The coronavirus pandemic has caused a sharp decline in oil demand, putting intense pressure on oil companies with large debts.

Smelling blood in the water, oil giants are moving in to gobble up smaller companies at distressed prices, as exemplified by Chevron’s agreement to buy Noble Energy.  The feeding frenzy may also offer the last best chance for oil producing states to stop socializing the environmental costs of oil extraction.

In It’s Closing Time, we described the unfolding train wreck in the U.S. shale patch:

  • The industry is legally obligated to Plug and Abandon (P&A) oil and gas wells, but it has not set aside the resources to pay for this. This is because state financial assurance requirements have been a race to the bottom.
  • States have inadvertently created a moral hazard: it’s always in the operator’s financial interest to delay permanent abandonment of wells as long as possible and sell late-life and marginal assets to weaker companies.
  • As a predictable result, inventories of idle wells, including some that have been nonoperational for more than 100 years, have ballooned. This trend will only accelerate as the industry enters a state of permanent decline.
  • Covid-19 has temporarily shut-in tens of thousands of producing wells. The energy transition may destroy any chance for the reactivation of these and hundreds of thousands more idle wells.
  • The ultimate cost to permanently retire the millions of producing, idle and orphaned wells in the U.S. will be much greater than expected.
  • Current liabilities are calculated based on an average cost of $20-40k per well, but the actual expected cost for a modern shale well is closer to $300k.
  • Industry as a whole may not have sufficient revenues and savings to satisfy liabilities for hundreds of billions of dollars in self-bonded asset retirement obligations (AROs) as they come due. State orphan well programs are barely a drop in the bucket.
  • Industry and oil-producing states are in a deep hole. If millions of wells with no future beneficial value are to be plugged as the law requires, it will mostly be at taxpayers expense. If instead, wells are not plugged, a price will be paid with pollution affecting landowners, citizens, and the environment.
  • By continuing to extend free unsecured credit for AROs, states are subsidizing oil and gas to the detriment of their citizens, the environment, and the competitiveness of renewable energy needed to combat climate change.

As we pointed out in California Gives New Meaning to Stripper Wells, it’s standard operating procedure for larger oil companies to sell off stripper wells to smaller, less well heeled companies. Those firms that profited the most thereby avoid cleaning up the mess they left behind.  They also increase orphan well risk for states, who generally lack legal authority to hold prior operators financially responsible when current operators default.

But when oil giants scoop up failing independents, states have a rare opportunity to correct past mistakes—by requiring companies with deep pockets to fully bond those newly acquired wells.  It may be the last best chance for states to redress the failed oil policy of privatizing financial benefits while socializing environmental costs.  It seems only fair that Big Oil apply a portion of its windfall from bargain purchases of distressed frackers toward fulfillment of the industry’s legal and moral obligation to restore the environment it polluted freely for profit.

For oil producing states, it’s the last call before closing time.