BOEM Releases Tougher Financial Assurance Requirements for Offshore Oil and Gas Operations

New and additional bonding requirements for certain companies operating on the Outer Continental Shelf (“OCS”) will take effect in June as a result of a recent rulemaking. These new requirements will be phased in over a three-year period for subject companies. For companies subject to this requirement and that must provide the additional financial assurance, the total amounts that are required to be posted could increase by as much as $6.9 billion.

Rulemaking Background

On April 24, 2024, the Bureau of Ocean Energy Management (“BOEM”) finalized its “Risk Management and Financial Assurance for OCS Lease and Grant Obligations” rule (the “Risk Rule”), increasing supplemental financial assurance (“SFAS”) requirements for offshore operators in the United States OCS. Our analysis of the proposed rule can be found here. The stated purpose of the rule is to ensure that taxpayers are not the ones left to cover the costs of decommissioning wells and offshore infrastructure if the current operator is unable to fulfill such obligations. BOEM references the more than 30 corporate bankruptcies in the oil and gas sector that have occurred since 2009 to justify this additional financial obligation but simultaneously acknowledges that “most OCS leases affected by the bankruptcies were ultimately sold or retained by the companies reorganized under chapter 11.” Interestingly, even though offshore wind power development projects have recently encountered a significant number of financial setbacks, BOEM limited the scope of this rule to just the offshore oil and gas industry.

All companies operating on the OCS are subject to general financial assurance requirements to address decommissioning liabilities. These bonds range from $50,000 for a lease-specific bond with no approved operational activity to $3 million for an area-wide bond that includes a Development and Production Plan. However, in some circumstances BOEM has required posting SFAS. The Risk Rule seeks to ensure adequate funds are in place to hedge against the risk of a future bankruptcy or restructuring so that taxpayers are not required to pay decommissioning liabilities.

Overview of the New Requirements

SFAS Triggers

The Risk Rule eliminates the five factor approach (operator’s financial capacity, projected financial strength, business stability, record of compliance with existing rules and regulations, and reliability) formerly applied by BOEM to determine whether SFAS was required and narrows the test to the two following conditions:

(1) whether the current lessee or a current co-lessee meets an investment grade credit rating threshold, or

(2) whether the proved reserves of the relevant lease exceed the estimated decommissioning costs by a 3-to-1 minimum ratio.

Credit Rating Threshold

The Risk Rule requires companies to have a credit rating of at least BBB- (S&P Global Ratings and Fitch Ratings, Inc.) or Baa3 (Moody’s Investors Service, Inc.). Companies lacking an issuer credit rating will be able to petition BOEM’s regional director for a proxy rating, which will be calculated using S&P Global’s Credit Analytics credit model. To receive a proxy rating, requesting companies will be required to provide BOEM with audited financial information for the most recent fiscal year, including an income statement, a balance sheet, a statement of cash flows, and the auditor’s certificate.

For leases where at least one co-lessee meets the credit rating threshold, all other co-lessees will be covered by the SFAS exemption for that lease. However, any exemption based on the credit rating of a co-lessee will only be effective to the extent that the accrued liabilities are shared among the other co-lessees; otherwise BOEM will require SFAS.

Minimum Reserves Ratio

This second condition exempts companies from SFAS for offshore interests where the discounted proved oil and gas reserves on the lease exceeds three times the undiscounted estimated cost of decommissioning associated with the production of those reserves. The Risk Rule allows proved oil and gas reserves to be determined on a unit or field basis. Operators must demonstrate proved reserves by submitting a reserve report (prepared consistent with the U.S. Securities and Exchange Commission’s requirements for such reports).

