Decommissioning liabilities set to rise

The costs associated with decommissioning oil and gas (O&G) assets are predicted to reach US$42 billion by 2024, as discovered in research conducted by Rystad Energy. The cumulative costs involved in decommissioning ageing oil and gas assets are considerable, and this is expected to rise significantly in the medium to long-term. For instance, the ratio of decommissioning expenditure to operational expenditure (opex) by oil and gas companies operating in the UK Continental Shelf in the North Sea is expected to increase from 10% to over 30% in the next 10 to 20 years. Additionally, one of the problems is that the planned retirement of oil and gas assets is not taking into account current factors that can drastically decrease the time seemingly left for productive and useful material, including: policy actions, market dynamics, and displacement of internal combustion engines with electric vehicles.

Financial assurance requirements

Asset retirement obligations (AROs) for O&G companies arise as the result of financial responsibilities stipulated in contracts or required by legislation to plug wells, dismantle, and remove installations at the end of an asset’s productive life and restore the surrounding area. However, limited financial assurance requirements and regulatory loopholes mean some of this burden may fall on governments while abandoned assets portend environmental hazards. Failure to prepare could lead to potentially significant financial burdens for companies and/or taxpayers in the event of bankruptcies, as well as non-compliance with regulations and increasing risks to health, safety, and environment related to abandoned and un decommissioned installations.

Scenarios point to the rise in decommissioning over the long-term

The anticipations for the future are that the energy system is to decarbonise rapidly, leading oil majors to set ambitious emissions pledges and rapid decarbonisation trajectories. Estimates indicate that over 45% of global carbon emissions stem from damaged, destroyed, and decommissioned oil and gas wells. Therefore, scenarios based on warming of 2°C or more anticipate demand remaining open or increasing, making it feasible that future iterations of company business strategies outline more rapid decarbonisation trajectories, potentially shortening lifespans and leading to more retirements than current company projections indicate.

Financing gaps pose multiple risks

The transition to a low-carbon economy is expected to be financed by multiples and various channels. The existence of financing gaps for sustainable finance and ESG-focused investors pose several risks. With the O&G sector likely to face increasing vulnerability over the coming decades, alternative means will be necessary for companies and governments to seek funding for decommissioning. Sustainable debt offers several routes to finance asset retirements and environmental remediation, for example, via green and other sustainability-linked bonds and loans. However, the appetite for financing such activities from ESG-focused investors and lenders is uncertain, particularly where green, social or sustainable debt is issued by O&G companies, causing questions regarding the levels of investor appetite.

Domestic regulation

National legislation governing decommissioning of onshore and offshore oil and gas assets vary considerably. National legislation in Australia includes new requirements covering abandonment and site restoration (ASR) for onshore and offshore oil and gas operations, including retroactively applying ASR obligations. However, other countries carry significant risks for the environment, such as a lack of clear requirements for dismantling and removal like Russia.

Recommendations

Governments must take the lead in formulating comprehensive regulation covering ARO, requiring financial assurances, and establishing methods of enforcement against non-compliance. Companies will need to prepare for retirements, dedicating resources for decommissioning planning and environmental assessments. Sustainable finance offers innovative ways to finance these activities, providing access to alternative funding for decommissioning projects, particularly in countries where bond rules are low. There is potential for green, social, and sustainability (GSS) debt to play an important role in financing decommissioning projects. Sustainability-linked bonds and loans (SLBs and SLLs) could also be further explored for financing asset retirement and climate mitigation and adaptation initiatives.