Thoughts and Tips on How to Navigate New and Evolving AER Processes
& SEAN WALLACE
NORTON ROSE FULBRIGHT
THE CURRENT ECONOMIC AND REGULATORY CLIMATE IN ALBERTA HAS GIVEN RISE TO NEW CHALLENGES FOR PURCHASERS AND VENDORS OF UPSTREAM OIL AND GAS ASSETS WISHING TO TRANSFER WELL AND FACILITY LICENSES AS PART OF THEM TRANSACTIONS. In the wake of high profile cases involving Redwater Energy Corp. (i) and Lexin Resources Ltd. (ii), the Alberta Energy Regulator (AER) has implemented several regulatory changes respecting how well and facility licenses are transferred, with a view to managing environmental risks and associated costs to the province. However, these changes have introduced new risks and uncertainty into purchase and sale transactions, as described below. This article offers some options for structuring your purchase and sale transactions to mitigate these risks and associated uncertainty.
An Overview of Changes to the License Transfer Regulations
Immediately following the Redwater decision in 2016 (iii), the AER issued Bulletin 2016-16 (iv), imposing certain restrictions upon parties wishing to transfer well and facility licenses. Specifically, the AER increased the LMR requirement for license transferees from 1.0 to 2.0, failing which those transferees would be required to post a security deposit. (v) To illustrate the broad impact on the industry, as of October 7, 2017, over two-thirds of licensees have an LMR below 2.0. (vi) Furthermore, we have been involved in transactions where, post Bulletin 2016-16, purchasers would have been required, as a result of these additional restrictions, to post security deposits ranging from a few million dollars to over $200,000,000.
In addition, pursuant to Bulletin 2016-16, all licence transfer applications are now treated as non-routine; meaning that, in addition to the LMR assessment, the AER may exercise its discretion to refuse a transfer or impose additional terms and conditions “if appropriate in the circumstances”.(vii) Through this non-routine process, the AER has generally assessed the circumstances surrounding the proposed transfer, including the characteristics of the transferee and the nature and complexity of any compliance issues identified by the AER.
Less than a month after Bulletin 2016-16 was issued, in response to initial feedback, the AER issued Bulletin 2016-21 (viii), which clarified that, rather than posting security with the AER, licence transferees could alternatively provide “other evidence that the transferee will be able to meet their obligations with an LMR of less than 2.0”. (ix) No further guidance was provided at the time, and the AER reiterated that these measures were both interim and “necessary to protect Albertans from unfunded liabilities”. (x)
The practice that has developed around this “other evidence” path is for a purchaser (that will have a post-closing LMR between 1.0 and 2.0) to present a plan to the AER setting forth how it will manage (technically, operationally and financially) the assets it will be acquiring and the associated abandonment and reclamation obligations. More specifically, the transferee must demonstrate how it will raise (with a high probability of success) its LMR to at least 2.0 within 12 months after closing. If the AER is satisfied with the plan, it may issue a relatively brief and non-binding letter confirming it may exercise its discretion and waive the security deposit requirement for a transferee with an LMR between 1.0 and 2.0.
We note that when considering whether to exercise its discretion the AER has also considered: (i) the transferee’s active to inactive well count; (ii) the transferee’s compliance record; and (iii) whether the transferee’s directors and officers have historically worked for companies in senior roles that have caused the AER problems.
An important takeaway for vendors and purchasers is to start the waiver application process early. The AER now generally takes at least 30 days for an application for discretion to be processed, and the application must be submitted before the license transfer application. Vendors may also wish to be involved in the application process, which may include regular communications with the purchaser, reviewing and commenting on the purchaser’s plan to manage the assets post-closing, and being included in any discussions and meetings with the AER relating to the purchaser’s asset management plan and waiver application more generally.
Finally, it is important to recognize that the policies and procedures underlying license transfers, including the exercise of discretion discussed above, have evolved over time, and will likely continue to evolve as the AER moves towards developing more permanent regulatory measures.
