There is a very good chance that California taxpayers will be on the hook for $500 million in future costs of plugging so-called “orphan” oil and gas wells, and a good chance the number could be as high as $5.7 billion, according to a new report.
The report, released Friday by the California Council on Science and Technology, an independent, state-commissioned body, exposes yet another massive cost the oil, gas, and petrochemical industry is attempting to pass off onto the public — and another risk to investors in the industry should the state act to force industry to internalize these costs, as justice and the existential threat of climate change demands.
As CIEL has demonstrated, the global shift to a low-carbon economy will have a substantial impact on fossil fuel investments, known as “transition risk.” Eliminating what is effectively a public subsidy for oil and gas production would force industry to internalize these costs — a prime example of the sort of shifting regulation that comprises these risks. As the hidden risks facing fossil fuel companies are brought to light, the economic case for investing in fossil fuels is becoming ever more tenuous.
What are Orphan Wells?
“Orphan wells” are wells that have been deserted by an insolvent operator. In other words, say Beta Company drills a well on land it owns or leases, or it buys the rights to operate a well from a prior owner. In any such case, Beta Co. is now the “operator” of this well and thus acquires a legal obligation to safely plug the well at the end of the well’s useful life to prevent the leakage of oil, gas, and toxic chemicals. However, if Beta Co. goes bankrupt and dissolves before performing that obligation, its well would be considered “orphaned” and effectively in the state’s hands to be plugged.
According to the report, it costs on average about $68,000 to plug a well in California, though figures vary by region. Multiplying region-specific average costs by the 5,540 wells that are already orphaned or highly at risk of becoming so (and subtracting the bonds the state has for these wells) leads to an estimated $502 million in future costs. Adding in other idle and marginal wells brings this number to $5.7 billion, which is $1.4 billion more than the state is slated to spend on early education and child care this year.
In most cases, before a well becomes orphaned, it has already been “idle” (i.e., not producing any oil and gas) for several years. Companies like to leave wells idle so they can strategically re-start production when the price of oil rises. But during this time the wells can leak toxic chemicals into the surrounding soil and groundwater, as well as greenhouse gases into the atmosphere.
How do Orphan Wells Cost the State Money?
When a well is orphaned, the state has a couple of options short of spending public dollars to plug it. First, it can collect on the bonds, which all operators are required by law to file when they drill, modify, or buy the rights to a well. (Bonds are financial assurances provided by a third party that an operator will meet its obligations.) However, the state only began requiring bonds in 1939. Furthermore, for many years these bonds could be returned to an operator once it completed the well. In other words, in some cases, CalGEM, the state agency that regulates energy production, may not have waited to ensure that the company met all the obligations that the bond was meant to secure before returning that bond to the operator (amendments that took effect in 2018 now require CalGEM to wait until plugging and abandonment to return to the bond). As a result, an unknown number of wells may no longer have a bond associated with them for the state to collect.
Moreover, even if there is a bond to collect, it’s almost guaranteed not to cover the costs of plugging the well. Bonds can be either tied to an individual well or “blanket” (meant to cover all of an operator’s wells in the state). In either case, the bond amounts have always been far below the actual cost of plugging a well — and continue to be too low despite being raised in 2018. The state currently holds about $107 million in available bonds according to the report, against a total future cost of $9.1 billion to plug all active and idle wells in the state.
The second option for the state to pursue is to try to force a prior operator to plug and abandon the well. Obviously this only works if there was an operator before the bankrupt operator, such as if Alpha Co. sold Beta Co. the rights to the well. And by law, the state can only go after operators who had rights to the well after 1996. Moreover, tracking down and seeking judgment against these prior operators requires resources, which, by any measure, CalGEM lacks. It’s only now adding critical monitoring and enforcement teams, according to the report.
When these measures fail, the taxpayer winds up on the hook, as recently happened in California when two major owners of offshore leases went bankrupt.
How Big is the Problem?
This problem is not unique to California, or even the United States. Taxpayers in every state with oil and gas production should be concerned. Pennsylvania and Wyoming appear to be particularly at risk, for instance. At the national level, the nonpartisan Government Accountability Office recently released a scathing report of how an insufficient bonding regime for wells drilled on Bureau of Land Management (BLM) lands has created similar future liabilities for the federal government. In Alberta, Canada, the total future cost of decommissioning all wells is likely as high as $40 billion, against just $200 million in security.
Some states are doing more than others to protect public health and taxpayer funds from idle and orphan wells. Texas, according to the report, has required operators to constantly keep up with new bond amounts, rather than grandfathering old wells into new regulations. And California is implementing new policies meant to discourage companies from keeping wells idle. However, unless the per-well bonding amounts are adjusted to match the real expected costs of plugging wells, the threat to the taxpayer will remain.
Regulators have woken up to the problem of orphan wells (literally, one Wyoming regulator says orphan wells keep him up at night). Fixing the problem would be a triple win for states. Requiring adequate financial assurances for well closure and cracking down on long-term well idling is not only important to protect public health and fight climate change; it saves taxpayers money by shifting costs back to the companies that are responsible.
Yet even in that scenario, accounting standards may allow these costs to remain undervalued on company balance sheets, masking the true costs facing fossil fuel companies. However, the savvy investor will recognize the regulatory changes already in effect or under consideration (in California and North and South Dakota, to name just a few) as yet another example of the transition risk that makes fossil fuels a bad bet.
By Nathaniel Eisen, Legal Fellow, Climate & Energy/Environmental Health
Originally posted on January 29, 2020