“Nobody move! I have a hostage. If anyone follows us, I’ll kill myself and then her.”

Roy MillerKnight and Day

A classic comedic trope is the situation in which a character takes him or herself hostage.

We would expect this absurdity in a satire, but sadly, it’s a metaphor for what’s happening in bankruptcy as oil and gas companies seek to escape their clean up obligations created by oil well closures.  It’s up to the states to prevent this from happening, and the best remedy is to require full bonding.  States should have learned this lesson from the 2005-2015 bankruptcies of the largest U.S. coal companies.[1]  Unfortunately, that lesson is not sinking in quickly.

By law, companies are obligated to clean up and reclaim sites, but states require little or no financial assurance.  This system works as long as companies prosper, but those days are over.  Weaker firms are now going bankrupt.  In bankruptcy, those firms put a metaphorical gun to their own heads, threatening to fully default on their clean up obligations unless regulators cut them, or their successors, slack.

Take the recent settlement between PetroShare Corporation, a Colorado-based oil and gas company, and the State of Colorado.

Our analysis indicates that PetroShare had, prior to filing bankruptcy, a total of 89[2] wells in the State of Colorado; based on the depth of these wells, we estimate they will cost nearly $16 million to plug.  This figure ignores any potential reclamation and monitoring costs which can add hundreds of thousands of dollars per site or more.  Such costs are common—Lynn Helms, Director of the North Dakota Industrial Commission, anticipates that roughly 30-40% of the wells they close this year will require cost-intensive reclamation activities.[3]

Reclamation costs aside, the State of Colorado had already identified a range of violations, including improper disposal practices, at many of PetroShare’s well sites.

States require companies to post bonds to ensure they actually plug wells and remediate sites.  One might expect the bonds would reflect actual costs.  But they don’t.  Colorado had required PetroShare to post bonds in the amount of $425,000, of which $400,000 were designated for plugging & abandonment costs (P&A).[4]  That’s just under 3% of the expected plugging costs.  In short, the state was not in a good position, even before PetroShare filed for bankruptcy.

The state dealt itself a bad hand, then decided to fold.  Seen in its most favorable light, the state’s bankruptcy settlement did not improve the situation and, at worst, has set an unfortunate precedent for soon-to-be bankrupt oil companies in Colorado.  It also shows the limits of what states can do if they wait until companies have defaulted before addressing bonding deficiencies.

So what did Colorado receive?

  • The right to seize $325,000 in PetroShare’s surety bonds.[5] Such bonds are typically not considered part of the bankruptcy estate; therefore, the state would have been entitled to them anyway.
  • A requirement for Wattenberg, an entity formed by PetroShare’s key creditors to acquire all of Petroshare’s assets, to remedy any outstanding regulatory violations for any wells it chooses to operate within 180 days. That’s useful, but merely obliges the new operator to comply with the law, like everyone else.

And what did Colorado give up?

  • Over $700,000 in administrative claims based on regulatory violations by PetroShare. “Administrative claims” are paid first (and fully) in bankruptcy.  Whilst these might have been reclassified with lower priority by the court, they might not have and so presumably held some value.
  • The right to pursue Wattenberg for any of PetroShare’s past but as yet undiscovered regulatory violations.
  • Perhaps worst of all, permission for Wattenberg to “orphan” wells to the state without having to plug and abandon them.

That’s a lot to concede for something the state could have already seized.  But the one that sticks out is the last point, which is a one-time “get out of jail free” card to abandon wells that they have profited from without having to pay for their closure.  You can be sure that every operator staring down bankruptcy will be looking for similar treatment.  The willingness to permit this raises many questions, especially these two: Did the state identify the wells that Wattenberg would likely abandon?  Did it then estimate what it would likely cost to plug them?

It is possible the state has some guesses on costs tucked away somewhere, but it is quite likely that they don’t.  Most states do not have a handle on how much these well closures will cost.

Our forthcoming report will make an educated guess.

As to abandonment, Wattenberg will presumably abandon the least productive and most costly to clean up.  So which wells are those?

Of the 89 wells we have identified from the Enverus database, three have been inactive for more than five years, seventeen have been inactive for more than two years, and 47 would likely qualify as “stripper” wells under federal guidelines, i.e., producing less than 15 barrels/day.  Of the remaining 22 wells, eight are injection or other wells (e.g., dry holes) that will require plugging, but are only valuable if they can be used to increase production from the remaining fourteen producing wells.

Presumably, Wattenberg will not take on wells that aren’t producing oil.  That’s 20 wells that we estimate will cost just over $3.5 million to plug.

Wattenberg might also decide to abandon the stripper wells now, while it can do so without paying for it.  That’s 47 more wells at an estimated cost of just over $8.2 million.

That’s a grand total of more than $11.7 million, assuming that all of the remaining eight non-production wells are all still useful.  And those numbers don’t begin to consider the reclamation costs.

The State of Colorado presumably believed it had no choice but to let PetroShare’s key lenders walk away from these liabilities, since the agreement notes that Wattenberg had conditioned accepting the assets on “…the resolution of certain issues concerning Colorado as set forth herein.”

There are legal precedents in which liquidating debtors have been forced to reclaim abandoned well sites, suggesting the state could have gotten more than it did.  But even if the state believes that it made its best deal, the result shows that Colorado’s bonding regime has left it woefully unsecured.  If bonding requirements don’t reflect the real costs of oil well closures, states can expect to be held hostage again in the next bankruptcy proceedings.

[1] See Carbon Tracker, Blazing Saddles: Coal miners are galloping out of bankruptcy; will taxpayers be left behind? (2017).

[2]   Colorado Oil and Gas Conservation Commission, “Data/Downloads, Daily Activity Dashboard,” Colorado Oil and Gas Conservation Commission, Department of Natural Resources, State of Colorado, full export of data updated daily, “Well Status” tab, operator number 10454, accessed 2020.04.24, https://cogcc.state.co.us/data2.html#/downloads.

[3] Director, Lynn Helms, Oil and Gas Division, Department of Mineral Resources, North Dakota Industrial Commission. Oil and Gas Division Three-Part Education Series: Well Plugging and Reclamation, 2020. https://www.dmr.nd.gov/oilgas/pressreleases/Part_3_Reclamation.pdf

[4] The bankruptcy agreement appears to list only $325,000 in bonds and appears to exclude a combined insurance and cash “blanket bond” in the amount of $100,000 that is listed on COGCC’s website.  (Surety ID 2017-0053, see, https://cogcc.state.co.us/cogis/SuretyDetail.asp?SuretyID=20170053&OPNum=10454).