Understanding the consequences of the Jan. 31 Supreme Court decision.

Thomas Matthews, P.Eng.

On January 31, 2018, the Supreme Court of Canada reached a 5-2 split decision ruling that abandonment obligations must be honoured as a public duty, upholding the principle of “polluter pay” and the “superpriority” of the Crown claim for the settlement of abandonment liabilities in the event of insolvency, or bankruptcy.

Ramifications for Debt Providers/Industry
Inside the full report, we discuss ten unique questions which need to be answered in the wake of the ruling which will have overarching consequences for how debt is issued, and/or how regulations may change in order to address the risks surrounding abandonment and reclamation obligations.

Unintended Consequences
Unintended consequences typically accompany any policy or regulatory change as companies struggle to understand the corresponding implications. We see four near-term and three long-term consequences as a result of the Supreme Court ruling including: impacts to the number and behaviour of debt providers; continued paralysis of the mergers, acquisition and divestitures market; potential for an increased pace of wells transferred to the Orphan Well Association; ongoing discounts to equity valuations given liability funding capacity; the benefits of operatorship; and impacts to other Canadian resource industries.

Identifying Potential Solutions
With over 100,000 wells currently in various stages of remediation, in addition to numerous abandoned pipelines and facilities, there is clearly a liability management issue which needs to be addressed. Inside the full report, we discuss the following industry proposals including:

• Creating a tax advantaged flow-through share structure
• Alternative Financing Mechanisms such as Abandonment Trusts
• Member-Owned Insurance
• Minimum Capital Expenditures

The Punch Line
Overall, we believe that the largest impact of the ruling will come at the expense of the junior and micro-junior (mainly PrivateCo’s) who may feel a credit pinch if lenders/investors begin to constrain capital (should liabilities exceed asset value). The largest risk to our covered junior and intermediate space, (namely those with LMR’s of <3.0x) would be the uncertain regulatory changes imposed by the Alberta Energy Regulator. Longer term, equity valuations should improve as overall liabilities decrease (debt and reclamation). We believe that a natural selection and consolidation process must continue, and a sector better able to fully fund its abandonment obligations will emerge.