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10 Questions Series: How a Reinstated NTL No. 2016-N01 Could Detrimentally Affect Offshore Oil and Gas Operators on the Outer Continental Shelf

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With U.S. President Joe Biden taking office in January 2021, many energy industry participants have questions regarding how new federal policy may adversely affect oil and gas operators pursuing exploration and development activities in federal waters of the Outer Continental Shelf (“OCS”). Having pledged to battle climate change and reduce greenhouse gas emissions, President Biden has indicated that he intends to place restrictions on the oil and gas industry, including delaying or restricting, on federal lands and in offshore waters, new drilling permits, hydraulic fracturing, and new leases for oil and gas exploration and production.

While emphasis has been placed on new leasing and production activities, the president also is almost certainly considering legal approaches for limiting existing operations. One such approach that may be considered could involve a seemingly mundane topic — financial assurance obligations — that could have serious repercussions for offshore operators. President Biden could seek to bolster existing financial assurance regulations imposed pursuant to the federal Outer Continental Shelf Lands Act (“OCSLA”) and enforced by the Bureau of Ocean Energy Management (“BOEM”). With an eye to timing, President Biden could go full circle and re-issue BOEM’s Notice to Lessees and Operators (“NTL”) No. 2016-N01 (“2016 NTL”) regarding supplemental bonding as an interim measure (until such time as a new, more rigorous program is implemented) or as an effective final measure, in and of itself. The 2016 NTL was issued under the Obama administration in 2016, but it was paused indefinitely by the Trump administration in mid-2017 and is now listed on BOEM’s website as “rescinded,” as Trump’s BOEM issued proposed revisions to the applicable financial assurance regulations on October 16, 2020.

This question-and-answer format summarizes the more burdensome requirements under the 2016 NTL and provides insights on steps that operators could take in hopes of mitigating adverse impacts from renewed coverage under the NTL should the new administration take that direction.1

  1. What is the current regulatory scheme for provision of financial assurance for decommissioning obligations, including plugging and abandonment of wells, removal of platforms, decommissioning pipelines, and returning the lease or pipeline rights-of-way (“ROWs”) to a condition free of obstructions?

BOEM’s financial assurance regulations are established under Subpart I of 30 C.F.R. Part 556 and apply to oil, gas and sulfur leases issued pursuant to Part 556 and pipeline ROW and right-of-use and easement (“RUE”) grants issued under Part 550. Under the regulations, general bonds of a relatively nominal amount are always required of lessee and ROW grant holders, and BOEM retains the right to seek additional financial assurance, typically performance bonds, to assure compliance with lease conditions, including, most critically, decommissioning obligations. While the existing financial assurance regulations have remained substantially unchanged since before 2000, BOEM is authorized by the rule to issue NTLs that “clarify, supplement, or provide more detail” about requirements already prescribed under its regulations. NTLs addressing supplemental bonding under BOEM’s financial assurance program were most recently issued in 2008 (NTL No. 2008-N07 issued under the George W. Bush administration) and 2016 (NTL No. 2016-N01 issued under the Obama administration).

The 2008 NTL is the last fully implemented NTL on secondary bonding. Following commencement of the Trump administration in January 2017, BOEM, in reliance on Executive Orders promoting the energy independence and economic growth of the United States, paused indefinitely the implementation of the 2016 NTL after June 2017 to reassess its financial assurance program. The 2016 NTL has been effectively mothballed by Trump’s BOEM since it was paused in mid-2017, and currently is listed as “rescinded” on BOEM’s website. Only recently, on October 16, 2020, BOEM (together with the Bureau of Safety and Environmental Enforcement, “BSEE”) issued a jointly proposed rulemaking that, in part, is the culmination of BOEM’s efforts since mid-2017, which includes consideration of a lessee’s or ROW or RUE grant holder’s credit rating (in replacement of the historical financial strength metrics) for purposes of determining whether supplemental bonding is required of those parties, which proposed rulemaking we have recently reviewed.