Public Opinion – Statements of Concern
Effective August 21, 2017, pursuant to Bulletin 2017-13 (xi), AER license transfer applications will have a standardized review period of at least 30 days before a decision to approve a transaction is issued. (xii) The AER is moving to a model of increased transparency, where public online notice is required for almost every application, including licence transfers. The purpose of the public notice is to let interested parties (such as landowners, First Nations groups and other energy companies) file a Statement of Concern (SOC) objecting to a transfer during the review period. If a SOC is filed, the licence transfer application can be significantly delayed.
The threshold for a claimant to file a SOC is not particularly difficult to satisfy. Any person who believes he or she may be directly and adversely affected by an application to transfer a license may file a SOC with the AER. (xiii)While no specific are provided by the AER, decisions of Alberta courts and the Alberta Environmental Appeals Board (AEAB) have provided guidance on the “directly affected” test. Generally, the test requires a reasonable degree of connection between the activities on the land underlying the licensed assets and the right or interest asserted by the SOC claimant. (xiv) Relevant factors can include how the claimant uses the area, how the activities will affect the environment, and how the impact on the environment will affect the claimant’s use of the area. (xv) The closer these elements are connected, the more likely the claimant is directly affected. (xvi) The onus is on the claimant to establish that it is directly affected.
Intuitively, it may seem unlikely that a SOC could prevent a well or facility license from being transferred, particularly in circumstances where the AER has already exercised its discretion under Bulletin 2016-21 to waive the security deposit requirement. However, we have seen cases where, due to the nature of the concerns expressed in a SOC, vendors and purchasers have had to revisit the transaction structure and, basically, go back to the drawing board.
In addition, working interest partners under operating agreements could, in addition to withholding their consent to the transaction in accordance with the operating agreement, file a SOC. Given the significant number of recent oil and gas insolvencies and the resulting impacts on solvent counterparties (i.e., see Lexin), increased attention and diligence by working interest partners can be expected.
Considering the foregoing, we have outlined briefly some options to consider when structuring your purchase and sale agreements that involve AER licensed assets:
- Closing in Escrow. If the purchaser might have a LMR less than 2.0 after closing, or if there is reason to believe that either the AER would be inclined to examine the purchaser ‘closely’ or that a SOC of the assets could be filed, one option is to close the transaction into escrow. (xviii) The trigger event for the release of the assets from escrow, and the transaction becoming effective, is the transfer by the AER of all well and facility licenses to the purchaser, either without any security deposit, or upon the purchaser posting some stipulated maximum-security deposit amount. Until these conditions are met, the vendor remains the owner of the assets, and if the transfer does not occur by some outside date, the transaction would typically terminate. The parties will need to agree upon how the deposit is to be dealt with in those circumstances, and how interim period risks and changing circumstances will be allocated between the parties.
The benefit of the escrow approach is that both the vendor and the purchaser can ensure they do not end up in the situation that the transaction closed, the sold assets are owned beneficially by the purchaser but the vendor continues to be the holder of the well and facility licenses and, more importantly, the party responsible in the first instance to the AER for associated environmental liabilities. This is obviously a result any vendor would want to avoid, but it’s not desirable from the purchaser’s perspective either. For one, Alberta regulations require a party to hold some working interest in a well to be entitled to hold the license for that well, and if these regulations are breached the AER is entitled to (among other remedies) shut-in those wells. Secondly, most purchase and sale agreements allow a vendor to post a security deposit on behalf of a purchaser if the purchaser fails to timely deliver any security deposit it is required to post, and to recover all associated costs from the purchaser. A purchaser does not want to be in a position where it may be subject to an open-ended security deposit requirement, remembering that even if the AER issues a waiver letter pursuant to Bulletin 2016-21, that letter is not binding.
- Change of Law Provision. Given the AER’s ability to introduce regulatory changes from time to time, vendors and purchasers may wish to include in their agreements a change of law provision setting forth a mechanism for unwinding or terminating a transaction if a change in law is so material it undermines the feasibility of the transaction.
