Oil & Gas Well Dilemma Continues as More Wells are Being Drilled in WV, etc.

by S. Tom Bond on August 30, 2023

Diversified subsidiaries have 22,876 non-plugged wells in WV and have plugged ca. 150 wells in the state since 2018

Numbers don’t add up for Appalachia’s largest gas & oil well owner or WV’s well inspectors

From an Article by Mike Tony, Charleston Gazette, April 30, 2022

All is often not well when wells end. In 2020, Carbon Tracker, a London-based think tank researching climate change impacts on financial markets, estimated the costs of plugging gas and oil wells that ceased production in West Virginia exceeded $7.6 billion — with bonds totaling just $28.7 million to cover that expense.

That same year, a senior advisor to Carbon Tracker reflected on the business model behind thousands of those wells in West Virginia and across Appalachia in a conference call with the Capitol Forum, a corporate news analysis service. The advisor called that business model a “legal Ponzi scheme.”“[I]t only works as long as there’s growth and the perception of profitability,” Greg Rogers said.

Headquartered in Alabama and led by Lumberport native and cofounder and CEO Rusty Hutson Jr., Diversified Energy has become the largest owner of oil and gas wells in the country. Most of the company’s nearly 70,000 wells are in Appalachia, acquired since 2018 from regional producers such as Pittsburgh-based EQT and Canonsburg, Pennsylvania-based CNX Resources.

“But … if your production is falling on those wells, especially if it’s falling faster than you think, then you’re going to need to continually acquire more and more wells,” Rogers said of Diversified’s business model. “The problem is you’re acquiring more and more liabilities as you do that, these liabilities for the closure.”

“[Diversified’s] business model is built around low decline assets paying out cash flow in the form of dividends to retail investors,” Tom Loughrey wrote in a June 2020 company analysis for Friezo Loughrey Oil Well Partners, an analytics firm serving investors in the oil and gas sector. “The problem with these structures, and why they always fail, is the valuations eventually exceed the future cash flows; the company must replace assets at an increasing rate until hitting the wall.”

States mandate that wells no longer producing gas or oil are plugged and abandoned and that well owners secure a bond or other financial assurance that helps cover the expense of closing wells that aren’t productive anymore.

Two recently released reports suggest Diversified’s expanding well portfolio poses long-term risks both to West Virginia’s bottom line and its environmental safety.

The Ohio River Valley Institute, a Johnstown, Pennsylvania-based pro-clean energy nonprofit think tank, published a report April 12 predicting it is highly unlikely Diversified will have enough money to plug and abandon all its wells, citing Diversified company data and federal projections for natural gas prices. Plugging and abandoning costs will be higher than the revenue generated by Diversified’s current well inventory by 2056, the report projects.

The report finds 96% of the company’s producing wells in West Virginia, Pennsylvania, Kentucky and Ohio produce less than five barrels of oil equivalent per day. Wells producing less than that amount are considered financially distressed by the Colorado Oil and Gas Conservation Commission, the report notes.

“The numbers just don’t add up,” report co-author and Ohio River Valley Institute research fellow Kathy Hipple said.

A week after that report was released, a Environmental Defense Fund study found low-production well sites like those dominating Diversified’s portfolio are a disproportionately large source of methane emissions.

The report published in the peer-reviewed scientific journal Nature Communications found roughly half of all well site methane emissions nationwide come from low-production well sites, which emit six to 12 times as much methane as the average rate for all U.S. well sites.

Methane has a 100-year global warming potential 28 to 36 times that of carbon dioxide, according to the U.S. Environmental Protection Agency, making Diversified’s deepening well footprint across Appalachia a climate concern in addition to a threat to states’ bottom lines.

“The percentage of methane emissions is disproportionately high,” said Karan May, senior campaign representative for the Sierra Club in West Virginia. “When I put that together with Diversified, it just scares me for what’s happening in Appalachia particularly.”

Diversified is only the 15th largest producer in Appalachia despite being its largest well owner, Ohio River Valley Institute researchers found, citing Capitol Forum data. “Diversified’s business model is based on harvesting cash flows from its wells and delaying P&A [plugging and abandoning] costs for as long as possible,” the Ohio River Valley Institute report concluded.

Diversified could have 60,000 wells to plug and abandon throughout Appalachia at the end of consent agreements reached with regulators in West Virginia, Pennsylvania, Kentucky and Ohio committing the company to decommissioning some 80 wells annually for the next 15 years. “[T]hey’ve become too big to fail,” report co-author and Ohio River Valley Institute research fellow Ted Boettner said.

The Ohio River Valley Institute report finds that Diversified has used unusual assumptions like implausibly long economic lives of wells though 2095 and an excessively long ramp-up timeline to start plugging and abandoning most of its wells to calculate the value of its asset retirement obligations, liabilities for well plugging and abandoning costs.“[E]nd of life liabilities … need to be pushed off as far as possible in order for the business model to work,” Rogers said in the 2020 Capitol Forum conference call.