  1. Why might President Biden want to revert back to NTL No. 2016-N01?

The 2016 NTL was issued under the Obama administration, when President Biden was vice president. The 2016 NTL replaced the 2008 NTL, which authorized the use of “waivers” from supplemental bonding if a record title owner or ROW grant holder was able to demonstrate that it had sufficient financial strength and reliability such that a supplemental bond was not needed. This waiver process was rejected by Obama’s BOEM, which had come to recognize that even large, well-capitalized energy companies could become bankrupt and unable to fulfill their lease obligations. Accordingly, the Obama administration issued the 2016 NTL (made effective in September 2016), which among other things, made lessees and grant holders responsible for 100% of decommissioning obligations through elimination of the waiver process, introduced a limited form of self-insurance, maintained the metrics used to assess a company’s financial ability but re-prioritized those metrics as well as the assessment process, and introduced the development and implementation of “Tailored Plans” to document that decommissioning obligations were being adequately covered through supplemental bonding.

BOEM under the Trump administration currently lists the 2016 NTL as rescinded on the agency’s website and only recently, in October 2020, published a proposed rulemaking revising its financial assurance regulations. However, the Biden administration might very well conclude that the October 2020 rulemaking reinstates the waiver process, as the 2020 proposed rule proposes to replace the historical metrics used for assessing an energy company’s financial strength with assessment of the company’s credit rating, coupled with consideration of the value of proved oil and gas reserves on the lease. Under the proposed process, in the event a lessee (or co-lessee or predecessor lessee) satisfies the applicable credit rating threshold necessary to avoid supplemental bonding, or in the event that review of the proved oil and gas reserves reveals that the net present value of those proved reserves is more than three times the cost of the decommissioning obligations on the subject lease, then supplemental bonding would not be required. Moreover, BOEM projects that adoption of the proposed rule could result in financial assurance amounts decreasing from $3.3 billion to $3.1 billion. It seems unlikely that Biden’s BOEM would adopt a program decreasing the current amount of financial assurance in place (as the fallback position for satisfying decommissioning obligations might be the U.S. taxpayer) and it is also unlikely that President Biden would accept the status quo. Re-issuance of the 2016 NTL would be likely even if such re-issuance only serves as a stop-gap measure to provide BOEM with time to develop and implement a more rigorous financial assurance program.

  1. How is financial strength determined for purposes of supplemental bonding under NTL No. 2016-N01?

BOEM’s evaluation of an energy company’s financial ability to carry out its lease, ROW or RUE obligations under the 2016 NTL (including decommissioning obligations) is based on consideration of the same set of metrics as historically considered: financial capacity, financial strength, stability, reliability, and record of compliance. However, BOEM intended to use the 2016 NTL to expand upon the methodology used in assessing these metrics.

Financial capacity. As before, an energy company’s ability to demonstrate financial capacity in excess of existing and anticipated end of lease obligations, is based on its most recent (not more than 12 months old) audited financial statements. BOEM’s focus, however, will now include consideration of specific financial criteria of the energy company for which the agency has established minimum thresholds:

  • Cash Flow from Operations/Total Debt
  • Return on Equity
  • Current Ratio (i.e., ability to pay short-term obligations with current assets)
  • Earnings before Interest and Taxes
  • Quick Ratio
  • Total Debt/Equity
  • Return on Assets
  • Total Debt/Earnings Before Interest, Taxes, Depreciation & Amortization
  • Total Debt/Capital

While the 2016 NTL was being implemented, BOEM had established minimum thresholds and criteria exceedances and posted this information on the agency’s website.

Projected financial strength. This measure is based on the energy company’s estimated value of its existing OCS lease production and proven reserves of future production.

Business stability. This factor requires at least five years’ continuous operation and production on the OCS or onshore.

Reliability. This metric is based on the energy company’s credit rating from Moody’s or Standard and Poor’s, or the energy company’s trade references (i.e., sources that supply past payment experience(s) between the energy company and its vendors) including names and addresses of other lessees, drilling contractors, and suppliers with whom the energy company has dealt.

Record of Compliance. BOEM set forth specific criteria in assessing this metric, including whether any of the energy company’s affiliates or subsidiaries have been: (i) assessed civil penalties by BOEM or BSEE; (ii) found by BOEM or BSEE to be non-compliant with any lease, plan or permit term or condition; (iii) cited by any other agency with jurisdiction on the OCS for non-compliance with any regulation; and (iv) cited for non-payment or under-payment of rentals, royalties, interest bills, civil penalties, or inspection fees and such non-payment or over-payment has been referred to the U.S. Treasury for collection within the past five years.

