The Bureau of Ocean Energy Management (“BOEM”) and the Bureau of Safety and Environmental Enforcement (“BSEE”) recently issued a proposed rule on Risk Management, Financial Assurance and Loss Prevention (“Proposed Rule”), which was published in the Federal Register on October 16, 2020 and is now open for public comment. The Proposed Rule is the result of an extended effort by the Department of Interior, through its subagencies BOEM and BSEE to “streamline its evaluation criteria for determining whether oil, gas and sulfur lessees, right-of-use and easement (RUE) grant holders, and pipeline right-of-way grant holders may be required to provide bonds or other security above the prescribed amounts for base bonds to ensure compliance with their Outer Continental Shelf (OCS) obligations,” primarily decommissioning obligations. The path to this Proposed Rule has been long and winding, beginning in 2014 with BOEM resisting making changes through formal notice and comment rulemaking pursuant to the Administrative Procedures Act, and instead continuing to regulate this issue through Notice to Lessee (“NTL”) guidance documents. BOEM issued the last and most controversial NTL, NTL No. 2016-N01, in 2016, which created widespread industry concern, and, as a result, was never fully implemented.
Below is a summary of the current regulations and some of the more significant proposed changes.
Decommissioning liability for predecessors:
Current regulations – All lessees and owners of operating rights are jointly and severally liable for meeting decommissioning obligations. A party that assigns a record title interest or operating rights remains liable for decommissioning liability. In most cases of default of a current lessee or owner of operating rights, BSEE will call upon a prior interest owner to perform the required decommissioning. The regulations, however, are silent as to the method BSEE uses to enforce against these prior interest owners; BSEE typically issues an order to all or multiple prior interest owners who are then responsible for determining among themselves who will perform decommissioning work and how costs will be apportioned. This often results in a stand-off between prior interest owners and leads to additional delay in decommissioning work being performed.
Proposed regulations – The joint and several liability scheme, with each party remaining liable for its own accrued obligations, remains the same. However, the proposed regulations specify the method BSEE will use to enforce accrued decommissioning obligations against “predecessors.” The proposed regulations define “predecessor” as “a prior lessee or owner of operating rights, or a prior holder of a right-of-use and easement grant [RUE], or a pipeline right-of-way grant [ROW], that is liable for accrued obligations on that lease or grant.” The proposed regulations provide that, when holding predecessors responsible for performing accrued decommissioning obligations, BSEE will “issue decommissioning orders to groups of predecessors who held interests in the lease or grant within the same general timeframe in reverse chronological order. BSEE will issue such orders to predecessors in groups organized by the following”:
- Changes in designated operator(s) over time (i.e., all predecessors who held relevant lease or grant interests during the tenure of a particular designated operator or during the tenure of contemporaneous designated operators); and
- Predecessors who assigned interests to a lessee, owner of operating rights, or grant holder that subsequently defaulted.
The proposed regulations provide that, when BSEE issues a decommissioning order to predecessors, the predecessors must, within 30 days of receipt of the order, “begin maintaining and monitoring, through a single entity identified to BSEE, any facility, including wells and pipelines as identified by BSEE in the order”; within 60 days of receipt of the order, “designate a single entity to serve as operator for the decommissioning operations”; and within 90 days of receipt of the order, the entity designated to serve as operator “must submit a decommissioning plan for approval by the Regional Supervisor.”
The proposed regulations also provide that BSEE may depart from the above order of recourse and issue orders to any or all predecessors under certain circumstances, which include, but are not limited to (1) the failure to obtain approval for a decommissioning plan or execute decommissioning as required pursuant to the regulations; (2) a determination by the Regional Supervisor that there is an emergency condition, safety concern, or environmental threat; or (3) a determination by the Regional Supervisor that proceeding in the manner summarized above “would unreasonably delay decommissioning.”
Decommissioning liability for RUE holders:
Current regulations – BSEE regulations are currently silent concerning decommissioning liability for RUE holders.
Proposed regulations – The proposed regulations fill this gap by providing: “All right-of-use and easement grant holders and prior lessees of the parcel on whose leases there existed facilities or obstructions that remain on the right-of-use and easement grant are jointly and severally liable for decommissioning obligations, including obligations for any well, pipeline, platform, or other facility, or an obstruction, on their right-of-use and easement, as the obligations accrue and until each obligation is met.” The criteria for when BOEM will require additional security with respect to a RUE is similar to that described below for leases under “Supplemental bonding.” This proposed regulation emphasizes the need for prior lessees to obtain adequate security from RUE holders if a facility is to remain in use following lease termination. A prior lessee could be held liable for decommissioning a hurricane-toppled platform years after its exit and completion of all lease decommissioning obligations.