Determining the Amount of SFAS

The Risk Rule also changes how BOEM calculates the required SFAS. Currently, BOEM uses a single algorithm-based deterministic estimate to determine the amount of SFAS required. However, in 2016, the Bureau of Safety and Environmental Enforcement (BSEE) clarified reporting requirements for operator decommissioning costs and began collecting and analyzing decommissioning cost data in greater depth. In 2020, using the data collected over the prior years, BSEE updated its Technical Information Management System with the latest industry-reported decommissioning costs. BOEM will now use this information in conjunction with a probabilistic factor to determine the new amount of SFAS required for a given lease. The Risk Rule specifies a P70 probabilistic scenario, meaning that the required financial assurance is expected to have a 70% likelihood of satisfying the full cost of decommissioning a facility.

Companies looking to challenge the amount of SFAS determined to be necessary must post an appeal bond in the amount of the mandated SFAS. As a result, companies that cannot afford to post the SFAS amount deemed necessary will likely not be able to bring a challenge to that assessment. In the initial phase-in periods, there may be some capability to do this, as the total amount of the SFAS is applied in three equal tranches so that posting an appeal bond in year 1 may be possible even if the operator cannot post the bond for the entire amount.

Phase-In Period

The Risk Rule’s requirements phase in over a period of three years for existing lessees. Under this approach, one third of any new SFAS requirement due on the deadline set forth in a BOEM demand letter to a lessee (otherwise within 60 days of the letter), the second third will be due within 24 months of the receipt of the demand letter, and the final third will be due within 36 months of the receipt of the demand letter. If a company fails to comply with the deadlines, it may be disqualified from the phase-in program and be required to post in full any remaining SFAS that is required.

Additional Flexibility For Third Party Guarantees

BOEM provided industry with some flexibility on using third-party guarantees for SFAS for a right of use easement, a right of way and a lease. First, the third party is no longer obligated to assume the risks of all obligations of the guarantee and can now limit its responsibility to one or more specific obligations or a precise dollar amount. While the guarantor must meet the same credit rating test, this approach will facilitate obtaining such guarantees. Since the obligated party must still provide financial assurance for any remaining liabilities not covered by the guarantee, this approach does not sacrifice any protections for taxpayers from any additional risks.

Key Takeaways

The costs of operating on the OCS will increase for all companies that are subject to this requirement. BOEM estimates that the cost of procuring surety bonds could increase by $258 per $1,000 of bond coverage for certain smaller entities (assuming the surety bond market can bear the increased demands that may result from implementation of the Risk Rule). Additionally, BOEM’s estimates that small entities are responsible for $11.6 billion of the current $14.6 billion liability of non-investment grade offshore interest holders. Smaller oil, gas and sulfur producing entities that do not have the credit rating needed to avoid a SFAS requirement and are producing at smaller properties are most likely to feel negative impacts from this proposal.

Bigger is better under this new rule when it comes to the obligations to post SFAS. Co-lessees or co-owners that meet the credit rating test in order to avoid the SFAS requirement may be able to command better terms for their investment in a project. Likewise, properties where investment grade lessees share an existing interest may also command higher premiums as smaller companies navigate a market with new barriers. Likewise, operators can focus on only pursuing larger properties that offer the potential for a valuation of the assets that is large enough to avoid the requirement. Leaner operators will have a bigger hurdle to cross when pursuing marginally economic wells than from other operators on the OCS. Inevitably, requirements like this will almost certainly suppress competition in favor of the entities that are exempt from the new requirements, while overall adding significant costs to the production of oil, gas or sulfur from offshore leases.

One of the most significant take-aways from this rule is that BOEM has imposed $6.9 billion in additional SFAS principally on the smaller oil and gas entities operating in the OCS because of a conceptual risk that taxpayers might be forced to bear decommissioning costs. BOEM failed to identify a single instance where taxpayers have been forced to pay for such costs due to a bankruptcy and candidly justified this burden because “challenges in bankruptcy proceedings . . . can result in unplugged wells and orphaned infrastructure.” BOEM’s willingness to impose such costs on the oil and gas sector because of a prospective concern that could arise in the future bears noting because BOEM also hinted in this rulemaking that the general bonding requirements are due for revision and suggested that increases in the general bonding requirements should be expected in a future rulemaking. If there is a second Biden administration, then additional rulemaking on offshore financial assurance requirements will surely be forthcoming.

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.