  1. How is liability for decommissioning obligations apportioned under NTL No. 2016-N01?

Prior to issuance of the 2016 NTL, for a particular lease, ROW or RUE, BOEM would assess all of the co-lessees to determine whether any one party had the financial ability to cover the decommissioning liability of that lease. Typically, such a party identified as having the necessary financial ability (“Big Energy Company”) and was large enough that BOEM would waive that party’s posting of some or all of the financial security required for the lease. And because Big Energy Company had sufficient financial ability to cover those decommissioning liabilities, BOEM would excuse the other co-lessees from posting any financial security for the decommissioning obligations. Consequently, scenarios would emerge where little or no financial security had been posted for a lease with multiple co-lessees, resulting in potential risk for satisfying decommissioning liabilities in the event that Big Energy Company was unable to fulfill the decommissioning obligation.

Under the 2016 NTL, when BOEM calculated the decommissioning liability for a particular lease, ROW or RUE, BOEM would determine the full amount (i.e., 100%) of the decommissioning (and other) liabilities for every co-lessee or co-owner that holds an ownership interest in that lease, ROW or RUE, or has provided a guarantee, even though Big Energy Company is also a co-lessee or co-owner. Because liability is joint and several, BOEM establishes a financial assurance level for each co-lessee or co-owner that is equal to 100% of the estimated cost to decommission the entirety of each lease, ROW and RUE in which covered parties hold an ownership interest or has provided a guarantee, not just such covered parties’ proportionate share. BOEM would also do the same with regard to Big Energy Company. While, at first glance, this appears to result in duplicative coverage, BOEM expected that Big Energy Company and the other co-lessees and co-owners would work cooperatively and agree to a collective, single allocation of the decommissioning liabilities they shared in common with respect to the lease, ROW or RUE, and would collectively present this sharing arrangement to the designated operator of the lessees when it was time for the operator to provide evidence of financial assurance to BOEM. The burden was on the co-lessees or co-owners of a particular lease, ROW or RUE to decide amongst themselves how the decommissioning liabilities would be apportioned; BOEM only cared that the decommissioning obligation was fulfilled.

  1. Does self-insurance have a role under NTL No. 2016-N01?

When BOEM issued the 2016 NTL, it planned to use the five factors described in Question 3, above, to assess whether the lessee or grant holder was eligible to self-insure some or all of any additional security obligations for a lease, ROW or RUE. However, the ability of a lessee or grant holder to be eligible for self-insurance, while helpful in defraying the amount of additional security required by BOEM for decommissioning obligations, is no cure-all. Unlike waivers, which allowed upwards of 50% of an eligible company’s net worth to be allocated to decommissioning obligations, under the 2016 NTL, companies may only self-insure up to 10% of their tangible net worth. This gap from 10% to 50% places an enormous burden particularly on small and medium-sized energy companies already strapped for cash due to the prolonged period of low prices for crude oil and natural gas.

With one caveat, assuming that a lessee or grant holder was eligible for a self-insured amount, then the lessee or grant holder would have to notify BOEM how it would apportion the self-insurance amount: spread over all its leases, all to one lease, or a mixture of specific leases, ROWs and RUEs. The caveat is that, depending on a lessee’s or grant holder’s credit rating (as determined when considering the “Reliability” metric), BOEM could prohibit the lessee or grant holder from using the self-insurance amount on properties where the lessee or grant holder was the only party that could be held liable for decommissioning cost (i.e., there are no co-lessees, co-owners, or assignors). These properties are referred to as “sole liability properties.” In support of the 2016 NTL, BOEM established a minimum credit rating threshold; under this NTL, lessees or grant holders are restricted from allocating any of its self-insurance amounts to sole liability properties. BOEM had posted minimum credit rating thresholds on its website but those thresholds were removed once the 2016 NTL was paused and subsequently withdrawn.

  1. What forms of security may be used by a regulated party to satisfy supplemental bonding under NTL No. 2016-N01?

Under the 2016 NTL, BOEM retained all the methods for satisfying financial assurance as were originally established under BOEM’s rules:

  • Surety bonds
  • U.S. Treasury securities
  • Abandonment accounts
  • Third-Party guarantees
  • Alternative forms of security approved by BOEM
  1. What are Tailored Plans and how are they used under NTL No. 2016-N01?

