Department of Interior Proposes New Financial Assurance and Decommissioning Regulations

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The Bureau of Ocean Energy Management (“BOEM”) and the Bureau of Safety and Environmental Enforcement (“BSEE”) recently issued a proposed rule on Risk Management, Financial Assurance and Loss Prevention, which is to be published in the Federal Register on October 16, 2020 and open for public comments at that time.  The proposed rule is the result of an extended effort by the Department of Interior, through its subagencies BOEM and BSEE to “streamline its evaluation criteria for determining whether oil, gas and sulfur lessees, right-of-use and easement (“RUE”) grant holders, and pipeline right-of-way grant holders may be required to provide bonds or other security above the prescribed amounts for base bonds to ensure compliance with their Outer Continental Shelf (“OCS”) obligations,” primarily decommissioning obligations. The path to this rule has been long, beginning in 2014, and winding, with BOEM and its predecessor first resisting making changes through notice and comment rulemaking and instead attempting to regulate through Notice to Lessee guidance documents that created widespread industry concern and were never implemented.

Below is a summary of the current regulations and some of the more significant proposed changes.

Decommissioning liability for predecessors:

Current regulations – Lessees and owners of operating rights are jointly and severally liable for meeting decommissioning obligations.  A party that assigns a record title interest or operating rights remains liable for decommissioning liability.  The regulations are silent as to the method BSEE uses to enforce against prior interest owners, and BSEE typically issues an order to all or multiple prior interest owners who are then responsible for determining among themselves who will perform decommissioning work and how costs will be apportioned.  This often results in a stand-off between prior interest owners and leads to additional delay in decommissioning work being performed.

Proposed regulations – The liability scheme remains the same.  However, the proposed regulations specify the method BSEE will use to enforce accrued decommissioning obligations against “predecessors.”  The proposed regulations define “predecessor” as “a prior lessee or owner of operating rights, or a prior holder of a right-of- use and easement grant [RUE], or a pipeline right-of-way grant [ROW], that is liable for accrued obligations on that lease or grant.”  The proposed regulations provide that, when holding predecessors responsible for performing accrued decommissioning obligations, BSEE will “issue decommissioning orders to groups of predecessors who held interests in the lease or grant within the same general timeframe in reverse chronological order…organized by the following”:

  1. Changes in designated operator(s) over time (i.e., all predecessors who held relevant lease or grant interests during the tenure of a particular designated operator or during the tenure of contemporaneous designated operators); and
  2. Predecessors who assigned interests to a lessee, owner of operating rights, or grant holder that subsequently defaulted.

The proposed regulations provide that, when BSEE issues a decommissioning order to predecessors, the predecessors must, within 30 days of receipt of the order, “begin maintaining and monitoring, through a single entity identified to BSEE, any facility, including wells and pipelines as identified by BSEE in the order”; within 60 days of receipt of the order, designate a single entity to serve as operator for the decommissioning operations; and within 90 days of receipt of the order, submit a decommissioning work plan to the Regional Supervisor.

The proposed regulations also provide that BSEE may depart from the above order of recourse and issue orders to any or all predecessors under certain circumstances, which include, but are not limited to (1) a party’s failure to obtain approval for or execute a decommissioning plan; (2) determination by the Regional Supervisor that there is an emergency condition, safety concern, or environmental threat; or (3) determination by the Regional Supervisor that proceeding in the manner summarized above “would unreasonably delay decommissioning.”

Decommissioning liability for RUE holders:

Current regulations – BSEE regulations are currently silent concerning decommissioning liability for RUE holders.

Proposed regulations – The proposed regulations fill this gap by providing: “All right-of-use and easement grant holders and prior lessees of the parcel on whose leases there existed facilities or obstructions that remain on the right-of-use and easement grant are jointly and severally liable for decommissioning obligations, including obligations for any well, pipeline, platform, or other facility, or an obstruction, on their right-of-use and easement, as the obligations accrue and until each obligation is met.”  The criteria for when BOEM will require additional security with respect to RUEs is similar to that described below for leases under “Supplemental Bonding.”  This proposed regulation emphasizes the need for prior lessees to obtain adequate security from RUE holders if a facility is to remain in use following lease termination.  A prior lessee could be held liable for decommissioning a hurricane-toppled platform years after its exit and completion of all lease decommissioning obligations.

Appeals of decommissioning orders:

Current regulations – Decommissioning orders that are appealed remain effective unless BSEE agrees to suspend the effectiveness of the order during the appeal period or the Interior Board of Land Appeals (“IBLA”) grants a stay of the order.

Proposed regulations – A party that appeals a decommissioning order to the IBLA may suspend the effectiveness of a decommissioning order if the appellant posts a surety bond in the amount that BSEE determines will be adequate to ensure completion of the specified decommissioning activities in the event the appeal is denied and the party thereafter fails to perform the decommissioning obligations.  This is a significant change that will essentially require an appealing party to pay up front in order to challenge a decommissioning order.

