Supreme Court’s abandoned well ruling for bankrupt energy companies is ‘credit negative’

The Supreme Court of Canada says the trustee for a bankrupt Alberta energy company cannot simply walk away from unprofitable wells on agricultural land without having to clean up. The ruling overturns an Alberta Court of Appeal ruling that upheld a 2016 decision in the Alberta Court of Queen’s Bench that allowed a bankrupt energy company to sever its connection with unprofitable and unreclaimed wells when the company’s assets were sold off to creditors, as if the wells were debts that the company couldn’t cover.

At the heart of the case was the question of whether federal bankruptcy laws conflicted with, and therefore superseded, provincial environmental regulations, or what lawyers and judges call “the doctrine of paramountcy.” The decision was highly anticipated across Alberta, where hundreds of thousands of inactive oil and gas wells dot the landscape, and at corporate offices in Calgary where oil and gas companies are under mounting pressure to remediate old wells. The largest oil producers in the province applauded the ruling, but financial analysts and lawyers acting for insolvency firms say it will have a chilling effect on financing for smaller companies — especially those that have not actively remediated existing wells and have sky-high environmental liabilities.

In a victory for landowners and the Alberta government, the Supreme Court of Canada has ruled trustees for bankrupt oil and gas companies cannot refuse to pay environmental clean up costs for uneconomic oil wells. However, financial analysts and lawyers acting for insolvency firms say the ruling will have a chilling effect on financing for smaller companies.

The 5-2 ruling came with a recommendation from Chief Justice Richard Wagner for Parliament to clarify the confusion between the federal bankruptcy law and the regulations provinces rely on to protect the environment. Since the case came to court, an estimated 1,800 wells representing more than CAD $100 million in liabilities have been abandoned.  “Bankruptcy is not a licence to ignore rules, and insolvency professionals are bound by and must comply with valid provincial laws during bankruptcy,” Justice Wagner wrote.

The Supreme Court ruled that Redwater Energy Corp.’s bankruptcy trustee, Grant Thornton Ltd., cannot walk away from the company’s obligations to render abandoned wells environmentally safe. When Redwater went bankrupt, Alberta’s provincial energy regulator ordered Grant Thornton to comply with end-of-life requirements to render Redwater’s abandoned properties environmentally safe. The trustee did not comply and filed its own counterclaim that included a challenge to the regulator’s action, citing the paramountcy of federal bankruptcy law.

The end-of-life obligations the Regulator seeks to enforce against Redwater are public duties. Neither the regulator nor the Government of Alberta stands to benefit financially from the enforcement of these obligations,” Justice Wagner wrote. “These public duties are owed, not to a creditor, but, rather, to fellow citizens, and are therefore outside the scope of ’provable claims’.

Moody’s Investor Services says the Supreme Court of Canada ruling on abandoned wells creates a “super priority position” for payment of such liabilities over repaying other creditors. It says the decision potentially reduces how much a lender could recover in the event of an insolvency and, therefore, how much it will be willing to lend to companies. That could potentially lead to a reduction in how much money oil and gas companies will be able to call upon to fund their exploration and development programs.

Moody’s says the ruling is also credit negative for banks and other creditors but adds it’s unclear how it will affect other industries and provinces going forward. “The ruling favoured the Alberta energy regulator, but the Supreme Court’s statement that Alberta’s regulations must be followed in bankruptcy could mean that bankruptcy trustees in other provinces would have to follow similar regulations, with unclear effects on how environmental regulations would affect recoveries for creditors elsewhere,” the agency said in a report.

Alberta’s Orphan Well Association

Redwater’s uneconomic wells, pipelines, and facilities would be handed over to the province’s Orphan Well Association, which is already struggling with a backlog of wells to remediate. There were 3,127 orphan wells in the province as of January 28 and the problem “will take several years to address,” Orphan Well Association executive director Lars De Pauw said in a release, adding that he was encouraged by the court’s decision.

The Orphan Well Association should be “a last resort,” said Brad Herald, Canadian Association of Petroleum Producers (CAPP) Vice-President Western Canada, in a release, adding the industry group was pleased with the decision. “CAPP has argued on behalf of industry that when a company declares bankruptcy, the value of any assets should go to abandonment and reclamations costs first,” he said.

Alberta’s energy regulator and the Orphan Well Association, an industry-funded group that cleans up wells that nobody else will, appealed the ruling to the high court. The Association’s last annual report said low oil prices had meant a sharp increase in the number of unprofitable wells it has had to take on from bankrupt companies. In 2012, it had 74 dud wells in its inventory; by the end of 2017, the number was 1,778. “The work we do varies from straightforward to highly complex,” that report said. “On one side of that spectrum is restoring the land on an orphan property that may, for example, have a low impact in a rural area. On the more complex side, we have safely decommissioned wells with potentially dangerous levels of hydrogen sulphide gas near more densely populated residential areas.

Orphaned wells are often on rented agricultural land and a group with the support of thousands of farmers also wanted to see the high court reverse the decision. The Action Surface Rights Association intervened in the case because it believes rights of landowners have been overlooked in the case.