As required under the 2016 NTL, lessees or grant holders issued an order by BOEM to provide additional security are required to meet the following timelines in providing the directed additional security:

  • Additional security for sole liability properties: within 60 days of receipt of the order.
  • Additional security for leases, ROWs and RUEs other than sole liability properties: within 120 days of receipt of the order (unless other time was specified in order).
  • Notice of intent to submit a tailored plan: within 10 days of receipt of the order.
  • Submittal of a tailored plan: within the 120-day timeline for leases, ROWs and RUEs other than sole liability properties (unless other time was specified in the order).

Under the 2016 NTL, lessees or grant holders ordered to provide additional security obligations (other than for sole liability properties) have the opportunity to request the phase-in of additional security through the development and implementation of a tailored plan. The phased-in approach allows lessees or grant holders to comply with the additional security requirement in accord with the following schedule:

  • Within 120 calendar days from the date of BOEM approval, provide at least one-third of the remaining required additional security.
  • Within 240 calendar days from the date of BOEM approval, provide at least two-thirds of the remaining required additional security.
  • Within 360 calendar days from the date of BOEM approval, provide the full amount of the remaining required additional security.

Under the phased-in approach, if BOEM will not approve a tailored plan within 180 days of its submission, BOEM may require the lessee or grant holder to provide the full amount of the required additional security within 30 days of the date on which the 180-day period ended. Though implementation of the NTL was cut short, this power wielded by BOEM likely could have forced lessees and grant holders to make certain concessions to BOEM that they might not otherwise make, if only to avoid triggering submittal of the full amount of additional security 30 days after the 180-day period ended. Finally, after a tailored plan is approved, a lessee or grant holder has the right to request and, upon BOEM approval, make modifications to the plan, with the caveat that the lessee or grant holder is obligated to adhere to its approved plan and timetable for compliance until the modified plan is approved.

  1. How are predecessor lessees and grant holders treated under NTL No. 2016-N01?

A lessee’s obligation to decommission does not terminate upon assignment of its interests in the facilities to a successor. Under OCSLA, lessees are jointly and severally liable for lease obligations, including decommissioning liabilities that accrued during their period of ownership of the facilities. Issuance of the 2016 NTL did not change the law. Accordingly, BSEE may require those predecessors (indeed, historically, BSEE has typically ordered all predecessors, whether directly or indirectly assigning lease rights) to perform decommissioning obligations if a subsequent assignee fails to perform its decommissioning responsibilities. BSEE has not really cared which prior assignor or group of assignors conducted the decommissioning activities – that is for the ordered parties to decide. BSEE only cares that the decommissioning activities are performed and completed.

Regarding RUE grant holders who have failed to perform one or more conditions in their grants, BSEE has historically issued orders to applicable lessees or owners of operating rights that had accrued obligations during their respective periods of ownership of the RUE facilities to perform required decommissioning activities. Issuance of the 2016 NTL did not change this practice.

  1. How might one appeal a BOEM order for additional financial assurance issued pursuant to NTL No. 2016-N01?

Under the applicable regulations, a lessee or grant holder has up to 30 days from the date of receipt of BOEM’s notification proposing increased financial assurance requirements for specified leases, ROWs and RUEs to notify BOEM in writing, that it disputes some or all of the agency’s determination. In making such dispute notice, the lessee or grant holder may request a meeting with BOEM to further discuss the dispute. If no dispute notice is timely submitted to BOEM, then BOEM will presume that the proposed additional security is acceptable to the lessee or grant holder and issue an order to either provide a specified amount of additional security, or to present BOEM with a tailored plan that meets the additional security requirements (provided the property is not a sole liability property). As a practical matter, because a lessee or grant holder has only 30 days to challenge BOEM’s determination, it is imperative that lessees and grant holders maintain contact with designated operators and ROW and RUE holders-of-record to assure that the lessee or grant holder has ample time to review and assess BOEM’s initial notification. Currently, the regulations do not obligate one who appeals a decommissioning order to first post the full amount ordered by BOEM prior to having the appeal heard and resolved. The 2016 NTL does not change the appeal process. Interestingly, however, the October 2020 regulations proposed by Trump’s BOEM do require posting of the disputed amount in advance of a hearing on the matter.

