January through April 2020 might go down in history as one of the most challenging economic times the oil and gas industry has ever faced. As the COVID-19 pandemic spread worldwide and citizens and business shut-in, consumption of petroleum products dropped by nearly one third.
To make matters worse, on April 20th, an unprecedented market event took place when the May futures contract for West Texas Intermediate (WTI) oil dropped below zero, hitting rock bottom at minus $40 per barrel. The news spread worldwide and organizations like IER focused on explaining what this event meant, and provided an enormous amount of caution why free-market principles shouldn’t be abandoned, even in a historic moment like this.
But what happens when an oil and gas company cannot afford to drill wells or produce a product at a favorable, or breakeven price? Do they automatically go out of business?
The Oil & Gas Industry Responds
You don’t need an MBA to predict some of the most common reactions to such a significant turn of events. Businesses will look at cutting costs, which often includes layoffs, and how to maintain core business functions to stay afloat. A slowdown in production is one of the most common first steps.
Another option might be to intentionally drill a well, but not complete it until prices are right. The industry often refers to these as DUCs—drilled but uncompleted wells. These wells sit poised, ready to produce when a company decides to bring them online to meet demand.
A slightly more extreme option is to shut oil wells in (in most basic terms it would be like turning the water off on a hose spigot.) Historically, wells have been shut-in many times, especially during inclement weather—think massive rain floods in Colorado or hurricanes off the coast of Louisiana.) It is a safe and reliable way to take oil production offline. However, unlike weather storms of the past, oil and gas companies have been shutting wells in until prices recover.
With a downturn like this, bankruptcies should be expected. In fact, some over-leveraged companies were already on their way and filed for Chapter 11 before the April 20th crash. It’s also important to note that bankruptcy does not mean a company is going out of business. Most of the time, a Chapter 11 filing results in a reorganization. Debtors can begin by proposing their own repayment plans and creditors may also propose reorganization plans. It all is sorted out in bankruptcy court. But certainly, some will go out of business.
And with a bump in shuttered oil and gas companies, some have expressed concern about abandoned oil and gas wells.
The Status of Orphan Wells
The recent downturn for the oil and gas industry has some asking if any out-of-business companies have drilled wells and been forced to abandon them. Considering the first oil well in the U.S. was drilled 161 years ago, there are bound to be some abandoned wells, often referred to as “orphan wells” with no one to maintain them. And could the current economic environment for oil and gas be exacerbating the situation? Unattended wells could pose a health, safety, and environmental risk to those nearby. It’s a fair question to ask. But in posing the question, some have likely leaped a little too far when claiming bankrupt oil and gas companies will undoubtedly result in hundreds of thousands (or more) abandoned, leaky orphaned wells scattered across American posing a looming environmental disaster.
Thankfully, this question was addressed years ago when many states put into place rules that require companies to pay a bond fee before a well is ever drilled. This form of insurance is a safeguard to protect states and local municipalities in case a company does go out of business and can no longer maintain its operations—no one wants deserted oil and gas wells sitting around that haven’t been secured and stabilized.
Some states like Oklahoma, ranked fourth in oil production and third in natural gas production, have created a multi-million dollar voluntary clean-up fund paid for by industry to ensure this potential problem is always addressed. The Oklahoma Energy Resources Board (OERB) is the entity responsible for overseeing the program. OERB focuses on a four-step restoration process that follows recognized environmental standards to clean up well sites and often improve landscapes, leaving an area better than before. Anyone who’s concerned about a well in Oklahoma can register the location and OERB will investigate. Since 1994, they’ve dedicated $125 million to restoring 17,000 orphaned and abandoned well sites across the state averaging two to three sites per day. Perhaps the most impressive part is there is absolutely no expense to landowners, the fund covers the costs of this restoration and reclamation process. To us, that sounds like real foresight and leadership.
Others have suggested connecting the two concepts together, using out of work oil and gas employees to plug abandoned wells. In theory, this could be a plausible idea. These workers would have a highly unique and valuable skill set that goes unused when prices are too low and wells become uneconomic. And many of these workers are looking for employment until prices recover. Recently in a “virtual hearing” attended only by Democrats, the House Natural Resources Committee heard testimony about the merits of such a program.
The question we are left asking if funded by the federal government, who would administer such a program? Time and time again, the government has proven an ineffective, inefficient manager often spending two dollars when only one was needed. Often the government’s attempts to clean things up create terrible outcomes, such as when the EPA’s actions under the Obama Administration led to the Gold King Mine disaster.
As we watch the COVID-19 story continue, from panic to recovery, we see a common theme of questionable government involvement emerge. The drop in oil and gas consumption was met by a drop in production. Naturally, this caused prices to change. Eventually, an increase in demand will be met with higher prices, rehiring of workers, and an economic re-balance. The truth is, if state Governors allow people to return to work, demand for energy will return, and there will be fewer abandoned wells. This latest attempt by some in Congress to make a mountain out of a molehill appears more about drawing attention to themselves, than to real problems that exist in America. It’s certainly appropriate for Congressional hearings to take place, but question asked, question answered: No, America does not have an orphan well problem on its hands.
