Some Canadian energy stocks look pricier once abandonment obligations are factored in, say analysts. (GETTY)
Clean-up costs for abandoned oil and gas infrastructure will remain a "hot-button topic" for regulators and investors, as public reporting on financial obligations varies wildly from one company to the next. That's according to analysts at Scotiabank who crunched the numbers on which firms are most exposed.
Wells and other infrastructure remain the responsibility of companies after they are no longer needed for oil and gas development. According to the Alberta Energy Regulator, 170,000 abandoned wells exist in Alberta, representing 37 per cent of all wells in the province. These differ from orphaned wells, which belong to companies that have ceased operations.
Scotiabank Global Equity Research says it stripped out a "wide range of discount rates and inflation assumptions" made by companies in order to compare their asset retirement obligations. Analysts measured this against metrics like the company's enterprise value and cash flow to gauge the scale of future costs.
The results show Vancouver-based Africa Oil (AOI.TO), Vermilion Energy (VET.TO)(VET) top the list, with retirement obligations representing about 40 per cent of each company's enterprise value. Those companies are followed by Paramount Resources (POU.TO), Whitecap Resources (WCP.TO), and Suncor Energy (SU.TO)(SU), which have asset retirement obligations greater than 20 per cent of their enterprise value.
With high commodity prices reviving investor interest in Canadian energy, Scotia's analysts note shares in some companies may look more expensive when asset retirement obligations are factored into their valuation.
"Generally, these companies have a higher proportion of inactive wells that need to be abandoned, or have oil sands operations which have significant abandonment obligations," Scotiabank analyst Jason Bouvier wrote in a recent note to clients.
Paramount, Vermilion, Suncor, Imperial Oil (IMO.TO)(IMO), and Cenovus Energy (CVE.TO)(CVE) saw the biggest increase to their enterprise value to debt-adjusted cash flow multiples when normalized for asset retirement obligations, according to the bank.
Scotiabank found companies across its coverage have an average of about 70 per cent of wells in production. NuVista Energy (NVA.TO), Spartan Delta (SDE.TO), Kelt Exploration (KEL.TO), Paramount, and Baytex Energy (BTE.TO) have the lowest proportion of producing wells.
The issue of abandoned assets has gained attention since the Supreme Court of Canada's Redwater ruling in 2019. The court determined that companies must address environmental liabilities before paying back creditors. In 2020, Ottawa announced $1.7 billion in aid to help clean up wells in Alberta, British Columbia, and Saskatchewan as part of its COVID-related stimulus. The latest update to the Alberta Energy Regulator's liability management procedures calls for the industry to spend $422 million in 2022, and $443 million in 2023.
"While we expect the sector to easily meet this target . . . [However], we believe asset retirement obligations will remain a hot-button topic for both regulators and investors," Bouvier wrote.
"If we assume that firms settle two per cent of their normalized asset retirement obligations balance per year, Paramount, Vermillion, Suncor, Imperial, and Cenovus would have the higher abandonment spending as a percent of 2022 cash flow at about 1.25 to two per cent."
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