Written by John McFarland of the Oil and Gas Lawyer Blog.
The draft Sunset Commission report on the Texas Railroad Commission makes recommendations for legislative changes to the bonding requirements for oil and gas wells. Landowners should be familiar with how the RRC’s bonding system works, and how it could affect operations on their property.
Operators of oil and gas wells in Texas must have a permit to operate. In order to obtain that permit, the operator must provide financial security in the form of cash, a bond, or a letter of credit to provide financial assurance that it will plug any wells it operates. The amount of financial security required is set by statute and was last revised in 1991. Most operators comply with the bonding requirement by furnishing “blanket” bonds. The amount of the bond depends on the number of wells operated by the operator:
- Operators with 1-10 wells must have a $25,000 blanket bond.
- Operators with 11-99 wells must have a $50,000 blanket bond.
- Operators with 100 or more wells must have a $250,000 blanket bond.
The theory is that, if an operator becomes insolvent and is unable to plug its wells, the RRC can call on the bonding company to provide the money to plug the wells. But in reality, bonds provide only about 16% of the cost of plugging abandoned wells. In FY 2015, the RRC collected $4.288 million on bonds from 94 operators who abandoned 1,584 wells – an average of only $2,707 per well. In the same year, the RRC spent $11.722 million plugging 692 wells – an average of $17,012 per well.
The RRC is charged with the responsibility of plugging wells that are “orphaned” — wells abandoned by insolvent operators. In addition to the bonds provided by operators, the RRC uses funds collected from various fees charged to operators and dedicated to the “Oil and Gas Regulation and Cleanup Fund” established by the Legislature. And the RRC also budgets some of the funds appropriated by the Legislature to fund well plugging and oil field cleanup activities.
As of August 2015, the RRC was tracking 433,146 wells in the state. 115,365 of those wells were shut in. 12,155 of those inactive wells were in violation of the RRC’s plugging rules. 9,715 of those wells were “orphan” wells – wells whose operators had lost their license to operate.
The number of orphan wells declined significantly from 2002 to 2010, from 18,000 to 7,000; but the number of such wells has increased since then to 9,715 as of August 2015. The number of orphaned wells plugged by the RRC each year has declined from 1,824 wells in FY 2006 to 692 wells in FY 2015.
At the beginning of FY 2015, the Cleanup Fund had $23.8 million; at the end of the fiscal year, it had only $12.9 million. Even though fewer wells had been plugged, the revenues from fees declined significantly and the cost of plugging rose.
The Sunset report concludes that the tiered structure for the amount of blanket bonds required by operators does not account for the risk of well abandonment. Operators with fewer wells were more likely to fail and leave orphaned wells than larger operators with more wells, but that rate of failure is not reflected in the bond structure. The report’s recommended revised bond rates:
- 10 or fewer wells, $22,500 blanket bond
- 11 to 20 wells, $40,500 blanket bond
- 21 to 35 wells, $74,000 blanket bond
- 36-60 wells, $128,000 blanket bond
- 51-99 wells, $213,000 blanket bond
- 100 or more wells, $250,000 blanket bond
The report estimates that this revised structure would increase revenue brought in from blanket bond collections by 35%, so that bonds would cover 21.5% of costs, up from the current 15.9%.
- First, why shouldn’t operators have to provide sufficient financial assurance to plug all of their wells if the operator is financially unable to do so? Why should the burden of plugging those orphaned wells fall on other operators who, through fees collected from their operations, contribute to the Cleanup Fund?
- Second, the regulatory scheme, as currently designed, encourages operators to relieve themselves of plugging liability by assigning marginal wells to marginal operators. Under current state law, only the last approved designated operator of a well is legally responsible for plugging the well. If that operator is unable to fulfill its obligations, prior operators of the well have no legal responsibility to plug the well. The result is that some operators sell leases that are in their last stages of depletion to smaller, marginal operators who assume the plugging liability for the wells on those leases, but who do not have the financial worth to plug the wells. After the wells are operated as stripper wells for some period of time, the last operator folds up, declares bankruptcy, and walks away from the leases, which are then just a liability. The RRC is left to collect what it can from the last operator’s blanket bond and then put the wells in line for plugging with funds from the Cleanup Fund.
In negotiating oil and gas leases with clients who own both surface and minerals, I explain to my clients that they cannot rely on existing laws and regulations to assure that wells drilled by their lessee will ultimately be plugged. Orphaned wells will eventually be plugged by the RRC, but those wells often remain unplugged for years. Some landowners insist on additional financial assurance from operators that wells will be properly plugged and abandoned, in the form of bonds or letters of credit or sinking funds. Also, landowners sometimes insist on the right to approve any assignment of the lease, and provide that their original lessee remains liable for plugging of wells notwithstanding any assignment of the lease to another operator. None of these solutions is perfect, but landowners need to consider how their lease agreement will deal with end-of-life lease issues. Current RRC rules do not, in my opinion, adequately address those issues.