Supplemental bonding:

Current regulations – BOEM can require additional security based on an evaluation of ability to carry out present and future obligations demonstrated by five factors: (i) financial capacity substantially in excess of existing and anticipated lease and other obligations as evidenced by audited financial statements; (ii) projected financial strength significantly in excess of existing and future lease obligations based on the estimated value of existing OCS lease production and proven reserves for future production; (iii) business stability based on five years of continuous operation; (iv) reliability in meeting obligations based on credit rating or trade references; and (v) record of compliance.

In the past, a lessee that passed the established thresholds was waived from providing additional security to cover its decommissioning liability.  Additionally, co-lessees (regardless of financial strength) were not required to provide additional security for the decommissioning liability for the lease if one lessee had a waiver.

Proposed regulations – BOEM’s guiding principle in connection with the proposed regulations is to limit the circumstances in which it would require additional security to (1) when a lessee or grant holder poses a substantial risk of becoming financing unable to carry out its obligations; and (2) there is no co-lessee, co-grant holder, or predecessor that is liable for the same obligations and financially capable of performing them; and (3) the property is at or near the end of its productive life such that it may not have sufficient value to be sold to another company that would assume the existing obligations.

Under the proposed regulations, instead of relying primarily on net worth to determine whether a lessee must provide additional security, BOEM would primarily consider a lessee’s credit rating.  In addition, the proposed regulations would consider the proved oil and gas reserves on the lease and the financial strength of predecessors in determining whether additional security was required.

The proposed regulations provide that BOEM may require a party to provide additional security if the party does not meet at least one of the following criteria:

The operator has an issuer credit rating from a nationally recognized statistical rating organization (NRSRO) greater than or equal to either BB- from S&P Global Ratings or Ba3 form Moody’s Investor Service, or an equivalent credit rating provided by an SEC-recognized NRSRO or a proxy credit rating determined by the Regional Director based on audited financial information greater than or equal to either BB- from S&P Global Ratings or Ba3 form Moody’s Investor Service, or an equivalent credit rating provided by an SEC-recognized NRSRO

Or, if the operator does not meet the credit rating or proxy credit rating criteria, and the net present value of proved reserves is less than or equal to three times the cost of the BSEE decommissioning estimated associated with production of those reserves, then BOEM will look to see whether

The party’s co-lessee has an issuer credit rating or proxy credit rating that meets all the criteria in (1) above

Or

A predecessor lessee liable for decommissioning any facilities on the party’s lease has an issuer credit rating or a proxy credit rating that meets the criteria in paragraph (1) above (But, BOEM may require that the party provide additional security for decommissioning obligations for which such a predecessor is not liable).

BOEM will require additional security for pipeline ROW and also RUE grant holders under similar circumstances as for leases with the exception that proved reserves are not a consideration with respect to these types of rights.

The proposed changes to supplemental bonding have the potential to eliminate some “double-bonding” issues where both BOEM and sellers of lease interests require additional security to backstop estimated decommissioning obligations.  However, sellers with good credit ratings who are soon-to-be predecessors on leases without substantial proved reserves left to produce will have even more incentive to ensure that their buyers provide them with security sufficient to cover future decommissioning in their purchase and sale agreements.

Third-party guarantees:

Current regulations – BOEM regulations allow for companies to provide additional security through third-party guarantees, often provided by related companies or parent corporations.  Third-party guarantees are available if the proposed guarantor’s total outstanding and proposed guarantees do not exceed 25% of its unencumbered net worth in the United States, and the proposed guarantor submits an indemnity agreement that includes specific BOEM-required provisions, including that the agreement must ensure compliance with all lessees’ lease obligations, the obligations of all operating rights owners, and the obligations of all operators on the lease.  Traditionally, a company can terminate the period of liability for a third-party guarantee, but there is no ability to cancel the agreement itself as can be done with a bond.

Proposed regulations – The proposed regulations would make several changes with respect to third-party guarantees.  First, BOEM would change the criteria for evaluating the financial ability of a proposed guarantor to use the same credit rating or proxy credit rating criteria as proposed for lessees.  In addition, the requirement for a third-party guarantee to ensure compliance with the obligations of all lessees, operating rights owners, and operators on the lease would be removed.  Third-party guarantees would also be available as additional security for ROWs and RUEs.  And, guarantors would be able to limit a third-party guarantee to specific lease, ROW, or RUE obligations and/or to limit the amount of the guarantee.  Finally, the proposed regulations would provide for cancellation of a third-party guarantee under the same terms and conditions that apply to cancellation of additional bonds.

Fixing the unlimited nature of third-party guarantees – both as to the obligations of “all” parties involved in a lease and as to the amount secured – along with providing for these agreements to be cancelled should make this a more acceptable option for some companies as a low or no cost manner to satisfy some or all obligations to provide additional security.

The public comment period for the proposed rule will last for 60 days, and comments can be submitted online or by mail.  

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