On Feb. 24, President Donald Trump issued the “Executive Order on Enforcing the Regulatory Reform Agenda.” Each agency is to create a Regulatory Reform Task Force. Each task force is to identify rules that eliminate jobs, are ineffective, or impose costs that exceed benefits. As the task force for the Department of the Interior begins to assemble, we would like to offer an opinion to aid its work: Overhaul the policies on bonding for pipeline and platform decommissioning for offshore oil and gas activities. Current policies tie up unnecessary capital to satisfy the department’s inflated demands for bonds.
Interior has required additional bonds to secure an offshore lessee’s compliance with lease requirements since at least 1979. Since November 1990, Interior’s Bureau of Ocean Energy Management (BOEM, successor to the Minerals Management Service) has also had statutory authority to use forfeited bonds to “cover the cost to the United States of any improvement, protection, or rehabilitation work” if a lessee defaults. Currently, the BOEM holds hundreds of millions, perhaps billions, of dollars in bonds and other financial security to ensure that American taxpayers will never foot the bill for decommissioning.
From the moment, a company applies for or becomes the holder of an offshore pipeline right of way (ROW), the holder is responsible for providing financial assurance for its future decommissioning. Financial security must be provided even before liability for the decommissioning itself has accrued under the regulations. The substance of the obligations is found in both the regulations and BOEM’s Notice to Lessees (NTL) No. 2016-N01 “Requiring Additional Security,” which superseded NTL No. 2008-N07 “Supplemental Bond Procedures.” The new NTL, with multiple “linked” attachments, became effective on Sept. 12, 2016. It addresses lessees, pipeline ROW holders, and right of use and easement (RUE) holders on the Outer Continental Shelf (OCS).
Offshore operators have objected to the new NTL. They have urged BOEM to go back to the prior system, which exempted financially sound companies from supplemental bonding. So far the bureau has only acquiesced by extending its implementation timeline. On Jan. 6, BOEM added six months to the compliance deadline for everyone except “sole liability properties.” On Feb. 17, the bureau withdrew the sole liability orders issued in December so the new administration could review the agency’s financial assurance program. The agency has yet to agree, however, with industry that the NTL “fixes” an unbroken system.
Some of BOEM’s NTL bonding requirements merely impose undue financial burdens on operators. For example, the bureau recently began requiring supplemental bonding on rights of way holders. At the same time, BOEM and its sister Bureau of Safety and Environmental Enforcement (BSEE) also began requiring that ROWs be in the name of one owner, even where there are multiple actual owners. The combined effect of these changes is to disproportionately increase decommissioning liability estimates for the company identified as the owner, while ignoring the practical financial reality that there are multiple parties jointly and severally liable for those ROWs.
Other of BOEM’s NTL bonding requirements, at least as to lessees, are unenforceable absent proper notice and comment rulemaking. For example, by ignoring Asset Retirement Obligations (ARO), which are already included in a company’s audited financial statements, BOEM effectively double-counts the costs of removal by subtracting its own estimates of removal liability from a tangible net worth already reduced by AROs. Additionally, although BOEM now limits a lessee’s ability to self-insure its obligations to a maximum of 10 percent of its tangible net worth. That limit can only be enforced after proper rulemaking.
Reason No. 1: Guidance Inconsistent with Regulations
For lessees, the regulations require BOEM to ask two questions: First, does a lessee have the financial ability to fulfill present and future lease obligations? And second, if the answer is no, how much additional security must be provided? BOEM recognizes this two-step process in the NTL No. 2016-N01: “[T]he Regional Director will evaluate your financial ability to carry out your present and future obligations annually to determine whether you must provide additional security and, if so, how much additional security you must provide” and “[i]f the BOEM Regional Director determines that the financial ability of any lessee or grantee for any lease, ROW, or RUE is not sufficient to assure performance of its lease, ROW, or RUE obligations, he or she may require the lessees or ROW and RUE owners to provide and maintain additional security” (NTL page 2, I. and II. [emphasis added]).
What happens if the answer is “Yes, a lessee has the financial ability to meet its financial obligations”? Under the rules, this would end the analysis. A company meeting the five criteria in 30 C.F.R. § 556.901(d)(1) should not have to provide any additional security.
