As the price of oil and gas falls the cost of plugging and abandoning wells increases

On March 31, 2020, the West Texas Intermediate price of oil closed at $20.48 a barrel.[1] Brent prices were not far behind, closing at $20.61.[2] These drops mark a price decline of roughly 60% for 2020.[3]  Analysts expect prices to remain low.[4]

Such low prices are especially troubling for shale drillers, many of whom require more than $45 per barrel to break even.[5] It is also troubling for traditional American producers that often stop drilling wells when oil reaches $25 per barrel.[6] But low prices are not exclusive to oil operators.[7] Experts expect natural gas prices to remain low too.[8][9]

Amid this uncertainty, operators will look to avoid significant costs. Plugging and abandoning wells can be such a cost.

Although these requirements apply regardless of the current low cost environment, a discussion of these rules may be helpful for current operators and those who may soon become operators through distressed sales or foreclosures – non-compliance with these rules may subject an operator to fines, foreclosures and limitations on their operations.[10]

Moreover, plugging and abandoning rules are distinct from provisions in oil and gas leases that govern shutting-in wells and ceasing production, although all may involve non-productive wells. While restrictions on shutting-in wells and ceasing production are generally lease specific, as mentioned, plugging and abandoning rules apply regardless.[11] Those considering shutting-in wells or ceasing production are encouraged to become familiar with plugging and abandoning requirements. This may allow them to avoid becoming subject to plugging and abandoning requirements despite complying with their leases.

This article provides an outline of the plugging and abandonment requirements of onshore oil and gas wells in Texas.  It also discusses the ties among these requirements and bankruptcy.

1. Governing body and overview 
   
   The Texas Railroad Commission (“Commission”) oversees plugging and abandoning operations.[12] In addition to the Texas Natural Resources Code, Title 16, Part 1, Chapter 3 of the Texas Administrative Code (collectively, “Commission rules”) are the primary sources for plugging and abandonment requirements.
   
   Generally, plugging operations must commence within a year after drilling or operations on a dry or inactive well cease, unless the Commission approves an extension.[13] Plugging operations are complete when the Commission determines that the well is plugged in compliance with Commission rules.[14] These rules immediately burden operators, but they can also burden non-operators and others too.[15]
   
   
2. Identifying to whom plugging and abandoning rules apply

   
   What is an inactive well? Inactive wells are required to be plugged and abandoned within a year after drilling or operations on them cease, unless the Commission approves an exception.[16] “Inactive” is a status that describes a particular well. For purposes of plugging requirements, an inactive well is one that meets these two characteristics: (1) for 12 consecutive months or longer, the well has not reported production of at least (a) five barrels of oil or 50 Mcf of gas during at least three consecutive months, or (b) one barrel of oil or one Mcf of gas each month for 12 consecutive months; and (2) it is not permitted as a disposal or injection well.[17] Accordingly, a well that is shut-in may become inactive, but its status as “shut-in” under  a lease may not in itself answer whether the well can be classified as “inactive” under Commission rules.

   Who is an Operator? An operator is any person,[18] firm, partnership, joint stock association, corporation, or other domestic or foreign organization who, acting for himself or herself or as an agent for others, assumes responsibility for the physical operation and control of a well.[19] This assumption must be recognized by the Commission before the legal status of operator is bestowed.[20] An applicant may become an operator of an existing well or a newly built well.[21] Just as the Commission conveys operator status, only it may remove this status.[22] Still, transferring operatorship involves a process,[23] and the operator seeking to have its status removed is burdened with proving that it has complied with Commission rules.[24]

   Who is a Non-Operator?  A non-operator is a person who owns a working interest in a well at the time that the well is required to be plugged and is not an operator.[25] 
   

3. Operator’s responsibilities

   
   Commission rules on plugging inactive wells generally break into three categories: (1) duties of operators with inactive wells; (2) methods for plugging; and (3) timing requirements.

   Operator’s Duties. Apart from the sweeping requirement to plug and abandon according to Commission rules, operators of inactive wells must observe other duties, such as filing the proper financial securities for the wells;[26] marking the wells as inactive,[27] maintaining wellhead control,[28] and preventing waste.[29] These obligations are separate from contractual covenants and common law duties.

   Methods for Plugging. The process for plugging an inactive well can be split into two phases: planning and execution.