- Vendor Due Diligence. It is advisable for a vendor to consider early on in negotiations whether its purchaser could reasonably be expected to delay or prevent license transfers. This can specifically include a review of a purchaser’s compliance record with the AER (including directors and officers), active and inactive well counts, and an assessment of the purchaser’s financial strength and proposed 12-month plan to improve its LMR and address any compliance concerns. Vendors may also wish to consider whether there are any “difficult” stakeholders (i.e., landowners, working interest partners) who could file a SOC and potentially delay or impair the desired transaction.
Should you require any assistance with a purchase and sale transaction that is complicated by the evolving AER processes, please feel free to contact the authors or any member of the Norton Rose Fulbright Calgary team (http://www.nortonrosefulbright.com/ca/en/offices/calgary).
i Redwater Energy Corp. (Re), 2016 ABQB 278, aff’d 2017 ABCA 124, leave to appeal to SCC pending [Redwater].
ii Alberta Energy Regulator v. Lexin Resources Ltd., 2017 ABQB 219 [Lexin].
iii Redwater supra note 1. In Redwater, the Alberta Court of Queen’s Bench held that certain sections of the Oil and Gas Conservation Act and Pipeline Act are inoperative to the extent they would frustrate a receiver or trustee’s ability to renounce the uneconomic licensed assets of a bankrupt energy company. This was upheld by the Alberta Court of Appeal, however, the AER has sought leave to appeal the decision to the Supreme Court of Canada.
Iv Bulletin 2016-16: Licensee Eligibility – Alberta Energy Regulator Measures to Limit Environmental Impacts Pending Regulatory Changes to Address the Redwater Decision [Bulletin 2016-16], online: <http://www.aer.ca/documents/bulletins/Bulletin-2016-16.pdf>.
v Ibid at page 2.
vi According to the AER Liability Management Programs Results Report run on October 7, 2017, 514 licensees out of 758 have an LMR below 2.0 (67.8%), online: <http://www.aer.ca/data/facilities/LLR_Report.pdf>.
vii Bulletin 2016-16 supra note 4 at page 2.
viii Bulletin 2016-21: Revision and Clarification on Alberta Energy Regulator’s Measures to Limit Environmental Impacts Pending Regulatory Changes to Address the Redwater Decision [Bulletin 2016-21], online: <http://www.aer.ca/documents/bulletins/ Bulletin-2016-21.pdf>.
ix Ibid at page 1. x Ibid at page 3.
xi Bulletin 2017-13: Changes to Process for Transfer Application Decisions [Bulleting 2017-13], online: <http://www.aer.ca/documents/bulletins/Bulletin-2017-13.pdf>.
xii Ibid at page 1.
xiv Dene Tha’ First Nation v. Alberta (Energy and Utilities Board), 2005 ABCA 68 at para 14.
xv Tomlinson v. Director, Northern Region, Operations Division, Alberta Environment and Sustainable Resource Development, re: Evergreen Regional Waste Management Services Commission (03 April 2013), Appeal No. 12-033. ID 1 (A.E.A.B.) at para 28.
xvi Ibid. xvii Ibid.
Lexin supra note 2. Lexin Resources Ltd. (“Lexin”) was an insolvent junior oil and gas producer that held over 1,300 well and facility licenses. After failing to comply with numerous AER orders and security deposit requirements, the AER was granted a court order placing Lexin into receivership in order to preserve its asset value and pay for the associated environmental clean-up costs. While the Orphan Well Association assumed the liabilities for wells and facilities held solely by Lexin, the care and custody (and all associated environmental liabilities) of the shared Lexin sites remained with its other named working interest participants, respectively, with little meaningful recourse to the Orphan Well Fund.
viii In an escrow arrangement, generally, both the purchase price and general and specific conveyances respecting purchased assets will be received by an escrow agent (usually a law firm), who will hold them in trust as an intermediary pursuant to the terms and conditions of an escrow agreement. The escrow agreement will outline when and how the escrow agent will release the escrowed items.
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