Bankruptcy is the endpoint of an oil and gas business strategy

Alberta Premier Jason Kenney has asked the Canadian government for financial assistance to clean-up abandoned oil and gas wells in the province. It has been estimated that cleaning up these wells could cost as much as $70 billion.

The existence of 77,000 abandoned wells across Alberta is the result of a financial strategy by the oil and gas business. Billions of dollars in profits and salaries reaped by oil executives are being subsidized by the public that is being asked to foot the bill.

Recently, the confusingly named Houston Oil & Gas declared bankruptcy. The company is abandoning over 1,000 oil wells.

This was not just the unfortunate outcome of a risky business operation. This type of company, and its eventual bankruptcy, is part of the financial ecosystem of the oil and gas business.

Returning Wells to Profitability

Houston’s stated purpose was to “rejuvenate legacy assets into profitable and beneficial operations.”

Over time, the amount of oil coming out of a well decreases. Eventually, the revenue earned from a well falls below the well’s operating costs. Companies like Houston can only return a well to profitability by cutting costs. If the company cannot get costs across its wells below the revenue the wells generate, then they will go bankrupt.

The Supreme Court ruled that bankruptcy does not absolve a company of its responsibility for the clean-up of unproductive wells. That means the assets of a bankrupt company can be seized by the Alberta Energy Regulator (AER) to contribute to well clean-up costs. However, often the sale of assets will not generate enough to cover all the costs. This is why companies like Houston are so useful to the broader oil and gas business.

Passing the Clean-up Liability

Imagine a big, established oil extraction company—we can call it Old MacDonald’s Oil & Gas Co.—has a bunch of wells approaching the limits of profitability; operating costs are close to revenues. They face a large future cost: cleaning up the well. Old MacDonald’s cannot just abandon the unprofitable wells. The AER can come after them. The company has lots of profitable wells and is generating returns for its investors and paying handsome salaries to its executives. It does not want to go bankrupt and disrupt this positive financial flow. But it also does not want to incur the costs associated with well clean-up. That’s where the sale to a company like Houston is useful.

If Old MacDonald’s sells the wells with waning profits to a company like Houston, then it eliminates the liability of future clean-up costs. Those liabilities shift to the buyer, which can try to cut the costs of operating the wells to squeeze more profits from them. If the buyer fails to return enough wells to profitability and goes bankrupt, then the limit of the AER cost-coverage is the assets of the bankrupt company. Neither the owners nor the executives, which may have enjoyed years of dividends and bonuses, will bear any of the liability. Old MacDonald’s will also bear no liability for the wells, since it sold them.

As the price of oil drops, well revenues will drop, meaning many more wells will cease to be profitable. This means many more wells are likely to shift to cost-cutters like Houston. Many of those are likely to be abandoned, with the costs ultimately borne by the public.