Appeals of decommissioning orders:
Current regulations – Decommissioning orders that are appealed remain effective unless BSEE agrees to suspend the effectiveness of the order during the appeal period or the Interior Board of Land Appeals (“IBLA”) grants a stay of the order.
Proposed regulations – A party that appeals a decommissioning order to the IBLA, in order to seek a stay of the effectiveness of a decommissioning order must post a surety bond in the amount that BSEE determines will be adequate to ensure completion of the specified decommissioning activities in the event the appeal is denied and the party thereafter fails to perform the decommissioning obligations. This is a significant change that will essentially require an appealing party to pay up front in order to challenge a decommissioning order.
Current regulations – BOEM can require additional security based on an evaluation of a lessee’s ability to carry out present and future obligations demonstrated by five factors: (i) financial capacity substantially in excess of existing and anticipated lease and other obligations as evidenced by audited financial statements; (ii) projected financial strength significantly in excess of existing and future lease obligations based on the estimated value of existing OCS lease production and proven reserves for future production; (iii) business stability based on five years of continuous operation; (iv) reliability in meeting obligations based on credit rating or trade references; and (v) record of compliance with laws and regulations. However, the regulations do not specify how BOEM weighs these criteria. To provide guidance on this issue, from 1998 through 2016, BOEM (and its predecessor) issued four NTLs, with each subsequent NTL replacing the prior NTL. This first of such NTLs, NTL No. 98-18N, was replaced by NTL No. 2003-N06, which was itself replaced by NTL No. 2008-N07.
Historically, under NTL No. 2008-N07, a lessee that passed the established thresholds was waived from providing additional security to cover its decommissioning liability. Additionally, co-lessees (regardless of financial strength) were not required to provide additional security for decommissioning liability on a lease if one lessee had a waiver. NTL No. 2008-N07 was subsequently replaced in 2016 by the controversial NTL No. 2016-N01, previously mentioned, which was never fully implemented.
Proposed regulations – BOEM’s guiding principles in connection with the proposed regulations is (a) to limit the circumstances in which it would require additional security to (1) when a lessee or grant holder poses a substantial risk of becoming financially unable to carry out its obligations, and (2) there is no co-lessee, co-grant holder, or predecessor that is liable for the same obligations and financially capable of performing them, and (3) the property is at or near the end of its productive life such that it may not have sufficient value to be sold to another company that would assume the existing obligations; and (b) to streamline its evaluation criteria.
In connection therewith, under the proposed regulations, instead of relying primarily on net worth to determine whether a lessee must provide additional security, BOEM would primarily consider a lessee’s credit rating. In addition, the proposed regulations provide that BOEM would also consider the proved oil and gas reserves on the lease and the financial strength of predecessors in determining whether additional security was required.
The proposed regulations provide that BOEM may require a party to provide additional security if such party does not meet at least one of the following criteria:
1. The party has an issuer credit rating from a nationally recognized statistical rating organization (NRSRO), as defined by the U.S. Securities and Exchange Commission (SEC), greater than or equal to either BB- from S&P Global Ratings or Ba3 form Moody’s Investor Service, or an equivalent credit rating provided by an SEC-recognized NRSRO or a proxy credit rating determined by the Regional Director based on audited financial information greater than or equal to either BB- from S&P Global Ratings or Ba3 form Moody’s Investor Service, or an equivalent credit rating provided by an SEC-recognized NRSRO;
2. The party’s co-lessee has an issuer credit rating or proxy credit rating that meets the criteria in (1) above;
3. The net present value of proved reserves on the lease is less than or equal to three times the cost of the BSEE decommissioning estimate associated with production of those reserves;
4. A predecessor lessee liable for decommissioning any facilities on the party’s lease has an issuer credit rating or a proxy credit rating that meets the criteria in paragraph (1) above. In such case, BOEM may require that the party provide additional security for decommissioning obligations for which such predecessor is not liable.
BOEM will require additional security for pipeline right of way (“ROW”) and also RUE grant holders under similar circumstances as for leases with the exception that proved reserves are not a consideration with respect to these types of rights.
The proposed changes to supplemental bonding have the potential to eliminate some “double-bonding” issues where both BOEM and sellers of lease interests require additional security to backstop estimated decommissioning obligations. However, sellers with good credit ratings who are soon-to-be predecessors on leases without substantial proved reserves left to produce will have even more incentive to ensure that their buyers provide them with security sufficient to cover future decommissioning in their purchase and sale agreements.