   Planning. Planning to commence plugging operations involves: (1) identifying water strata and production horizons because cement plugs must be set to isolate each;[30] (2) communicating with the Groundwater Advisory Unit of the Oil and Gas Division;[31] (3) finding an approved cementer;[32] (4) ensuring materials such as the API oil well and concrete mixing comply with Commission rules;[33] (5) placing the well in static condition;[34] (6) cleaning the well;[35] (7) timely filing all required notices, including with the Commission and surface owners;[36] (8) seeking the Commission’s approval on its notification of intention to plug;[37] and (9) making other necessary arrangements, such as those to restore the surface or empty related piping and flowlines.[38]

   Executing. Executing plugging operations involves: (1) directly supervising the cementer, which means the operator should be present at the wellsite during plugging operations;[39] (2) verifying that the plug is placed at the base of the deepest usable quality water stratum by tagging it with tubing or drill pipe;[40] (3) filling the remainder of the well not filled with cement or other alternate materials with mud-laden fluid;[41] (4) placing a 10 foot cement plug in the top of the well and cutting off casing three feet below the ground surface;[42] (5) following surface remediation requirements;[43] and (6) complying with any special considerations for the kind of well. Special considerations include additional requirements for (1) surface casing;[44] (2) intermediate casing;[45] (3) production casing;[46] (4) well screens or liners;[47] (5) production casing and open hole wells;[48] and (6) horizontal drainholes.[49] 

   Timing. When an operator is required to plug an inactive well generally depends on whether the well became inactive under that operator or if it was acquired that way.[50] When a well becomes inactive, the operator must plug it on or before the date that the operator is required to renew its annual organization report.[51] When an operator acquires an inactive well, the operator must file an affirmation that complies with Texas Natural Resources Code § 89.029 and at least one of the documents listed in Texas’ Natural Resources Code § 89.023(a)(3).[52] However, the operator may be able to seek an extension on its obligation to plug an inactive well.

   The operator may seek an extension if (1) the operator has a current organization report; and (2) the operator files with the Commission (a) an affirmation that complies with Natural Resources Code § 89.029; (b) a statement that it has evidence of a good faith claim to a continuing right to operate the well; and (c) at least one of the documents listed in Texas’ Natural Resources Code § 89.023(a)(3).[53] This extension appears valid for one year; an operator is encouraged to be prepared to seek an extension each year.[54] However, additional circumstances may cause the operator to plug and abandon a well sooner than expected.[55]  
   

4. Economic and environmental consequence of non-compliance

   
   Economic costs. Not only may the non-compliant operator be forced to re-plug a well, which can be costly in itself, but the Commission or attorney general may also (1) foreclose on well-site equipment;[56] (2) deny a subsequent organization a permit to operate if the organization has outstanding violations or if one of the organization’s officer or controlling persons violated Commission rules for plugging wells within the last seven years and the violation remains outstanding;[57] (3) fail to refund the operator’s deposited financial securities;[58] and (4) impose fines, which may be up to $10,000 a day with each day considered a separate violation.[59] Additionally, the operator may be liable to a non-operator that is ordered by the Commission to plug and abandon the well.[60]

   Environmental costs. Unplugged or poorly plugged wells may affect groundwater, methane emissions, and the area around them.[61] Groundwater is infected because oil, gas, or salty water can leak into freshwater aquifers.[62] Unplugged wells may leak methane; methane is a gas that is linked to climate warming.[63] Further, unplugged wells affect the area around them when oil, gas, drilling mud, or salty water rises in the well and spills onto the ground.[64]  
   

5. Bankruptcy/lender considerations

   
   If an operator lacks the funds to plug and abandon a well when required, non-operators may be ordered to provide funding.[65] Non-operators are given statutory authority to pursue other non-operators and operators for any costs spent above that non-operator’s proportional share for plugging and abandoning the well.[66] Accordingly, non-operators may become unsecured creditors of the operator.

   Lenders are not in the business of operating wells.  Instead, lenders looking to foreclose on their debtor’s well assets may consider either finding a contract operator before foreclosing, if they seek to continue to operate the wells, or finding a buyer that the Commission will recognize as an operator.[67] Otherwise, the lender risks being liable for the plugging and abandoning of the debtor’s well.  Any costs associated with the plugging and abandoning of a debtor’s wells may need to be factored into decisions the lender makes with respect to their strategy to realize upon the debtor’s assets after a default.

   Once a well is properly plugged and abandoned, the operator ceases to be an “operator” for that well. The Commission may then refund the proceeds from the operator’s financial security and release the operator from “operator” status.[68]

   If a well has not been plugged by its deadline, the Commission is granted a statutory lien, superior to all other preexisting and subsequent liens and security interests, on the operator’s and non-operator’s interest in well-site equipment in the amount of the total cost of removing well-site equipment from the well, plugging the well, and transporting, storing, and disposing the well-site equipment.[69] Because a lender will be subordinate to the Commission’s lien, it would be advisable for the non-compliant well or wells to be segregated or dealt with. Other creditors can therefore be affected by an operator’s non-compliance.

   An operator that fails to comply with Commission rules may have its operations in Texas severely limited, which can affect its ability to have its Chapter 11 plan approved.[70] 
   

6. Conclusion.  
   
   Non-compliance with Texas’ plugging and abandonment rules can deprive operators of their ability to continue operating and can also affect their bankruptcy proceedings.[71] Accordingly, it is critical to know when and how to comply with Commission rules. Plugging requirements begin to have increasing relevance when plugging operations are undertaken or when the well becomes inactive.[72] Once operators have determined that these regulations apply, they can organize compliance efforts into a planning and execution phase. Within each of these phases, operators are urged to carefully note and observe notice and method requirements. Careful compliance not only protects operators from financial liability, but it also benefits public health. Accordingly, operators are encouraged to become familiar with plugging and abandonment requirements that may be applicable now or in the future.
   
