In context of the Bureau of Ocean Energy Management’s new NTL 2016-N01, the recently in force Notice to Lessees and Operators in the outer continental shelf (OCS) laying out strict new financial demands of operators and leaseholders to cover decommissioning liability on the OCS, Oil & Gas 360® took a call from the Surety & Fidelity Association taking issue with the idea that the capacity of the surety industry to cover the Gulf of Mexico OCS liability is limited.
“As a simple economic fact, there is not sufficient capacity in the entire bonding industry to issue the bonds needed to cover the current cumulative P&A and Decommissioning liabilities that BOEM has estimated at $40 billion,” was the quote in a previous Oil & Gas 360® story about the new requirements.
Robert J. Duke is the general counsel for the Surety & Fidelity Association of America, a surety industry trade association that has been in force since 1908. Oil & Gas 360® spoke with Duke and others in the surety industry about the changing requirements for supplemental security for operators on the OCS.
Duke said his organization’s membership is about 400 underwriting companies, which includes multiple companies under about 150-200 parent companies. Those are the companies that collectively write the majority of surety and fidelity bonds in the United States. Duke said he estimates that the number of sureties that work in the energy and mineral space is probably somewhere between a dozen and 20.
“A surety provides a bond—it’s guaranteeing an obligation. In this case, the payment of and meeting of your decommissioning obligation,” Duke explained.
“A surety will provide a bond only to those entities through its financial and operational review that it determines through its assessment can perform that obligation. They want to avoid the loss. The underwriting is more akin to a credit product than an insurance product. So just like you would provide a loan only to those you think could repay you, it’s the same with a bond. You’re going to provide a bond only to those you think can meet the decommissioning obligation.
“That’s why I was alluding to credit quality. If an operator comes to a surety and says ‘we just got this letter from BOEM, and our supplemental requirement is $5 million’, a surety is going to review the operator’s financial wherewithal, it’s going to review the economics of the particular lease and well operation, and the surety will make a determination as to if it believes the operator can meet the $5 million obligation down the road?
“If they believe they can, they will provide the bond, and if they believe they can’t [meet the obligation], they likely won’t provide the bond. If it’s a gray area they may require some collateral. Collateral certainly is an option [to the surety], I just don’t think it’s an across the board option.”
Oil & Gas 360® also spoke to Adam S. Pessin, President and CEO of Tokio Marine HCC – Surety Group, one of the larger carriers in the class. Pessin’s group works with OCS oil and gas operators.
“If you have appropriate and competent management, if you have appropriate capital structure, and if the asset quality is appropriate, the surety markets are very much open on an unsecured basis for these operators,” Pessin said. “It’s your parties that have problems in one or more of those three areas that wind up in a situation where security might be required by the surety providers.”
Duke said in the industry overall there is plenty of capacity to cover the BOEM’s estimated $40 billion in decommissioning liability in the Gulf of Mexico. “There’s enough capacity in the surety market to absorb that,” he said, “but it comes down to the credit quality of the bond principal—that’s the operators themselves and the economics of the particular well.
“So of that $40 billion that the industry has available to extend, the question is: are they willing to extend it? When you look at the available capacity, the more important issue is: will the operators qualify for it?”
“I think that BOEM has to some degree recognized this issue, because they are considering this idea of ‘dual obligee.’ Particularly in instances where a major operator—a Chevron or a Shell, for example—has conveyed an interest to an independent, and there is already an existing private bond. Not a bond to BOEM, but a bond from the independent to the major operator,” Duke said.
“I know the independents have expressed concern that if they have to also provide a bond to BOEM, that would be double bonding. And BOEM seemed willing to say that ‘if somehow we can get onto the private bond, then that may be sufficient to meeting the additional security requirement’.”
Duke said his association has been providing suggestions to BOEM as to what would be workable language in that scenario. “If we can get language that all parties like, then that will alleviate some of the need to provide supplemental security up to $40 billion.”