Cleanup liabilities in Alberta’s oil patch: Risks vs. costs
Last week, a news story broke with an eye-grabbing headline: Cleaning up Alberta’s oil patch could cost $260 billion. This figure massively exceeded the provincial regulator’s official estimate of $58 billion. Reading a little further down revealed some key details. First, the $260 billion was — according to the Alberta Energy Regulator — a worst-case scenario. Second, it would only come about if every oil and gas operator went bankrupt overnight. But some of these nuances about probability have gotten lost in the discussion that followed. $260 billion isn’t an estimate of the cost that Alberta will definitely pay; it’s what it could pay. When we consider risk, we must weigh possible costs by the likelihood that they come to pass. Still, that doesn’t mean we should ignore the risk—in fact, quite the opposite.
What’s this number about?
The $260 billion figure in last week’s news story was referring to the possible costs of cleaning up the environmental legacy of Alberta’s pipelines, oil and gas wells, and oil sands mines. It was an unofficial estimate done internally by the Alberta Energy Regulator (AER) that appeared in a presentation to an industry audience in February. And yes, it massively exceeded the official estimate of $58 billion.
The AER has since apologized for confusing the public with this figure. But while it has been careful to not endorse the number, it hasn’t disavowed it either. It has only said the number is based on a hypothetical worst-case scenario and that it has not been validated by the AER (this contradicts the presentation, which stated it was probably an underestimate).
Who’s on the hook here?
Just to be clear, regardless of whether the number is $58 billion, $260 billion, or something else entirely, it’s industry that is liable for it. Oil and gas companies in Alberta are responsible for cleaning up their sites at the end of their useful life. If the costs are more than they might have anticipated, too bad for them.
At the same time, that legal liability is not a guarantee that they’ll be the ones to ultimately pay the costs. As we show in our report Responsible Risk, society can sometimes get stuck with the costs of privately-caused environmental damage due to “liability gaps.”
The key liability gap for Alberta in this case is bankruptcy. Even where laws hold firms fully liable for the damage they cause, they may be able to avoid paying for them by declaring bankruptcy. This liability gap is driving Alberta’s growing orphaned and abandoned oil and gas wells problem.
Of course, it’s not a given that Alberta companies will go bankrupt and pass their costs on to the public in this way. Rather, it’s a risk. More on that in a minute.
Naturally, the AER is well aware of the bankruptcy liability gap. It’s why the Mine Financial Security Program (MFSP) and the Orphan Well Association (OWA) exist. Both require oil and gas companies to provide “financial assurance.”
Financial assurance requires companies to commit funds against their environmental liabilities. It plugs liability gaps by helping ensure that funds are available to pay for clean-up — whether a company goes bankrupt or not.
The challenge (as we’re seeing with Alberta’s orphaned and abandoned oil and gas wells) is that Alberta’s financial assurance systems don’t fully cover the potential costs. For example, the AER-administered MFSP holds only $900 million in security against an (officially) estimated $27 billion cleanup liability in the oilsands. It does this because it’s trying to do several things at once.
You can’t have it all
In setting financial assurance requirements, policy-makers face a difficult balancing act across three competing goals:
- Compensation: if things go wrong, they want to make sure society doesn’t get stuck with the bill.
- Deterrence: they want to make sure that companies have a strong incentive to limit and reduce environmental damage.
- Economic activity: they want to facilitate production and investment, in order to benefit from the employment and income it generates.
The AER has struck its own balance across these goals. Broadly speaking, it has opted to keep financial assurance requirements light in projects’ early, capital-constrained phases and scale them up later on. This approach has helped facilitate economic activity—witness the growth in the oil sands over the past decades. But it also carries risks. If an oil sands company goes bankrupt early in the operating life of a project (or even in the middle), cleanup costs could fall on Albertans.
However, the bigger concern is not one company going bankrupt, but several. Many oil sands projects won’t have to provide significant financial assurance for decades, or even until next century. A sustained downturn in oil prices (due to, for example, global action on climate change starting to bite) could leave the sector unable to muster the required financial assurance. In other words, the risks of environmental liabilities from individual companies aren’t independent of each other. This could leave Albertans with a hefty cleanup bill.
Weight for it
There are a number of ways the AER could change its financial assurance system to reduce Alberta taxpayers’ potential exposure to cleanup costs. Immediately, one stands out: risk-weighting.
“Risk-weighting” financial assurance requirements means adjusting them to reflect the fact that cleanup costs might exceed what companies lay out in their remediation plans. It does not mean setting requirements in line with a worst-case scenario. Rather, it means that requirements reflect the distribution of possible cost outcomes that exist.
Risk-weighting requires a comprehensive estimation of risk. In some cases, historical experience with cleanup and remediation plans will serve as a guide. In areas where remediation is still in its infancy (such as the oil sands), it might require using more qualitative criteria, or simply applying a premium to account for high uncertainty (for example, the Canadian Nuclear Safety Commission (CNSC) applies contingencies of 10 to 30% when estimating facility decommissioning costs). These methods are inevitably imprecise. But so long as they are done carefully, imprecise adjustments for the risk of higher costs will be better than none at all.
Financial assurance and responsible risk
Albertans can—and should—debate whether their financial assurance system is striking the right balance across deterrence, compensation and economic activity. Revisiting the slow phase-in of financial assurance requirements would be a good place to start (our report suggests several others). The province should also consider risk-weighting.
More importantly, in the short term, there is a need for greater transparency. Last week’s news raised a lot of still-unanswered questions about how high the costs of cleaning up the oil and gas sector’s environmental legacy might prove to be. Albertans need to better understand the nature of these risks to make an informed decision.
Regardless of whether the $260 billion was a good estimate of the worst-case scenario, the AER clearly believes there is a risk of costs exceeding its official estimates. Albertans deserve to know more.Read Responsible Risk