   

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This information does not, and is not intended to, constitute legal advice. All information, content, and materials are for general informational purposes only. No reader should act, or refrain from acting, with respect to any particular legal matter on the basis of this information without first seeking legal advice from counsel in the relevant jurisdiction.

[1] Market Insider, "Oil (WTI) in USD – Historical Prices," April 2, 2020, https://markets.businessinsider.com/commodities/historical-prices/oil-price/usd?type=wti

[2] Market Insider, "Oil (BRENT) in USD – Historical Prices," April 2, 2020, https://markets.businessinsider.com/commodities/historical-prices/oil-price/eur?type=brent

[3] Bloomberg News, "How Low Can Oil Go? One Forecast Sees $5 a Barrel," April 2, 2020, https://www.bloomberg.com/news/articles/2020-03-19/how-low-can-oil-go-traders-see-crude-prices-heading-below-20

[4] Id.; Reuters, "U.S. Crude Stockpiles Rise, Fuel Draws Down Despite Pandemic: EIA," March 18, 2020, https://www.reuters.com/article/us-usa-oil-eia/us-crude-stocks-rise-fuel-inventories-down-eia-idUSKBN2152IE

[5] Fed. Res. Bank of Dallas, Energy Slideshow (Mar. 4, 2020), https://www.dallasfed.org/-/media/Documents/research/energy/energycharts.pdf?la=en

[6] Jim Patterson, "Saudi Arabia Tanks the Oil Market," Kiplinger, March 16, 2020, https://www.kiplinger.com/article/business/T019-C000-S010-energy-price-forecast.html

[7] NASDAQ, Historical Prices, https://www.nasdaq.com/market-activity/commodities/ng%3Anmx

[8] Jeremiah Shelor, "Analysts Slash 2020 Natural Gas Price Forecast; More Cuts Said Needed as Coronavirus Hits Crude," Natural Gas Intel, February 26, 2020, https://www.naturalgasintel.com/articles/121161-analysts-slash-2020-natural-gas-price-forecast-more-cuts-said-needed-as-coronavirus-hits-crude; Avi Salzman, "Natural Gas is in a Tailspin, and Things Could Get Much Worse. Here’s How," Barron’s, February 10, 2020, https://www.barrons.com/articles/natural-gas-prices-falling-demand-coronavirus-51581119054

[9] Reuters supra note 5; Sarah Hansen, "Oil Bounces Back Up 24% After Trump Says He Would Consider Intervening in Price War," Forbes, March 19, 2020, https://www.forbes.com/sites/sarahhansen/2020/03/19/oil-bounces-back-up-24-after-trump-says-he-would-consider-intervening-in-price-war/#4a4b84cab0e3

[10] See e.g., Tex. Nat. Res. §§ 81.0531, 89.083, 91.142 (2020).

[11] See e.g., John Lowe, Owen Anderson et at., Cases and Materials on Oil and Gas Law 273-296 (1986, 7th eds.).

[12] Tex. Nat. Res. § 40.008 (2020).

[13] Tex. Nat. Res. § 89.011 (2020); 16 Tex. Admin. Code § 3.14(b)(2) (2020).

[14] Tex. Nat. Res § 89.011(e) (2020), “The duty of a person to plug an unplugged well that has ceased operation ends only if the person’s interest in the well is sold or conveyed while the well is in compliance with rules of the Commission relating to safety or the prevention or control of pollution and the provisions of Sections 89.002(a)(2)(A)-(D) have been met.”

[15] Tex. Nat. Res § 89.042(b) (2020). "Outside of operators and non-operators, plugging and abandonment requirements tend to be more organized around regulating types of activities, than regulating individual actors. For example, people applying for a permit to store, handle, treat, reclaim, or dispose of oil and gas waste may fall under the reach of Texas’ plugging and abandoning rules." See Tex. Nat. Res § 91.109 (2020).

[16] Tex. Nat. Res. § 89.011 (2020); 16 Tex. Admin. Code § 3.14(b)(2) (2020).

[17] 16 Tex. Admin. Code § 3.15(a)(1) (2020).

[18] 16 Tex. Admin. Code § 3.79(20) (2020). “Any natural person, corporation, association, partnership, receiver, trustee, guardian, executor, administrator, and a fiduciary or representative of any kind.” Commission rules suggest that more than one person may be recognized as an operator. See Tex. Nat. Res § 89.081 (2020).

[19] Tex. Nat. Res §§ 89.002(a)(2), 91.142 (2020); 16 Tex. Admin. Code § § 3.79(19) (2020). 

[20] Tex. Nat. Res § 89.002(a)(2) (2020).

[21] Id.

[22] See Tex. Nat. Res § 89.011(e) (2020).

[23] Tex. Nat. Res § 89.002(a)(2) (2020).

[24] Tex. Nat. Res § 91.701 (2020).

[25] Tex. Nat. Res § 89.002(a)(3) (2020).