Barriers to the exit of fossil fuels

November 09, 2020 Energy

Faced with the slowdown in their activity due to the pandemic and the transition to a decarbonized economy, companies exploiting fossil fuel deposits will have to reduce their activity, or even shut it down for good. What will become of their extraction facilities? Stopping their operations will not be without consequences for the environment and the climate.

Uncontrolled degassing

In the United States, oil and gas field closures are increasing. For 2020, it is estimated that around sixty companies in the sector will be placed under Chapter 11 of the bankruptcy code (close to the French safeguard procedure), and the same is expected for 2021. To these companies in difficulty but not yet in suspension of payments, we will probably have to add an equal number that will go bankrupt without going through the Chapter 11 regime. These closures or reorganizations obviously pose problems for employees, customers, suppliers and creditors. But they also raise important environmental issues. When a company permanently ceases mining a mineral deposit, it must plug the shafts, dismantle the surface facilities and restore the site to its original state. This is at least what the regulations in France require. In some American states, it seems that oil and gas companies can abandon deposits that have become unprofitable without worrying too much about their future, in particular by letting them release large quantities of methane into the atmosphere in addition to the 'normal' degassing of sites still in operation. Methane is a very powerful greenhouse gas with a global warming potential 28 times higher than that of carbon dioxide. According to an article in the New York Times, there are already more than 2.5 million abandoned gas and oil wells in the US, 2 million of which are unclogged, releasing quantities of methane equivalent to the annual greenhouse gas emissions of more than 1.5 million automobiles.

Barriers to entry and exit

Having to invest to get into an activity is easy to accept when you know you will make a profit from it. The expenses necessary to acquire or rent land and machinery, purchase raw materials and hire labor are natural barriers to entry, to which must be added institutional barriers (administrative authorizations, patents, diplomas) designed to guarantee a certain level of quality and safety. But having to pay to get out of the business and no longer earn anything is more difficult to rationalize for profit-driven economic actors. It is a barrier to exit that makes people want to remain active, or, if they are not yet in the business, that plays the same role as a barrier to entry. If there are barriers to exit, we will keep inefficient or even loss-making companies active over several years (zombie companies) and slow down innovation and the reconversion of production assets. But, if there are none, firms will tend to use their environment (in the broad sense) as a free dumping ground for everything that no longer interests them. Breaking a delivery or supply contract may be profitable, but harmful to the co-contractors who had invested to meet the contractual terms. Terminating a labour contract may be beneficial to the employer, but to the community it is one more unemployed person who will need help and training to get back to work. Termination benefits are there to avoid excessive opportunism. But they are not sufficient, as economists Olivier Blanchard and Jean Tirole suggested a few years ago when they advocated applying a principle of accountability whereby companies should pay the unemployment insurance fund an amount equal to the anticipated amount of unemployment benefits that this fund will have to pay to the dismissed employee.

Forecasts and provisions

Awareness of environmental concerns is more recent than the concern to improve trade and labour relations. The rules on corporate responsibility towards the environment are therefore still imprecise, especially when they cease their activity, leaving a slate that will eventually have to be settled by the community. Regarding methane leaks, companies that undertake the drilling of a well should be obliged to make provision for the expenses that will be necessary to secure it when it is closed. But provisioning is not enough.

The American example shows that profits earned during operations are used at best to invest in new drilling (the promoters of accelerated decarbonation would say that this is the worst case), at worst to pay bonuses to managers and dividends to shareholders before any provision is made for dismantling equipment and securing sites. In New Mexico and Texas, there are plenty examples of oil and gas companies applying for Chapter 11 in the weeks following substantial bonus payments to those responsible for their setbacks. The value of the liquidation assets does not cover the costs of clean-up, which must ultimately be paid for with public money.

It is true that the recent acceleration in the shift away from carbon-based energy was difficult to predict. But all industrial activities are risky, and it is one of the tasks of the entrepreneur who wants to benefit from the favorable risks to provide coverage for unfavorable risks. According to Carbon Tracker, it would cost $280 billion to plug the approximately 2.5 million onshore wells identified in the United States. This figure excludes unrecorded wells, estimated at around 1.2 million. The states concerned, in particular Texas, have secured only 1% of the necessary funds. In the end, taxpayers will pay, or future generations will live in an even warmer climate if the wells are not plugged.



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With the ecological transition, the number of orphaned oil and gas wells, i.e., wells that have become unproductive or unprofitable and are not being capped for financial reasons, is expected to increase. The resale value of exploration and operating assets will gradually decline as all operators will slow down their activity. It is therefore not with the liquidation of these stranded assets that companies will be able to cover their exit costs. As a result, there should be a worsening of greenhouse gas leakage before public finances are called upon to replace the failing private operators. The cost of entry into green energy is high. It should not be forgotten that the exit from durty energies will also be very expensive. One more line to add to the energy transition bill. But all of these costs of reconversion of the economy must be weighed against those that humanity will suffer if nothing is done to curb global warming.