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Vol. 25, No.12 Week of March 22, 2020
Providing coverage of Alaska and northern Canada's oil and gas industry

Primer on financial assurance agreements

DNR Commissioner Corri Feige provides legislators with information on how department ensures state will be covered for DR&R costs

Kristen Nelson

Petroleum News

How does the Alaska Department of Natural Resources ensure that state oil and gas leases are left in condition acceptable to the state when the lease is relinquished or terminated?

The subject came up when DNR Commissioner Corri Feige updated House and Senate Resources committees in late February on required state approvals for the purchase of BP’s Alaska assets by Hilcorp (see story in March 8 issue).

In a March 11 letter, Feige provided an overview of how DNR handles the requirement that leases be returned in acceptable condition through a process called DR&R, dismantlement, removal and restoration.

DR&R obligations are incurred when lessees make improvements to state lands, but those obligations may not occur for many years, Feige said, so DNR negotiates financial assurance agreements with lessees to cover that obligation.

“The lag between creation and extinguishment creates a material risk that the lessee may not have the financial wherewithal at the end of field life to fulfill its DR&R obligations to the State,” she said.

Negotiated agreements

Feige said DNR and its lessees negotiate financial assurance agreements, FAAs, to satisfy both the department’s goals and those of the lessee, with the agreements commonly entered into when leases are assigned.

There are two goals: to ensure state lands are returned in good condition and to ensure the maximum benefits of Alaska’s natural resources are captured, she said, “by preventing the inefficient deployment of capital, thereby reducing the probability of maximum recovery of the oil and gas resources.”

“Through the flexible FAA process developed by DNR through many years and several administrations, the State can manage its lands in a robust yet flexible manner,” Feige said.

The evaluation

She said the department evaluates both the magnitude of the DR&R obligation and the lessee’s financial strength. The FAA typically requires a third-party, independent estimate of current DR&R costs, even though the state may ultimately not require removal of some infrastructure - such as roads and gravel pads, allowing “DNR to understand the magnitude of the ‘all-in’ DR&R obligation,” Feige said.

In evaluating financial strength, the department “analyzes financial information supplied by the lessee, operational history and extent, third-party estimates of reserves, and third-party indications of credit quality (e.g. rating agency assessments).”

An assurances structure is prescribed in the FAA, with security instruments varying according to the risk to the state.

Feige said dedicated sinking funds have been required in some cases, with an account created to hold funds for the DR&R obligation, and with the lessee making regular cash contributions to the account as specified in the FAA.

For wholly owned subsidiaries of financially capable corporate parents, a guarantee from the parent has been accepted for DR&R obligations.

Feige said that in many cases the state requires third-party surety bonding.

Risk not static

The state recognizes, Feige said, “that the risk of failure to complete DR&R is not static,” evolving with the financial health of the lessee, markets, technology and policy change.

With that in mind many FAAs require submittal of updated information so DNR can understanding the changing risk and update financial assurances as needed.

“The assurance structure prescribed in many FAAs contain financial metrics and standards that both the DNR and the lessee agree will be used to periodically measure the financial strength of the lessee,” Feige said.

Whatever the amount of the DR&R estimated in the FAA, “the lessee is still obligated for the full cost of DR&R,” she said.

“The flexible FAA process enables efficient deployment of capital for the operators,” Feige said, “so as not to drive projects into an uneconomic state, and yet still provides assurances to DNR for future DR&R.”

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