Carbon Tracker pioneered work on the oil and gas industry’s “stranded assets”; as investors increasingly ask whether oil demand is or will soon be in terminal decline, we are turning attention to the flipside of stranded assets – “stranded liabilities.” Specifically, the cost of retiring long-lived oil and gas infrastructure. This paper is the first in our series focusing on the dynamics that are driving the acceleration of these risks and a method for assessing the magnitude of the problem.

By law, after production ceases, all oil and gas wells must be permanently plugged and abandoned. In finance, these debt-like legal obligations to Plug and Abandon wells are called “asset retirement obligations” (AROs). They are reported in company financial statements on a discounted present value basis.

Companies typically assume that the bulk of ARO costs will be incurred in the distant future, but the low carbon energy transition will bring them forward – further accelerating the industry’s woes brought on by the coronavirus pandemic.

There’s no money set aside to cover retirement costs, and lax regulations are to blame.

And this illuminates the problem: regulators have not required the industry to set aside funds to retire these wells. In short, the industry cannot afford to retire. If industry can’t pay, then its lenders, investors, creditors and ultimately oil-producing states will eventually be forced to foot the bill. Else, landowners and citizens will be left to live with the consequences of millions of unplugged wells.

Key Findings

  • 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 financial assurance requirements for oilfield asset retirement obligations have to date 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, often by selling late-life and marginal assets to weaker companies.
  • As a predictable result, inventories of largely self-bonded idle wells, 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 industry’s asset retirement obligations (AROs) are accelerating, and the ultimate cost to permanently retire the millions of producing, idle and orphaned wells in the U.S. in accordance with the law will be much greater than expected.
  • Current liabilities are calculated based on an average cost of $20-40k, but the actual expected cost for a modern shale well is closer to $300k.
  • Industry – not just a few insolvent companies but the entire U.S. oil and gas industry – may not have sufficient revenues and savings to satisfy liabilities for hundreds of billions of dollars in self-bonded AROs as they come due. Industry-funded orphan well programs are barely a drop in the bucket.
  • Self-bonded AROs have left industry and oil-producing states 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 taxpayer expense. If instead, they are not plugged, the price will be paid by 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.