  1. What measures could a lessee or grant holder take to mitigate adverse impacts arising from re-issuance of NTL No. 2016-N01?

With the possibility of BOEM potentially re-issuing the 2016 NTL, how can an OCS operator act now, to be in the best position for future negotiations with BOEM on the possible posting of supplemental bonds? There are several proactive measures that all energy companies may take that all focus on obtaining a current snapshot of an operator’s decommissioning obligations, based on its actual, real-time operations occurring on the OCS. While BOEM relies upon joint and several liability to impose these obligations on lessees of a lease, the trick is to accurately demonstrate to the satisfaction of the BOEM the relative obligations of each of the liable parties with respect to decommissioning activities.

As a practical matter, BOEM has neither the staff nor the resources to revisit or reconfirm what decommissioning obligations may be incurred by an OCS operator beyond what is initially assessed, absent a clear trail documenting changes in these liabilities. Consequently, the operator might consider what its actual decommissioning obligations are (or should be) and take the necessary steps now to rectify any inaccuracies. Many of these tasks may seem relatively straightforward but are often taken for granted or overlooked. While potentially burdensome, there is real and immediate value to performing these tasks in light of possible changes to the BOEM’s supplemental bonding requirements.

Step One. As an initial step, a lessee should consider confirming that the list of offshore facilities for which it is responsible (as well as any co-lessees or holders of operating rights) are properly reflected in BOEM’s records. Important issues to verify may include whether: (i) all lease interests are properly reflected in BOEM’s records; (ii) all assignments of leases by the lessee to third parties have been correctly addressed in BOEM’s records; and (iii) the relative co-leased or operating rights interests of those leases (including both operated and non-operated by the company) are properly reflected in BOEM’s records. These tasks are critical to ensure that both the lessee and BOEM are evaluating the same set of offshore facilities and related interests associated with those OCS properties.

Step Two. A lessee should also consider confirming the scope and extent of supplemental bonds held by it (as well as by any co-lessees or holders of operating rights) and whether those bonds are properly reflected in BOEM’s records. The lessee could review internal and BOEM records to determine whether there are any gaps in bonding coverage or any “double-bonding” of properties. For leases where there are co-lessees or holders of operating rights, consideration should be given to confirming what financial assurances are in place for which of these parties in order to address the decommissioning obligations of those leases. Such consideration could include identifying which of those financial assurances have resulted in the posting of bonds with BOEM, as opposed to the posting of letters of credit or other financial assurances with third parties to which BOEM has no access. At the end of this task, the lessee would hopefully have a clear understanding of which of its leases are covered by financial assurance and whether that financial assurance is accessible by BOEM or only a third party. It is critical that the lessee consider reviewing BOEM’s records to confirm that BOEM concurs on the existence and availability of bonds.

Any financial assurance posted with third parties but inaccessible to BOEM presents a potential roadblock to operators in the implementation of NTL No. 2016-N01. BOEM will want access to those bonds and, while it is willing to consider “dual obligee” language in such third-party agreements that would allow BOEM (in addition to the third party) to have access to those bonds, there may be little incentive for the third party to agree to the insertion of dual obligee language with respect to financial assurances already obtained from the assignee-operator, and therein lies the impasse. If a third party that received financial assurances from a lessee in return for assigned lease interests balks at providing access to those assurances to BOEM, and BOEM refuses to consider that the third party has the financial strength and reliability to decommission the specified facilities, then the lessee could be faced with the prospect of having to “double bond” for those facilities. The lessee will have to convince the third party that it is also in the best interests of the third party to allow inclusion of the dual obligee language, or else risk being ordered in the future to conduct decommissioning as a predecessor, should the lessee be unable to provide the requisite amount of financial assurance and otherwise is unable to perform decommissioning activities.

