Oil and Gas Assets and Retirement Obligations

Every year oil companies seek to expand their production capacity.  That is how capital markets measure their success.  Every year these companies originate new producing assets.  Each new asset comes bearing a new set of “asset retirement obligations” or “AROs”.  For example, 30 CFR Part 250, Subpart Q describes decommissioning requirements for oil and gas exploration and productions assets in the U.S. outer continental shelf.

Oil companies are required to record estimated AROs on their balance sheets.  But they can only guess as to how much it will cost to decommission assets and perform environmental restoration 15, 30 or 60 years in the future.  And they do not want to consider or disclose the odds that these debts could come due earlier than the end of the forecasted economic life of the asset.

The timing as well as the amount of asset retirement costs are inherently uncertain.  For example, consider that the cost to decommission an ocean platform damaged by a hurricane can be 10 to a hundred times greater than the cost to decommission an unimpaired asset.  How can an oil company predict such outcomes prior to discovery of the damage, which may or may not ever happen?  And what incentive would management have to speculate about such unfortunate events?

Moreover, governments are free to impose new environmental requirements, thereby increasing a company’s future asset retirement costs.  For example, in coming years it is possible that regulators will impose more stringent and costly well plugging and monitoring standards to control fugitive greenhouse gas emissions.  Expected future changes in law and regulatory standards are not reflected in current liability estimates.