Transcript Slide 1

A Trending Risk and Liability on the OCS:
What Happens When a Party Can No Longer
Pay to Play?
Presented by Dana E. Dupre and
Rick M. Shelby
April 24 Houston Seminar
TOPIC: Trending Risk on the Outer Continental Shelf (OCS)
• Business of Managing Risks – understanding offshore oil and gas activity and lessons
learned
• Overview of Risks
o Operational issues – cost of doing business (P&A – expensed to co-owners)
o Sunset Properties/Idle Iron – P&A cost outweighs value of
reserves/environmental hazards
o Regulatory Compliance – BOEM (financial obligations) and BSEE (‘fit for
purpose’ requirements)
o Offshore decommissioning liabilities are expensive – in the range of $10-100
million per lease
o Contractual disputes regarding decommissioning liabilities
o Bankruptcy – culmination of all risks
• ATP Oil & Gas Corporation – case study of E&P company failure and sophisticated
approach to shedding residual liabilities
A Trending Risk and Liability on the OCS
OUTLINE
1. Decommissioning Liabilities
2. Decommissioning liabilities in bankruptcy
3. To be or not to be an overriding royalty interest – Comments on ATP case
4. OCSLA choice of law issues
Regulatory decommissioning
liabilities
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§ 250.1701 Who must meet the decommissioning obligations in this subpart?
(a) Lessees and owners of operating rights are jointly and severally responsible for meeting
decommissioning obligations for facilities on leases, including the obligations related to leaseterm pipelines, as the obligations accrue and until each obligation is met.
(b) All holders of a right-of-way are jointly and severally liable for meeting decommissioning
obligations for facilities on their right-of-way, including right-of-way pipelines, as the obligations
accrue and until each obligation is met.
(c) In this subpart, the terms “you” or “I” refer to lessees and owners of operating rights, as to
facilities installed under the authority of a lease, and to right-of-way holders as to facilities installed
under the authority of a right-of-way.
§ 250.1702 When do I accrue decommissioning obligations?
You accrue decommissioning obligations when you do any of the following:
(a) Drill a well;
(b) Install a platform, pipeline, or other facility;
(c) Create an obstruction to other users of the OCS;
(d) Are or become a lessee or the owner of operating rights of a lease on which there is a well
that has not been permanently plugged according to this subpart, a platform, a lease term
pipeline, or other facility, or an obstruction;
(e) Are or become the holder of a pipeline right-of-way on which there is a pipeline, platform, or
other facility, or an obstruction; or
(f) Re-enter a well that was previously plugged according to this subpart.
Residual liability post-transfer
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The BOEM must approve all assignments of record title (lessee’s interest) or
operating rights (working interest) in an OCS lease
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§ 556.62 (d) You, as assignor, are liable for all obligations that accrue under your
lease before the date that the Regional Director approves your request for
assignment of the record title in the lease. The Regional Director's approval of the
assignment does not relieve you of accrued lease obligations that your assignee, or
a subsequent assignee, fails to perform.
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(e) Your assignee and each subsequent assignee are liable for all obligations that
accrue under the lease after the date that the Regional Director approves the
governing assignment. They must:
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(2) Remedy all existing environmental problems on the tract, properly abandon all wells, and reclaim
the lease site in accordance with 30 CFR part 250, subpart Q [decommissioning regs].
(f) If your assignee, or a subsequent assignee, fails to perform any obligation under
the lease or the regulations in this chapter, the Regional Director may require you
to bring the lease into compliance to the extent that the obligation accrued before
the Regional Director approved the assignment of your interest in the lease.
Residual liability continued § 556.64:
• You do not gain a release from any accrued obligation under your lease or
the regulations by assigning your record title interest or transferring your
operating rights in the lease.
• You are jointly and severally liable for the performance of each
nonmonetary obligation under the lease and under the with each prior
lessee and with each operating rights owner holding an interest at the
time the obligation accrued, unless this chapter provides otherwise.
• Sublessees and operating rights owners are jointly and severally liable for
the performance of each nonmonetary obligation under the lease and
under the regulations in this chapter to the extent that:
– The obligation relates to the area embraced by the sublease; and
– Those owners held their respective interest at the time the obligation
accrued
Recent Decisions Re: Decommissioning
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Noble Energy, Inc. v. Salazar, 671 F.3d 1241 (D.C. 2012) – decommissioning
obligation discharged by DOI breach of lease?
Cutting Underwater Technologies USA, Inc. v. ENI US Operating Co., 671 F.3d 512
(5th Cir. 2012) – defining decommissioning for OCS properties.
Nippon Oil Exploration U.S.A. Limited v. Murphy Exploration & Prod. Co. – USA,
2011 WL 1193005 (E.D. La. 3/25/2011); 2011 WL 2456358 (E.D. La. 6/15/2011) –
predecessor responsible for decommissioning costs accruing before effective date
of assignment.
Mariner Energy, Inc. v. Devon Energy Production Co., 690 F.Supp.2d 558 (S.D. Tex.
2010)- decommissioning costs measured at time Agreement executed.
Apache Corp. v. W&T Offshore, Inc., 626 F.3d 789 (5th Cir. 2010) – no
decommissioning owed under farmout agreement.
Chieftain Int’l (U.S.), Inc. v. Southeast Offshore, Inc., 553 F.3d 817 (5th Cir. 2008) –
assignee remains solidarily liable for decommissioning costs.
Contracting around residual liability
• Today, residual liabilities are always considered in the PSA
and other contracts, but less likely in older contracts
• Use of performance bonds or decommissioning escrow
accounts to guarantee performance is sometime
advisable
• Beware of how you define decommissioning obligations;
courts will look to the regulations for guidance if
ambiguous
• Careful of who may be the last owner in the chain of title
Bankruptcy: A Culmination of Risks
TOPICS:
• Property of the Estate
• Priority of Claims
• Shedding Liabilities
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Abandonment
Rejection
• Safe Harbors
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Equitable Title
Farmouts
Production Payments
Property of the Estate
• 11 U.S.C. § 541 – an estate is created by commencement of
the bankruptcy case
• All legal or equitable interests of the debtor in
property as of the commencement of the case
NOTE: Section 541 does
not define the interests.
The question of whether
or not the debtor has an
interest in property and
the determination of the
nature and extent of
interest is resolved under
nonbankruptcy law.
Bankruptcy Principles to Shed Liabilities
• Abandonment of Burdensome Assets
– 11 U.S.C. § 554
– Administrative burden – no value/no benefit
– Midlantic Nat’l Bank v. New Jersey Dept. of Environmental
Protection, 474 U.S. 494 (1986) = a debtor cannot abandon
property that would violate decommissioning regulations
“reasonably designed to protect the public health or safety
from identified hazards.”
ATP Bankruptcy Case Background
• Case No. 12-36187 (Isgur) – S.D. Texas
• ATP sought Chapter 11 bankruptcy protection in August
2012, citing dramatically reduced cash flows from the
deepwater drilling moratorium.
• ATP listed assets of $3.6 billion and liabilities of $3.5
billion in its Chapter 11 petition.
• Much of ATP’s development and production was funded
by debt.
• ATP was exempt from supplemental bonding until July
31, 2012 when DOI revoked ATP’s exempt status.
– ATP filed for bankruptcy in August 2012, leaving its assessed
decommissioning liabilities un-bonded
ATP Sheds Residual Decommissioning Liabilities
• After filing for bankruptcy protection and a series of failed
negotiations to continue operations, ATP shut-in certain OCS
properties and moved to concurrently reject any unexpired
leases related to the certain properties and abandon any
property, right or interest in those properties.
• ATP, as operator, was responsible for decommissioning all of
the wells and facilities located on the Gomez Properties.
• The Gomez Properties consisted of several OCS leases
including the MC 711 Lease, a floating offshore platform along
with a network of pipelines and wells.
• The cost to decommission was estimated to exceed $100
million.
ATP Seeks to Shed Residual Decommissioning
Liabilities - Continued
• The ATP court permitted abandonment in light of Midlantic
• In re ATP Oil & Gas Corp., 2013 WL 3157567, (Bankr. S.D. Tex.
June 19, 2013) = Midlantic did not hold that a debtor may
abandon property where abandonment would be consistent
with – and perhaps in furtherance of – an environmental
regulatory scheme.
Objections to ATP Abandonment
• The DOI and Anadarko objected to abandonment
• DOI – ATP cannot abandon environmental liabilities
under Midlantic
• Anadarko – same; as only P-I-T, Anadarko would be
saddled with decommissioning liability
• DOI withdrew objection, preserving admin claim
• Judge Isgur permitted abandonment under Midlantic
• Under the applicable decommissioning regulations, DOI
could look to Anadarko to satisfy decommissioning
obligations (at least for wells and facilities in place when
Anadarko transferred its interest to ATP and for which
ATP had no security posted).
IN RE: ATP OIL & GAS CORPORATION, Debtor(s).
Motion to Abandon Gomez Properties
• The Court is not unsympathetic to Anadarko. It may be forced
to bear a substantial cost as a result of ATP’s financial woes.
Nevertheless, like many things in a bankruptcy case, the cost
that Anadarko may bear is a reflection of the credit risk it
took. Anadarko sold a portion of the Gomez Properties to ATP,
and required ATP to bear the financial burden of plugging and
abandonment in accordance with applicable federal law. This
unfortunate position is no different from that of any other
creditor that relies on the promise of performance from an
eventually failed entity. In re ATP Oil & Gas Corp., 2013 WL
3157567, (Bankr. S.D. Tex. June 19, 2013)
Anadarko’s Relief?
• After ruling, DOI ordered Anadarko to decommission
properties
• DOI, ATP and Anadarko ultimately settled with Anadarko
receiving proceeds of ATP’s $3 million area wide bond but
responsible for decommissioning properties (at cost projected
to exceed $115 million)
• The Anadarko decommissioning settlement agreement also
preserved any administrative expense claim arising out of the
maintenance and decommissioning of the platform and MC
711 Lease.
• Anadarko filed a proof of claim on 1/6/2014 for $115,217,808
of projected maintenance and decommissioning costs.
• Estimated $1.6 million available for to pay priority claims
Priority of Claims – Administrative Priority
• Priorities are important in bankruptcy because some
creditors’ claims are more important than others.
• Holders of administrative expenses are the highest priority
next to secured claims.
• In Midlantic, the court ruled when a debtor cannot abandon
the property, the resulting post-petition clean-up cost is an
administrative expense.
• In re H.L.S. Energy Co., 151 F.3d 434 (5th Cir. 1998) = P&A is an
“actual and necessary” cost of administering the estate
• In re American Coastal Energy, Inc., 399 B.R. 805 (Bankr. S.D.
Tex. 2009) = environmental claims arising from a pre-petition
liability do not fit within the same framework as tradecreditor claims arising from pre-petition liabilities
Priority of Claims
• Rejection Damage Claims
– 11 U.S.C. § 365(g) – “rejection of an executory contract or unexpired
lease of the debtor constitutes a breach”
– Estate will be liable for damages caused by the breach, but such claim
is treated as a prepetition unsecured claim. See 11 U.S.C. § 365(g)(1).
– The non-debtor party to the contract may file a proof of claim for the
pre-petition rejection damages. See 11 U.S.C. § 502(g).
– The effect of rejection is significant because the rejection claim will
rank below administrative claims, priority claims and secured claims.
• Contract Assumption – Cure Claims are administrative claims
• Subrogation issues - In re Tri–Union Development Corp., 314
B.R. 611 (Bankr. S.D. Tex. 2004) = subrogated only to the claim
and priority of BOEM (not police power)
Are OCS leases and carved out interests
property of the estate?
• Rejection of Executory Contracts
– “Bringing interests back into the estate”
• Remember the non-cost bearing interests that ATP created
• What is the nature of the interest conveyed by these assignment?
– What is the nature of the debtor’s interest in the OCS lease and
derivative interests?
• ATP put this creative approach into practice
To Be or Not to Be an ORRI…
versus
To Be or Not to Be an ORRI…
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Pre-bankruptcy = ATP assigns/conveys Term ORRI / NPI
to raise capital (lenders, drilling contractors, charterers)
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Post-bankruptcy = ATP labels conveyances of non-cost
bearing interests as financing transactions and not sales
of a property interest
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WHY? Property of the Estate or not?
To Be or Not to Be an ORRI…
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ISSUE: “disguised financing” or transfers of ownership
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Summary Judgment Phase = court not deciding on nature of
the interest; only legal issue of consistency/inconsistency with
the interest conveyed and possibility of “Recharacterization”
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Consistent with Term ORRI?
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Subordinated Interest/Payment Terms
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Reversionary/Retention of Control
Inconsistent with a Debt Instrument?
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Lack of Foreclosure Remedy
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Economic Substance
Nature of Federal, Offshore Mineral Interest?
• Underlying legal issue in adversary proceedings was about the nature
of an OCS lease and its “derivative interests” – i.e. the nature of an
OCS estate
• This issue begs fundamental questions re: what
law should apply to determine the nature of
an OCS lease/mineral interest – federal or state
law?
• It’s well-established that non-bankruptcy law
(generally, state law) creates and defines property
interests in bankruptcy proceedings. So for jurisdictions that characterize
a private mineral lease as a fee simple determinable (Texas), the lease is
not considered a true lease or executory contract under § 365. But
jurisdictions that characterize a mineral lease as conveying only a true
lease, then the mineral lease is an executory contract under § 365.
• Thus, the question what is an OCS interest and what law should
define it.
OCSLA CHOICE OF LAW PROVISION – 43
U.S.C. § 1333(a)(2)(A)
• Federal law under OCSLA applies on the OCS.
• However under the OCSLA choice of law provisions, state law serves
as surrogate federal law, if there is a “gap” in applicable federal law.
• So, should we be asking: why doesn’t Louisiana law apply to
determine the nature of an OCS lease in a bankruptcy proceeding?
ATP and DOI Position on Applicable Law
• ATP argued that under the OCSLA, the title it acquired from
the DOI in the OCS leases was that of a lessee, and did not
constitute absolute title.
• Making the OCS leases executory contracts and/or unexpired
leases.
• Accordingly, any ORRI or NPI conveyance that is derivative of
ATP’s OCS leases, did not constitute real property interests.
• Therefore, the ORRIs are not property of the burden holder
and may be rejected in bankruptcy.
• The DOI supports ATP’s position because it agrees that OCS
leases are merely contractual leasehold rights.
Interesting DOI arguments in ATP
In recent ATP filings, the DOI has urged that OCS leases and interests
carved out of OCS leases are limited contractual rights under applicable
federal law:
(1) since OCS leases are governed by the OCSLA, federal law applies;
(2) because the OCSLA uses the word “lease” to characterize the
property interest granted by the US, OCS leases are by their plain
language, leases – viz., contractual rights between lessor and lessee;
(3) the OCSLA enabling statute grants lessees only the right to “explore,
develop, and produce the oil and gas contained within the lease
area,”;
(4) the OCSLA language comports with the Bankruptcy Code’s definition
of a lease in § 365 as being “any rental agreement to use real
property.”; and
(5) DOI supports its argument with jurisprudence holding that an OCS
lease “does not convey title in the land, nor does it convey an
unencumbered estate in oil and gas.” Boesche v. Udall
State Law as Surrogate
Federal Law
• As we all know, under Louisiana law, all mineral rights are real
rights, incorporeal immovables and alienable.
• The DOI argues then that Louisiana law cannot apply as
surrogate federal law under the OCSLA because Louisiana law is
inconsistent with this federal law – that OCS leasehold interest
and other mineral rights on the OCS are merely
contractual/personal rights.
• But if applicable federal law exists, is there even a need for state
law as gap filler?
• And is this what was intended? What property law should
define OCS mineral interests? What was the OCSLA choice of
law provision meant to do?
Bonding Requirements
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BOEM/BSEE Regulations
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30 CFR 256 – Bonding
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Required prior to issuance of lease, RUE, ROW or any
proposed activity, or assignment of same
General Operating Bond – area wide
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Level of Activity
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None = $300,000
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Exploration Plan = $1,000,000
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Development Plan = $3,000,000
Lease Specific
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Level of Activity
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None = $50,000
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Exploration Plan = $200,000
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Development Plan = $5,00,000
Role of supplemental bonds
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When is a supp bond required?
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BOEM with BSEE technical assessment will determine
decommissioning liability
How is decommissioning liability determined?
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Review of potential liabilities, financial strength and reliability –
see NTL No. 2008-N07
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Some companies are exempt from providing supp security
When is decommissioning liability adjusted?
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After partial abandonment
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Revised activity plan
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Any change in responsible parties
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Company request
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BSEE/BOEM determination
More bonding Issues
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BOEM/BSEE Bond Reassessment Study
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To apply to all shelf properties
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Increase bonds for non-exempt and some cos. may lose exempt status
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Bonds for ROWs?
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Bonds for operating rights interest?
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Bonds needed where one record title holder exempt?
ANY QUESTIONS?