But the new NTL’s attachments contradict this position. “This NTL discontinues the policies under NTL No. 2008-N07, whereby if BOEM determined that one or more co-lessees or co-owners had sufficient financial strength and reliability, it was not necessary to provide additional security.” (NTL page 1, Introduction.) In other words, “[l]essees will no longer be granted waivers, but may be eligible for self-insurance to meet some or all of their supplemental bond obligations.” See
Reason No. 2: BOEM Double-Counts Decommissioning Costs
Under the regulations, BOEM’s Regional Director may require additional security to ensure a lessee’s compliance with its obligations under the lease, permit or regulations, including decommissioning obligations (C.F.R. § 556.901(d)). The Regional Director is to base this determination on five indicia of financial ability, including “[f]inancial capacity substantially in excess of your ability to carry out present and future financial obligations, as evidenced by audited financial statements…” Id. at § 556.901(d)(1)(i).
A company’s audited financial statements already account for future decommissioning obligations using accounting standards for asset retirement obligations. ARO is reflected as a mathematical calculation using three variables: 1.) estimated cost to decommission, 2.) estimated time until the decommissioning occurs and 3.) inflation rate factor to arrive at an estimated future cash out flow, and an estimated credit adjusted risk-free rate to calculate the present value of the estimated future cash flow.
In determining a company’s financial capacity, however, BOEM has historically subtracted from a company’s tangible net worth (a figure already adjusted for ARO) the government-estimated decommissioning liability. This results in a decommissioning double dip: first in calculating tangible net worth, and again in assessing a company’s financial capacity to carry out future obligations.
This also makes those decommissioning cost estimates even more important. Where does BOEM get its cost estimates? From BSEE. BSEE, however, does not value decommissioning liabilities using the discounted ARO balance audited and included in the financial statements of every lessee. Instead BSEE’s uses present-value numbers, or an estimate of what a third party would demand today to assume the decommissioning obligation of a single well, facility or platform, ignoring any possible economy of scale. (See “BSEE Implementation of NTL No. 2016-N03,” M. Mark Harbison, Bureau of Safety and Environmental Enforcement, Aug. 25, 2016, slides 35 and 37.)
This problem is compounded by BOEM’s position that it must “consider 100 [percent] of your decommissioning and other liability for every lease, ROW, and RUE in which you hold an ownership interest or for which you provide a guarantee.” NTL No. 2016-N01. This position is an about-face from BOEM’s approach under NTL No. 2008-N07 of excluding from bonding those leases, ROWs and RUEs on which there was a financially strong co-lessee or co-owner. Thus, BOEM is now assigning 100 percent of the costs of decommissioning to every interest holder — no matter how small the interest.
The result is that industry capital is tied up in inflated and unneeded bonds.
Reason No. 3: Self-Insurance Cap Adopted Without Rulemaking
Under the prior NTL, BOEM exempted a company from posting supplemental bonding when it could demonstrate the ability to self-insure by meeting a minimum net worth and other financial tests. These so-called “waivers” were available for those with a decommissioning liability up to 50 percent of their net worth. Under the new NTL, BOEM not only abolished waivers, but also imposed a self-insurance cap of 10 percent of tangible net worth. The 10 percent cap leaves no room for agency discretion, which makes it a “substantive standard” by which the agency determines whether supplemental bonding is required. BOEM must use notice and comment rulemaking to create a substantive standard.
BOEM should learn from the experience of the Bureau of Land Management (BLM). After three years of notice-and-comment rulemaking, BLM issued a new set of requirements for hydraulic fracturing on federal and Indian lands. But the agency failed to explain why the rule was needed, for there was no evidence that hydraulic fracturing operations had contaminated groundwater. That failure, among other reasons, resulted in the rule being preliminarily enjoined, Wyoming v. Dept. of the Interior, 136 F. Supp.3d 1317 (D. Wyo. 2015), and alter vacated. BOEM should give careful thought to the reasons for its bonding requirements and the evidence supporting BOEM’s belief that the requirements are warranted. BOEM has not yet identified why so much more supplemental bonding is needed than the agency required before.
Tags: April 2017 Print Issue, BOEM, Offshore Pipelines, Regulatory Policy
Poe Leggette, Carey Gagnon and Jasper Mason are attorneys with the national law firm BakerHostetler. The firm’s Energy team has successfully secured major projects for leading international and domestic energy companies and service providers with interests in oil, natural gas and alternative energy sources.