The report also says the company appears to be avoiding its obligations to report methane leakage from its wells, citing an analysis of emissions reporting submitted by Diversified for more than 20,000 active wells in Pennsylvania.

Ohio River Valley Institute’s researchers and other industry experts anticipate a rapid decline in gas production. That would leave Appalachian states particularly vulnerable to being on the hook for cleaning up thousands of additional orphaned wells.

“[W]hen one company owns so many of these wells, that risk is just huge,” Boettner said. “Who’s going to be left holding that bag? It’s important that our state oil and gas regulators take a huge look at this company and figure out a way to ensure that they can cover these costs.”

West Virginia’s leaders have let the state’s inspection unit responsible for looking after wells statewide atrophy in recent years, declining to shore up funding for well regulators even amid a surge in production. The West Virginia Department of Environmental Protection has reported major manpower shortages in its Office of Oil and Gas, which manages the state’s abandoned well-plugging and reclamation program. The state’s well inspection staff dwindling from 18 to nine in the past two years on the Legislature’s watch has concerned not just environmentalists but royalty owners who see a corrosive connection between the state’s well inspector shortage and a growing orphaned well problem.

“[Inspectors] may spot problems that can be fixed to keep the well from becoming essentially uneconomic or they could spot a well that needs to be plugged,” West Virginia Royalty Owners Association President Tom Huber said. “As these wells grow older and older and older, that’s when they become orphaned, and then there’s no one to go after to get to plug the well.”

{ 1 comment… read it below or add one }

Kathy Hipple August 30, 2023 at 8:40 pm

Diversified Energy’s Questionable Financial Practices Continued in 2022

Ted Boettner and Kathy Hipple, Ohio River Valley Institute, January 23, 2023

In 2022, we published Diversified Energy: A Business Model Built to Fail Appalachia, which questioned the company’s ability to pay for decommissioning its inventory of over 60,000 wells in Appalachia. Since that time, Diversified Energy (“Diversified”), the nation’s largest well owner, has acquired additional wells while reducing the amount it expects to pay to decommission its well inventory. Most recently, the company has projected that its cash flows over the next 50 years can not only retire its well inventory of 72,000, but that it can continue to pay large dividends and eliminate its debt obligations within the next 10 years.

Well ownership carries the responsibility to retire, or plug and abandon (P&A), these wells. The company must account for these future P&A costs as a liability, called an Asset Retirement Obligation (ARO), in its financial statements. The assumptions that undergird Diversified’s AROs do not follow industry norms. Diversified assumes it can P&A its wells at an average cost of $21,000, a fraction of industry norms, and that its wells, most of which are in Appalachia and are more than 20 years old, will be economically viable through 2095. By using such questionable assumptions, Diversified’s AROs are far lower—hundreds of millions of dollars lower—than they would be if the company used assumptions in line with the industry.

Even with the low ARO value on its books, Diversified was, by some definitions of insolvency, technically insolvent at the end of June 2022. Its total liabilities ($4.387 billion) exceeded its total assets ($4.033 billion). This is noteworthy because Diversified added to its well inventory through acquisitions, yet reduced its AROs by $60 million, from $522 million at year-end 2021 to $462 million mid-2022, primarily by reducing the per-well P&A cost assumptions. As noted in our 2022 report, if Diversified used assumptions based on industry norms, its ARO liabilities would make the company technically insolvent, by some definitions of insolvency.

Using estimates from in-state regulators in Pennsylvania, West Virginia, Ohio, and Kentucky, as well as cost estimates from companies that specialize in P&A, our analysis reveals that Diversified’s P&A estimate of $21,000 per well is well below industry averages.

Diversified’s estimates of its own P&A costs are also questionable because they are only a fraction of what the company will charge states when it P&As orphaned wells using federal funds. For example, the company has been awarded a contract to P&A 100 wells in West Virginia, at an average cost per well of $126,000. Yet it claims in its financial filings that it can P&A its own wells for roughly one sixth the cost it will be paid with federal dollars.

By acquiring three plugging companies in Appalachia in 2022, Diversified not only plans to benefit from the $4.7 billion in federal funds to clean up orphaned wells but it is also poised to benefit from $700 million in federal grants from the Inflation Reduction Act (2022) to P&A its low-producing conventional wells and install new equipment designed to reduce methane emissions.

The company has also continued other unusual, often questionable, financial practices throughout 2022. For the ninth consecutive year, the company booked a Gain on Bargain Purchase, which is an uncommon financial practice of recording a financial gain on an acquisition on its income statement. And, at the end of 2021, it carried forward $183 million in unused marginal tax credits, which are tax credits it generated when natural gas prices were low. These ongoing, highly irregular financial practices question Diversified’s ability to retire its own wells and suggest that it may be an inappropriate steward to help solve the country’s orphan well crisis.


Leave a Comment

Previous post:

Next post: