How to get Alberta off the hook for orphan wells
The Alberta government needs to open up its financial assurance toolbox and re-assess which instruments will best manage this growing environmental problem.
Emily Nickerson (EN) is a graduate student at the Max Bell School of Public Policy where she is co-editor of The Bell. Emily is passionate about promoting sustainable, inclusive growth, and ensuring that natural resources are well governed. Write us at newsletterthebell@gmail.com
ALBERTA HAS A MASSIVE, and growing, orphan well problem. Currently, there are 3,321 orphan sites that require decommissioning, and another 4,422 orphan sites that have been decommissioned and now need reclamation.
And despite significant investments by the federal and provincial government to reduce the number of orphan wells, estimates suggest that these efforts are just a drop in the bucket. With COVID-19 response and recovery continuing to strain the government budget, Alberta needs to revamp the Orphan Fund Levy to ensure that oil and gas companies are not simply shifting their costs onto Albertans.
While oil and gas companies are technically required to decommission and clean up their wells, there is little financial incentive for them to make these investments. There are now 97,000 inactive wells in the province, with the number of wells falling under care of the Orphan Well Association (OWA) growing steadily each year as the legal or financial owners go bankrupt. In 2020, the Alberta government introduced Bill 12 to support OWA, but these changes merely improved OWA’s ability to manage existing orphan wells, with little attention to meaningfully preventing or limiting new ones. Even though there were provisions to improve the corporate health assessments regarding their ability to meet regulatory obligations, and creation of spending targets for industry to reduce inactive wells, critics argued that these announcements lacked specifics and any teeth.
Oil and gas companies contribute to the OWA annually through the Orphan Fund Levy. The latest OWA annual report for 2019 shows that industry contributed $60 million to the OWA through the levy. While funds raised by the levy appear to be growing each year, the OWA budget in 2019 was equally carried by a portion of the $235 million loan from the Alberta government. More recently, the Alberta government provided an additional $100 million loan while $200 million from the federal funding announced last April has also been loaned to the OWA.
Orphan wells are not only an economic problem for Alberta, they pose health and environmental risks as well. If these wells fail, they can pollute surrounding water, contaminate soil, and release greenhouse gases. Farmers are increasingly raising concerns about challenges growing crops near old wells.
Economists at the Ecofiscal Commission previously highlighted in their research on pricing environmental risks that the Orphan Fund Levy, and similar industry funds, fail to create the necessary economic incentives for firms to lower their environmental risks. They suggested that incentives for deterrence could be improved through risk-differentiated premiums, deductibles, co-payments, and mutual monitoring.
More broadly, the Commissioners recommended that policymakers need to closely consider which financial assurance instruments will best deliver on (1) deterring the environmental risk, (2) ensuring businesses compensate for any damages, and (3) keeping costs to firms as low as possible to limit impacts on production and investment. There are many types of financial assurance to choose from, including cash deposits, trusts, parent company guarantees, environmental bonds, insurance, and industry funds. The Alberta government needs to open up its financial assurance toolbox, and re-assess which instrument, or combination of instruments, will actually create the right incentives for deterrence, compensation, and economic activity.
Texas, for example, has required bonds for all wells since 2002. Instead of putting up their own money, most producers buy a surety bond from an insurer, and according to C.D. Howe Institute's research, premiums vary from 1-15% of the bond value. While six percent of firms exited during year one of the policy change, with higher rates for small firms and no net exits for large firms, these rates quickly returned to pre-implementation levels by year two. Importantly though, production levels did not fall overall despite the policy change, with larger firms buying up smaller ones. As a result of the bonding requirement, environmental violations fell, and “the number of unplugged orphan wells left behind dropped by 75 percent.”
While many may fear the investment impacts of requiring oil and gas companies in Alberta to cover their environmental damage, early evidence suggests that these companies are not the most exposed to competitiveness pressures. More research is needed on the various financial assurance mechanisms and related competitiveness pressures so that policymakers in Alberta can choose wisely, and make accommodations as required.
Clean up costs for the oil and gas sector are showing little sign of slowing and the current framework is saddling Albertans with financial liabilities that outweigh the benefits. With society increasingly picking up the clean up tab, and eventual clean up costs for every oil and gas well pegged at $30 billion, Alberta needs an updated, cost-effective financial assurance mechanism that does a better job of preventing or limiting new orphan wells. (EN)
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The Bell is edited by Emily Nickerson, Mariel Aramburu, and Andrew Potter of the Max Bell School of Public Policy at McGill University. If you have any feedback or would like to contribute to this newsletter, please send an email to the editors at newsletterthebell@gmail.com