Cancellation of supplemental bond and return of pledged security:
Current Regulations – BOEM regulations only provide that it may cancel a supplemental bond when the Regional Director determines that a party has met all of its obligations covered by the additional bond. Occasionally, there may be other circumstances in which the cancellation of a bond may be warranted, but the regulations do not expressly provide for cancellation for such other circumstances. BOEM does receive requests to cancel supplemental bonds under other circumstances, and will approve such requests, when warranted, on the basis of a departure from the regulations.
Proposed Regulations – The proposed regulations provide the following three additional circumstances when BOEM may cancel a supplemental bond: At any time (1) when BOEM determines, using certain criteria specified therein, that a lessee or grant holder no longer needs to provide the additional bond for its lease, RUE or ROW; (2) when the operations for which the bond was provided ceased prior to accrual of any decommissioning obligation; and (3) when cancellation of the bond is appropriate because BOEM determines such bond never should have been required under the regulations. The proposed regulations would also allow BOEM to cancel a third-party guarantee under the same terms and conditions that apply to cancellation of a supplemental bond and to return pledged security.
Current regulations – BOEM regulations allow for companies to provide additional security through third-party guarantees, often provided by related companies or parent corporations. Third-party guarantees are available (1) if the proposed guarantor’s total outstanding and proposed guarantees do not exceed 25% of its unencumbered net worth in the United States, and (2) the proposed guarantor submits an indemnity agreement that includes specific BOEM-required provisions, including that the indemnitor must ensure compliance with all lessees’ lease obligations, the obligations of all operating rights owners, and the obligations of all operators on the lease. Traditionally, a company can terminate the period of liability for a third-party guarantee, but there is no ability to cancel the agreement itself as can be done with a bond.
Proposed regulations – The proposed regulations would make several changes with respect to third-party guarantees. First, BOEM would change the criteria for evaluating the financial ability of a proposed guarantor to use the same credit rating or proxy credit rating criteria as proposed for lessees. In addition, the requirement for a third-party guarantee to ensure compliance with the obligations of all lessees, operating rights owners, and operators on the lease would be removed. In addition, third-party guarantees would also be available as additional security for ROWs and RUEs. And, guarantors would be able to limit a third-party guarantee to specific lease, ROW, or RUE obligations and/or to limit the amount of the guarantee. Finally, the proposed regulations would provide for cancellation of a third-party guarantee under the same terms and conditions that apply to cancellation of supplemental bonds.
Fixing the unlimited nature of third-party guarantees – both as to the obligations of “all” parties involved in a lease and as to the amount secured – along with providing for these agreements to be cancelled should make this a more acceptable option for some companies as a low or no cost manner to satisfy some or all obligations to provide additional financial security.
Lease-specific abandonment accounts:
Current Regulations – BOEM regulations allow for companies to establish lease-specific abandonment accounts instead of providing a supplemental bond. The regulations provide that the institution managing the account is required to use account funds to purchase Treasury securities pledged to BOEM until the amount of the funds in the account equals the maximum amount insurable by the Federal Deposit Insurance Corporation (“FDIC”).
Proposed Regulations – The proposed regulations would make several changes with respect to these abandonment accounts. First, BOEM would rename the accounts to “decommissioning accounts” and eliminate the words “lease-specific” in the provision to remove any perceived limitations that a decommissioning account can only be used for a single lease, and allowing these accounts to be used to ensure compliance with additional security requirements for a RUE or ROW grant, as well as a lease, or a combination of any of the foregoing. The Proposed Rule also removes all requirements that the account’s managing institution must use funds in the account to purchase Treasury securities pledged to BOEM, which requirements would be replaced with a new provision providing that if a party fail to make the initial payment or any scheduled payment into the decommissioning account, it must immediately submit, and subsequently maintain, a bond or other security in an amount equal to the remaining unsecured portion of its estimated decommissioning liability.
BOEM noted that due to the current requirement of pledging Treasury securities to fund a decommissioning account, lessees may have been unwilling to use such accounts because the vast majority of decommissioning moneys would be in the form of low-yield Treasury securities. BOEM determined that the risk of loss through a bank failure is minimal, and, practically speaking, BOEM’s security does not depend on FDIC insurance.
The public comment period will last for 60 days, and comments can be submitted online or by mail. Liskow lawyers Jana Grauberger, Steve Wiegand, Anthony Marino, and Kathleen Doody are available to discuss the proposed regulations described above or any of the other items contained in the proposed rule.
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