A sudden regulatory shift threatens to curb Canadian energy asset deals, just as producers and creditors look to unload properties two years into a crude market downturn.
The Alberta Energy Regulator made a surprise rule change Monday evening, requiring a more stringent solvency test for buyers of oil and natural gas assets. While the move is meant to ensure purchasers can cover well cleanup costs, some dealmakers say it will also hinder transactions.
“It’s going to create dampened activity on asset dispositions,” said Sonny Mottahed, managing partner and chief executive officer of Calgary-based Black Spruce Merchant Capital Corp. “People are caught off guard and they’re very surprised.”
The rule change — meant to be an interim measure — is in response to an Alberta court decision last month. That ruling, which the regulator is appealing, let the receiver of bankrupt oil company Redwater Energy Corp. walk away from some assets it deemed unprofitable, plus the related clean-up responsibilities. The case triggered a broader discussion over how environmental liabilities should rank among debts of an insolvent producer, as more default on their loans with U.S. crude still about 50 percent below its mid-2014 peak.
“We recognize that it’s going to inconvenience some stakeholders but they’re interim measures and we want to ensure the continued protection of Albertans and also confidence in the regulatory system,” Ryan Bartlett, a spokesman for the Alberta Energy Regulator, said in a phone interview. “We are working with the government of Alberta on a way to come up with a long-term regulatory solution to these issues.”
The main change from the regulator is the doubling of the liability management ratio for asset buyers. The rating is a reflection of the extent to which a company’s assets cover its liabilities related to well cleanup. Purchasers are now required to have ratings of 2.0 or higher, up from a minimum of 1.0 previously. About 72 percent of 788 licensees evaluated have ratios below the 2.0 threshold, according to the regulator’s online list.
Among those with ratios below 2.0 and with a mandate to buy assets are Pine Cliff Energy Ltd., Northern Blizzard Resources Inc. and Spartan Energy Corp., Ryan Mooney, a director and energy specialist on Dundee Capital Markets’ sales team in Calgary, wrote Tuesday in a note.
Phil Hodge, chief executive officer of Calgary-based Pine Cliff, agreed in a phone interview that the company, which has been acquiring assets for more than four years, may be impeded under the new rule. More concerning though is the potential broader impact on the industry, Hodge said. With low oil prices, the company is more focused on improving its balance sheet than making purchases, he said.
Chief executive officers of Spartan and Northern Blizzard didn’t immediately return messages seeking comment.
Buyers can improve their rating by taking a number of steps, including posting a security, addressing existing abandonment obligations or selling assets, according to the regulator’s bulletin.
The move was a “chilling announcement on the first day of summer,” Carolyn Wright, a partner at law firm Burnet, Duckworth & Palmer LLP in Calgary, wrote in a note on Tuesday, calling the development sudden and dramatic. “It is expected to have a chilling effect on the rise in transaction activity in a province struggling to get back on its feet following a two-year long rut in commodity prices.
The Alberta regulator’s change, which doesn’t affect corporate takeovers, is meant to prevent asset deals in which the buyer risks adding to the so called orphan-well backlog. When bankrupt producers are unable to cover the costs of repairing lands where they pumped oil and gas, the Orphan Well Association, an industry group, becomes responsible for dealing with them at the expense of other companies.
But the regulatory shift may actually push more of the responsibility onto the Orphan Well Association, if struggling producers can’t find buyers for their assets and end up insolvent, said Pine Cliff’s Hodge.
Black Spruce’s Mottahed said he doesn’t expect the rule change will kill transactions altogether, but it could lead to more corporate takeovers or different kinds of financing arrangements, he said.
“People are left scratching their heads as to what’s going to be the outcome of this,” he said. “It’s certainly on the surface going to create less liquidity on the asset basis.”