The Bureau of Ocean Energy Management (BOEM) announced the finalization of a rule substantially revising the financial assurance requirements applicable to offshore oil and gas operations. The final rule revises the criteria for determining whether oil, gas, and sulfur lessees, right-of-use and easement (RUE) grant holders, and pipeline right-of-way (ROW) grant holders are required to provide additional financial assurance above the current minimum levels of basic obligations. The final rule also codifies the federal government’s process for estimating decommissioning costs; clarifies bonding requirements for RUE and ROW grant holders; and removes restrictions on the use of third-party guarantees to fulfill financial assurance obligations. BOEM estimates that a total of $6.9 billion in new additional financial assurances will be required as a result of the final rule, down from the $9.2 billion estimated in the proposed rule.
BOEM’s final rule marks the federal government’s latest attempt to ensure that operators have adequate financial insurance to cover the decommissioning of oil and gas assets on the Outer Continental Shelf (OCS). BOEM states that the final rule aims to ensure “the protection of U.S. taxpayers from exposure to financial losses associated with the development of OCS, while ensuring that the financial insurance program does not adversely affect offshore investments or does not position U.S. offshore exploration and production at a competitive level.” disadvantage.” The final rule will take effect 60 days after its publication in the Federal Register and will be phased into compliance over a three-year period.
The History of BOEM Financial Insurance Regulations
BOEM’s final rule is the latest development in a multi-year effort to overhaul the agency’s financial insurance regulatory framework. BOEM’s current financial insurance regulations consist of two main parts: (1) basic obligations, generally required in the amounts prescribed by the regulations; and (2) additional financial assurance, which is an amount above the base deposit that is required at the discretion of the agency to ensure that a tenant or grant recipient can fulfill its contractual and regulatory obligations. Under current regulations, BOEM considers five criteria in evaluating whether a tenant or subsidy recipient is required to obtain additional financial assurance: (1) financial capacity; (2) projected financial strength; (3) business stability; (4) reliability in meeting obligations based on credit rating or commercial references; and (5) a history of compliance with laws, regulations, and lease terms. Additionally, BOEM provides additional guidance on how it analyzes the five criteria through the issuance of Notices to Tenants (NTL). Historically, BOEM has waived additional financial insurance for many tenants and subsidy recipients.
From 2015 to 2020, following several major oil and gas bankruptcies, BOEM and its sister agency, the Bureau of Safety and Environmental Enforcement (BSEE), issued NTLs and proposed rules aimed at remedying what agencies considered a significant problem: decommissioning costs estimated by the federal government far exceed the amount of financial insurance held by oil and gas companies operating on the OCS. BOEM estimates it has financial assurance for less than 8 percent of the estimated $38.2 billion decommissioning obligations. In its latest proposed rule released in June 2023, BOEM proposed significant revisions to its financial insurance regulations to address these risks.
BOEM Final Rule for 2024
The final rule, announced on April 15, 2024, is largely consistent with the agency’s proposed rule in June 2023. Significant regulatory revisions resulting from the final rule include:
- New criteria for additional bonding: Under the final rule, BOEM will consider a new set of criteria to determine whether OCS lessees and grant recipients are required to obtain additional financial assurance. BOEM will review (1) the credit rating; and (2) assessments of proven petroleum reserves. BOEM will accept two forms of credit ratings: (1) a credit rating from an NRSRO; or (2) a proxy credit rating determined by BOEM based on a company’s audited financial statements. To determine proxy credit ratings, BOEM will use S&P Global’s Credit Analytics credit model, but reserves the right to use a different model if it believes that model will more accurately reflect the true credit rating. As a threshold, BOEM will not require a company to obtain additional financial assurance if it has an investment grade credit rating (i.e., a credit rating from an NRSRO greater than or equal to BBB- from S&P or Baa3 from Moody’s, or the equivalent of another NRSRO). BOEM may also consider the value of proven oil and gas reserves per lease. Using BSEE’s cost estimates, if BOEM determines that the value of the reserves in a given lease exceeds three times the cost of the decommissioning estimate associated with the production of those reserves, then BOEM will not require this company to obtain additional financial assurance.
- New decommissioning cost estimation process: BOEM has finalized its proposal to use BSEE’s P70 decommissioning cost estimate to determine whether additional financial assurance is necessary. BOEM’s P70 probabilistic estimate is the value that BSEE determines has a 70 percent chance of recovering the full cost of decommissioning. According to BOEM, “additional financial assurance based on the P70 value means that, based on the uncertainty and risk applied by BSEE to its model, there is a 70% probability of covering the cost of dismantling the installation (and therefore a 30% risk). % probability of exceeding it). BSEE’s probabilistic decommissioning cost estimates are based on actual spending data collected from oil and gas companies since April 2016 for wells and facilities, and since May 2017 for pipelines.
- Taking into account roommates: BOEM will not require additional financial assurance for rental agreements where at least one roommate meets the credit rating threshold. BOEM recognizes that “all current owners benefit from ongoing operations and are jointly responsible for compliance with DOI requirements.”
- Changes to bonding requirements for ROW and RUE grant holders: In evaluating whether ROW or RUE grant recipients need to obtain additional financial assurance, BOEM will only consider the recipient’s credit rating, as ROW and RUE grants do not entitle the grantee to any interest in oil reserves and gas. For RUE grant holders, they will now be required to provide a basic financial assurance of $500,000, whether the RUE serves a state lease or a federal OCS lease. An RUE grant recipient may now be required to provide additional financial assurance if it does not maintain an investment grade issuer credit rating or equivalent credit rating.
- Third Party Guarantees: The final rule allows tenants and grant recipients to use third-party guarantees for additional bonding purposes. It also removes the requirement that a third-party guarantee must ensure compliance with the obligations of all tenants, rights holders and operators of the lease. The amendments authorize a guarantee limited to a specific amount or limited to one or more specific rental obligations, subject to BOEM’s agreement.
- Impacts of assignments or transfers of leases: BOEM may refuse approval of any new transfer or assignment of any leasehold interest unless and until financial assurance requests have been satisfied. This review could impact oil and gas transactions and restructurings.
- Compliance Timeline: The final rule will take effect 60 days after publication in the Federal Register, but BOEM will phase it into compliance over a three-year period. BOEM will initially require a company that receives a request for additional financial security to provide one-third of the total amount by the deadline indicated on the demand letter. BOEM would then require a second third within 24 months following receipt of the formal notice, and the final third within 36 months following receipt of the formal notice. BOEM states that the “compliance window” will end three years after the effective date of the final rule, and any party receiving a request for additional financial assurance after that date will be required to provide the additional financial assurance in its entirety, as required by law. on demand, without gradual implementation. BOEM acknowledged in the final rule that it maintained the general practice of assessing the financial risks of tenants, RUE grant recipients, and pipeline ROW grant recipients at least annually, but that it could require additional financial assurance at any time.
- Appeal bond: The final rule also requires that any business wishing to stay an application for additional financial security pending appeal must, as a condition of obtaining a stay of the order, post an appeal bond in the amount of the financial security additional required. If the appeal is unsuccessful, the appeal bond may be replaced by, or converted to, surety bonds or other forms of financial assurance to cover BOEM’s request for additional financial assurance.
The BOEM final rule is expected to have market-wide implications. BOEM’s regulatory changes will likely require oil and gas operators to obtain billions of dollars in additional financial guarantees. This could prove difficult for some companies, as the U.S. industry surety bond market has become less accessible in the wake of major oil and gas bankruptcies.