequacy of its well surety bonding procedures. Last year the commission proposed a change to its regulations, requiring an operator, when applying for a permit to drill, to provide an estimated plugging and abandonment cost that would act as a basis for the level of the surety bond for the well. But, following objections to the practicalities of that procedure, the commission has reverted to proposing a set of bonding levels, tiered to the number of wells covered by a bond. The proposed bonding amounts are much higher than those used in the current bonding tradition and reflect what the commission views as realistic plugging and abandonment liabilities.
Essentially, under the proposed new regulations, the minimum bond amount would be $500,000 for one or two wells, $800,000 for three or four wells, $1.1 million for five or six wells, with the bonding amount steadily increasing through multiple steps to a maximum of $30 million for 3,500 to 3,999 wells.
At its core, the questions over the surety bonding levels revolve around, on the one hand, the state’s desire to protect itself from well remediation liability should an operator become insolvent or lack the financial capability to deal with a defunct well, and, on the other hand, the deterrent effect of high bonding levels on oil and gas exploration and development in the state.
Impact on small companies In testimony to the AOGCC hearing, Robert Duke, general counsel to the Surety and Fidelity Association of America, urged the commission to consider the impact on smaller companies of elevated bonding levels. Members of SFAA write the majority of surety and fidelity bonds in the United States and, when doing so, must conduct a financial assessment of the potential bond holder. The surety will require some threshold of financial strength relative to the amount of the bond - the higher the bond the higher that threshold will be. Thus, an operator with limited net worth and working capital may find it difficult to obtain the bond that is required for multiple wells, Duke wrote.
Amaroq Resources LLC, a small company that operates six wells in the Nicolai Creek gas field on the west side of Cook Inlet, expressed its dismay at the proposed new bonding levels. It is questionable whether Amaroq would be able to obtain the required bonds at the proposed level, wrote Scott Pfoff, Amaroq president. And, without the bonds, the company would not be able to continue to operate its wells. As a result, the company could go out of business and would not be able to plug and abandon its wells. Wells that would otherwise remain on production would go out of operation, rather than continue to generate benefits from employment, state royalties and resource waste prevention, Pfoff wrote.
Moreover, by having much higher bonding levels than oil and gas producing states in the Lower 48, the proposed levels would discourage investment in Alaska, he wrote.
AIX Energy LLC, operator of four gas wells in the Kenai Loop gas field on the Kenai Peninsula, told the commission that, with a combination of bonds currently required by both the commission and the Alaska Department of Natural Resources, AIX already has more than adequate bonding to cover the remediation, plugging and abandonment of its wells. Moreover, the proposed regulations do not take into account the significant cost differential for plugging and abandonment between onshore and offshore wells, AIX told the commission.
Differing views The Alaska Oil and Gas Association commented that the proposed new levels of bonding could discourage investment in the state. The increases in the bonding levels range from 150 percent for a small producer with just two wells to 6,900 percent for a large producer with 500 wells. These increases are unprecedented and unreasonable, AOGA said. And, when assessing appropriate bonding levels, the commission should take into account DNR well bonding requirements, the association added.
ConocoPhillips suggested to the commission that the 23 well-count levels used to determine bonding amounts in the proposed regulations would pose a high burden on operators and the commission, with the need to keep the bonding up to date, as operators drill and abandon wells. The company suggested a much simpler three-level arrangement, with a minimum bonding requirement of $1.2 million for up to 19 wells ranging up to $12 million for more than 200 wells. The relative high bonding requirement for a small number of wells reflects the higher non-compliance risk associated with smaller operators, ConocoPhillips said.
Oil Search, the company planning to develop a major oil field in the Pikka unit on the North Slope, suggested a bonding approach that integrates the bonding requirements for different state agencies. In particular Oil Search has a bonding agreement with DNR for surface restoration associated with the land impacts of well drilling. A unified bonding approach would clarify state expectations for financial assurance, enable flexibility in companies’ negotiations over bonding structures, and eliminate duplicative bonding requirements, Oil Search told the commission.
Independent oil and gas explorer Jim White told the commission that the proposed bonding requirement would price homestead owners in the state out of the right to develop oil and gas resources in their property. James Gottstein, White’s attorney, said that he had determined that the proposed regulations are illegal under the relevant state statute, in that they would apply the new bonding requirements to existing permit holders, and that they would go beyond the statutory intent of simply ensuring the plugging and abandoning of dry or abandoned wells.
Expressions of support Three Alaska citizens provided testimony, expressing concerns about the specter of leaking, abandoned wells in the state, and commenting that they support the AOGCC proposals.
And in a joint statement, environmental organizations The Wilderness Society, Audubon Alaska and Cook Inletkeeper expressed their support for the proposed bonding regulations. The proposed bonding requirements would help ensure that companies have the resources needed to address concerns regarding the possibility of oil spills and other forms of contamination from operating or abandoned wells, the organizations told the commission. The bonding requirements would also reduce the likelihood of state government having to foot the bill for the high cost of problematic well operation or abandonment in Alaska, the organizations said. The organizations also praised the proposed tiering of the bonding levels, based on the number of wells operated by a company. This arrangement makes rational sense and appropriately eliminates the blanket bonding of all of an operator’s wells in the state, the organizations said.
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