Step Three. Another step that the lessee should consider pursuing proactively is to confirm that errors, discrepancies or other disputed items identified by the lessee are resolved with the BOEM. Any identified errors, discrepancies or other disputed items should be promptly brought to the attention of BOEM and corrected or resolved. For example, a lessee may have assigned certain leases to a third party and, while the assignment was approved by BOEM, the bonds may not have been released by BOEM. Under those circumstances, the lessee might consider initiating changes to have the third party obtain proper bonding for the assigned facilities and having BOEM revise its records to reflect the changes in bonding. Otherwise, decommissioning obligations based on incorrect or incomplete records could result.

Step Four. The lessee might consider evaluating the methodology used by BSEE in establishing the cost of decommissioning obligations and consider whether an independent evaluation of those liabilities is necessary. BSEE, not BOEM, is charged with estimating the cost of decommissioning obligations for facilities associated with a lessee’s leases and other interests on the OCS. However, a lessee may have concerns as to how BSEE prepared the initial estimated amount or whether those cost estimates should be decreased based on new information that is beneficial to the company (e.g., cheaper labor or supplies, newer technologies or methods for decommissioning, etc.). BSEE largely relies on a database of information relating to past decommissioning projects and associated costs in establishing cost estimates for future projects. However, technologies and methodologies improve over time, and there may be a more efficient, less costly manner in which to perform those projects. The lessee should consider whether there are possible costs savings in engaging an offshore consultant experienced in decommissioning activities to assess proposed project tasks and determine an updated cost for decommissioning facilities. To the extent that a lessee knows of other practices used to decommission offshore facilities in a less costly manner that have not been reported to BSEE, the lessee could attempt to have such information submitted to the agency. Updated determinations could be shared with BSEE in an attempt to reduce the cost of decommissioning. One caveat is that BSEE is disinclined to accept untried or “theoretical” decommissioning methods; BSEE will want to see actual project data where the proposed decommissioning methods have been successfully used. In the event BSEE concurs with a lessee’s updated determination, the lessee should seek to confirm that BOEM will also update its records for that company’s decommissioning obligations.

Step Five. An additional step that a lessee should consider goes well beyond review of internal or BOEM or BSEE informational sources. A lessee might consider reviewing its assignment history and undertake an assessment of the assignment and bonding status of assigned interests based on publicly available sources of information. In addition to providing BOEM with any corrections it identifies with respect to those assigned interests, a lessee may gain insights into assigned properties where a current assignee-operator may be at risk of not satisfying applicable bonding or decommissioning obligations. Knowledge of instances where such assignee-operators are at risk may provide lessees with an opportunity to anticipate BOEM enforcement directives and prepare accordingly.

Step Six. Don’t forget about sureties and considering whether to review the need to provide additional collateral. Compounding the problems described above are demands made by surety companies for the provision of additional collateral to bolster the bonds issued by those or other surety companies on behalf of OCS lessees. Lessees that already supply supplemental bonding for decommissioning obligations on the OCS typically do so through the use of surety companies and associated surety agreements. Lessees typically will engage surety companies to post the bonds on their behalf. Generally, the terms of the contractual agreement between a lessee and a surety company require the company to post collateral at the outset of the agreement or subsequently on demand. Oftentimes, these agreements allow the surety company to increase the amount of the collateral required at the surety company’s discretion. Given the relatively low prices of oil that have been experienced over the past several years, together with the on-going COVID-19 pandemic as well as the recent election of President Biden, who has expressed an intention to restrict new oil and gas leasing on federal waters and land, it is not unreasonable to suggest that, at some point in the future, surety companies posting bonds on behalf of OCS lessees might demand increased collateral to cover the posting of such bonds. The ability of a lessee to post additional collateral under circumstances where its assets are already mortgaged may present a significant issue, and may force the company to seek relief from its credit facilities. This would likely reduce the amount of borrowings available under such credit facilities to use in exploration and production activities. The alternative is uninviting, as any failure to post necessary added collateral may result in default under the surety agreements, which in turn could result in loss of the associated bond coverage provided to BOEM.

1 NOTE: The information contained in this 10 Questions alert reflects Vinson & Elkins LLP’s assessment of the issues covered at the time of publishing. There may be post-publication developments in the law that render that assessment no longer current. These materials should not be relied on as legal advice and are not guaranteed to be correct, complete, or up-to-date. Legal advice must be tailored to the specific circumstances of each particular matter, and nothing provided herein constitutes legal advice or should be used as a substitute for the advice of counsel.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.