February 28, 2017 Articles

Decommissioning Oil and Gas Facilities: Challenges in (and out of) Bankruptcy

The convergence of the financial challenges presented by lower oil prices and an increase in decommissioning obligations has forced some companies into bankruptcy.

By Andrew J. Gallo and Duke K. McCall III – February 28, 2017

Aging facilities and lower oil prices have led to a substantial increase in the number of oil and gas facilities being decommissioned in the United States. More than 40 percent of the active oil and gas facilities located on the U.S. Outer Continental Shelf (OCS) are projected to be nearing the end of their designed service life. Economic pressures also have forced less productive facilities to be taken out of service. The U.S. Bureau of Ocean Energy Management (BOEM) recently calculated the cost of “routine” decommissioning obligations to be $40 billion—and that’s just in the Gulf of Mexico. Michael Celata, Bureau of Ocean Energy Mgmt., Regulatory Considerations for Ensuring Decommissioning and Other Lease Obligations 7 (Feb. 4, 2016).

The convergence of the financial challenges presented by lower oil prices and an increase in decommissioning obligations has forced some companies into bankruptcy, where decommissioning obligations may be reallocated from the bankrupt record title owner to prior or subsequent lessees. Even outside of bankruptcy, regulatory changes intended to ensure that taxpayers do not bear decommissioning costs have increased the complexity and cost of providing financial assurance for decommissioning obligations; industry representatives have warned that this could force some producers out of the OCS, increasing the likelihood that others in the record chain of title will have to bear decommissioning costs. 

Liability for Decommissioning Costs
Federal regulations provide that “[e]very current and prior record title owner is jointly and severally liable . . . for fulfilling all non-monetary obligations, including decommissioning obligations, which accrue while it holds record title interest.” 30 C.F.R. § 556.604(d); see also id. § 250.1701. “Record title owners that acquired their record title interests through assignment from a prior record title owner are also responsible for remedying all existing environmental or operational problems on any lease in which they own record title interests, with subrogation rights against prior lessees.” Id. § 556.604(e). Thus, a record title owner accrues joint and several liability for decommissioning obligations (i) when it becomes a lessee of a lease on which there is an existing platform, pipeline, facility, or well that has not been permanently plugged and (ii) when it drills a well or installs a platform, pipeline, or other facility during the term of its lease. Id. § 250.1702.

The result of these regulations is that responsibility for decommissioning older wells and facilities often is borne by multiple parties. In addition, multiple parties may be co-lessees on a lease, increasing still further the number of parties responsible for decommissioning obligations. In such situations, BOEM and U.S. Bureau of Safety and Environmental Enforcement (BSEE) have taken the position that liability is not sequential; they can pick the order in which they will pursue prior record title owners to cover decommissioning costs. See, e.g., In re Devon Energy Corp., 188 I.B.L.A. 268, 269–70 (2016).

Treatment of Decommissioning Obligations in Bankruptcy
Whether or not a debtor in bankruptcy is responsible, postbankruptcy, for ongoing or future decommissioning obligations depends upon what it does with the lease in bankruptcy. There are three primary options: (1) if the debtor is going to reorganize, it could seek to assume (if the leases are considered executory) or otherwise retain the lease; (2) the debtor could seek to sell the lease to a third party; or (3) the debtor could seek to reject or otherwise abandon the lease back to the federal government.

BOEM and BSEE have generally taken the position that offshore leases are executory contracts that must be assumed by a debtor in bankruptcy if they are going to be retained and/or sold. BOEM and BSEE also take the position that assumption of the lease requires the debtor, or the party to whom the lease is going to be assigned, to assume all decommissioning liability with respect to the lease. Only when the debtor abandons the lease should decommissioning obligations become the responsibility of prior record title owners. The general rule in bankruptcy is that a debtor cannot abandon property in a manner that would cause it to violate environmental health and safety laws. However, if a bankruptcy entity does not have the funds available to satisfy its decommissioning obligations, federal regulators can, and will, look to prior owners.

If a debtor enters bankruptcy with some valuable assets (including profitable leases) and some leases that are not profitable, it may seek to reorganize around or sell the profitable leases and to abandon the nonprofitable leases back to the government. In that scenario, the issue that arises is whether the debtor can rid itself of decommissioning obligations for the abandoned leases. In Midlantic National Bank v. NJDEP, 474 U.S. 494 (1986), the Supreme Court held that a debtor cannot abandon property in bankruptcy for the purpose of avoiding environmental obligations that are designed to protect the public health or safety from identified hazards. Both federal regulators and prior owners have used the Midlantic case to argue that a debtor that owns offshore leases with decommissioning liabilities cannot abandon those leases in bankruptcy without resolving the decommissioning liabilities. A contrary argument is that abandonment should be permitted under Midlantic if there are third parties responsible for the decommissioning obligations (i.e., prior owners) with the means to satisfy those obligations because, in that scenario, the debtor abandoning the lease does not place the public at risk. This issue has not been fully litigated in the courts with respect to decommissioning obligations.

If abandoning a lease is not permitted, then the debtor will need to use available assets to satisfy its decommissioning obligations prior to distributing amounts to other creditors. The generally accepted view is that claims by the federal government for decommissioning obligations are administrative claims that have priority over unsecured, prepetition claims. Administrative claims must also be paid in full in order for a plan of reorganization to be approved. Accordingly, if a debtor’s goal in bankruptcy is to reorganize, it would have to satisfy decommissioning obligations on any leases it seeks to abandon in connection with any reorganization plan.

However, administrative claims do not have priority over secured claims in bankruptcy. Whether, in a liquidation or partial sale scenario, a secured creditor would be entitled to payment out of the proceeds of its collateral prior to payment of ongoing decommissioning obligations on leases that remain with the bankruptcy estate is unresolved. Again, the issue likely will turn on whether Midlantic requires satisfaction of decommissioning obligations by a debtor where there are prior owners with the ability to pay.

Of course, the scenario could also arise where the debtor simply does not have enough assets to satisfy decommissioning liability regardless of the priority it is given. In that case, the federal regulators would clearly look to prior owners to cover any obligations that the debtor cannot pay.

Resolution of Decommissioning Obligations in the ATP Case
The ability of a debtor in bankruptcy to abandon unprofitable leases or leases with nonperforming wells was addressed in the bankruptcy of ATP Oil & Gas Corporation. ATP filed for bankruptcy protection in 2012 as the owner of numerous offshore leases in the Gulf of Mexico. Some of those leases were profitable, performing leases; some were performing but not profitable; and some of the leases contained nonperforming wells with “idle iron” that had yet to be fully decommissioned. After filing for bankruptcy and an unsuccessful attempt to market its assets to third parties, ATP entered into a Section 363 asset sale with its secured lenders pursuant to which the lenders acquired certain of ATP’s assets, including some but not all of ATP’s offshore leases, in exchange for the forgiveness of a portion of its secured debt. Because ATP would receive no cash in the transaction, it would be left with numerous nonprofitable and/or nonperforming leases (Remaining Leases) and no ability to pay the decommissioning obligations with respect to the Remaining Leases. Both federal regulators and prior owners of the Remaining Leases objected to the sale on the grounds that it violated Midlantic to allow ATP’s secured lenders to take certain of ATP’s leases and leave the bankruptcy estate with no ability to pay decommissioning obligations on the Remaining Leases. ATP’s lenders thus entered into a settlement with BOEM in which they agreed to provide BOEM with cash sufficient to pay decommissioning obligations on the Remaining Leases that had no prior owners to cover decommissioning obligations. They also agreed that the entity formed to purchase ATP’s assets would assume decommissioning liability on the leases it purchased. In exchange, BOEM agreed to consent to the sale and not to pursue claims against ATP for decommissioning liability on the Remaining Leases. The bankruptcy court approved the sale and the BOEM settlement over the objections of prior owners on the Remaining Leases, which became responsible for decommissioning obligations on those leases. .

Regulatory Developments
The question that was not resolved in the ATP case is what would have happened had BOEM and ATP’s lenders not reached a settlement. Would the bankruptcy court have allowed ATP to abandon leases where there were no predecessors in interest that BOEM and BSEE could pursue for decommissioning liability? While its settlement with ATP’s lenders allowed BOEM to avoid the prospect of numerous leases being abandoned back to the government with no party liable for the tens of millions of dollars of decommissioning liability, it is likely that the prospect of such an outcome prompted, in part, the recent changes to financial assurance guidelines that have been issued by BSEE and BOEM.

BSEE Mandates Summaries of Decommissioning Costs
In order to “help BSEE better estimate future decommissioning costs,” which, in turn, “may then be used by BOEM to set financial assurance levels necessary to minimize or eliminate the possibility that the government will incur decommissioning liability,” BSEE promulgated a rule on December 4, 2015, requiring lessees and owners of oil and gas operating rights to provide summaries of their actual costs for decommissioning wells, platforms, and other OCS facilities. 80 Fed. Reg. 75,806–07 (Dec. 4, 2015). Under the rule, a company that has decommissioned an OCS facility must submit a summary of its decommissioning costs, certified by an authorized representative of the company, within 120 days. BSEE may also request on a case-by-case basis additional supporting documentation as evidence of the decommissioning costs. On November 16, 2016, BSEE extended this rule to cover lessees and owners of pipeline operating rights and rights-of-way. 81 Fed. Reg. 80,587 (Nov. 16, 2016).

BOEM Issues Bonding Requirements
To avoid the abandonment of leases back to the government without the completion of decommissioning obligations or funding for those obligations, BOEM issued a notice to lessees on July 14, 2016, updating BOEM’s policy with respect to its “supplemental bonding” requirements. NTL 2016-N01. Preexisting regulations and notices required companies to provide bonds for the cost of their decommissioning obligations unless they could satisfy a financial test demonstrating ability to meet their decommissioning obligations. See 30 C.F.R. § 556.901; NTL No. 2008-N07. The notice, which applies to federal oil and gas lessees and owners of pipeline rights-of-way, rights of use, and easements, modifies several aspects of the procedures that BOEM uses when determining whether a particular company’s financial resources are sufficient to avoid supplemental bonding.

First, the notice requires each lessee or owner of an offshore oil and gas asset to meet BOEM’s standards for financial strength on an individual basis in order to avoid supplemental bonding. Under previous regulations and guidance, only one co-owner or co-lessee of an offshore oil and gas asset needed to meet BOEM’s financial strength standards to avoid supplemental bonding.

Second, the notice establishes that BOEM will consider 100 percent of a company’s decommissioning liability across each of its leases, rights-of-way, and rights of use when determining whether supplemental bonding is necessary. BOEM previously excluded from this calculation other leases, rights-of-way, and rights of use for which there was a financially strong co-lessee or co-owner.

Finally, the notice further explains and modifies the factors that BOEM uses in determining a company’s financial strength. BOEM analyzes a company’s financial resources by assessing (a) financial capacity, (b) record of compliance, (c) reliability, (d) projected financial strength, and (e) business stability. The notice updates how BOEM will assess the first three of these factors:

  • Financial Capacity: The notice requires companies to meet specific benchmarks for nine different financial ratios. This benchmark analysis is significantly more rigorous than BOEM’s previous assessment of financial capacity.
  • Record of Compliance: The notice establishes that BOEM will consider as part of a company’s record any civil penalties, findings of noncompliance by BOEM or BSEE, citations by any other agency with jurisdiction over the OCS, or citations by the Department of the Treasury for nonpayment of rents. The notice also clarifies that a company’s record includes the records of its subsidiaries and affiliates.
  • Reliability: The notice establishes that a company’s reliability will be determined by a company’s credit rating or trade references. That test replaces a more amorphous standard under previous guidance.

Implementation of BOEM’s revised policy for properties that involve multiple co-lessees and/or prior interest owners has proved challenging. As a result, and in order to allow BOEM to focus on obtaining security for those properties with a single responsible lessee, BOEM announced on January 6, 2017, that it was extending the implementation timeline for NTL 2016-01 by six months for properties for which there are multiple responsible parties.

The Future
The regulatory changes implemented by BSEE and BOEM have increased the cost and complexity of providing financial assurance for decommissioning obligations. The final tally, in terms of both cost and complexity, will depend on the extent to which BOEM allows the existing financial arrangements between multiple responsible parties to be taken into account in the financial assurance calculus. At the same time, provided that existing offshore lessees can satisfy the new bonding requirements, the changes to the financial assurance guidelines should decrease the possibility that future bankruptcy filings by lessees will result in a reallocation of decommissioning obligations to prior lessees in the chain of title. The possibility of such a reallocation cannot be eliminated, however. Moreover, the issues left unresolved by Midlantic and ATP—whether a lessee may abandon leases where there are no prior lessees available to satisfy the decommissioning obligations and whether proceeds from the liquidation of a bankrupt lessee must first be applied to decommissioning obligations—are likely to arise again.

Andrew J. Gallo is a partner in Morgan Lewis’s Boston, Massachusetts, office, and Duke K. McCall III is a partner in the firm’s Washington, D.C., office.

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