Oil and Gas Bonds After COVID-19

Oil and Gas Bonds. Oil rig during sunset with Oil and Gas Bond During COVID-19 on it

Oil and Gas Surety Bonds could be headed for a hard market. Many industries are struggling to deal with COVID-19 (Coronavirus) and the current economic crises. The oil and gas industry has been hit particularly hard. Self quarantine orders in much of the world has led to a significant decrease in demand. Meanwhile, many countries are continuing significant outputs of crude oil. This oversupply has led to a sharp decrease in oil prices. This cut in prices will have a significant negative impact on small producers and will likely trickle down the surety bond market. In particular, plugging and abandonment bonds may become very challenging for smaller producers, operators and contractors.

What Is a Plugging and Abandonment Bond?

There are many types of surety bonds tied to the Oil and Gas Industry. Plugging and Abandonment Bonds are required by most states although the amounts differ. They guarantee that once a well is at the end of it’s useful life, the Principal on the bond will be responsible for closing out the well. Usually this process involves removing all pipe from the ground or cutting it at ground level. Then the well is filled with a plug (usually cement) to permanently seal the well. In theory, this protects groundwater and surrounding land from well contaminants and leakage. It also serves to block methane leakage. If the Principal and indemnitors on the bond cannot complete the plugging, the surety bond company must step in and pay for it.

Underwriting Challenges With Plugging and Abandonment Bonds

Often it takes many years for these wells to get plugged. Therefore surety bond companies want to make sure that the Principal on the surety bond is financially sound and can weather the ups and downs in the market and economy. This already makes it more difficult on smaller producers and contractors who do not have the same cushion and resources as larger companies. Additionally, these surety bonds have to be issued before the well is drilled. There is no guarantee that the well will be a success. Again, bigger companies can often withstand these risks much better than smaller ones.

Even before COVID-19, there were signs that we may see the industry tighten up on these surety bonds. Consider that many states including Alaska, New Mexico and others have passed legislation to increase the amount of these Plugging Bonds in recent years. The growing cost of plugging wells along with the large backlog of orphaned wells around the country have led to increased surety requirements. Larger surety requirements require that the Principal have more financial strength to get bonded.

Additionally, the industry was already seeing financial challenges before COVID-19. This report indicates that there were already 208 bankruptcy filings over a five year period. The shortage of demand and ensuing price declines will almost certainly increase this number. It could also increase the claim against surety bonds and drive the market into a hardened state. In surety bonds, a hard market refers to increased underwriting standards, increased rates, more difficult terms and less capacity in the marketplace. Often, both primary surety bond companies and their reinsurance underwriters may exit the segment or marketplace altogether. The longer this current pandemic continues, the more oil and gas bond claims we are likely to see and the more likely we see a hard market in this segment.

What Can Producers and Contractors Do?

Unfortunately, there is not much that can be done about the pandemic and the cost of oil. Principals should expect to allow more time to get a surety bond if their financial situation deteriorates. They should also be ready to communicate their plan for the current market and how they will turn things around. Depending on the situation, they may also want prepare for difficult surety bond terms such as rate increases, increased indemnity or even collateral in some cases.

MG Surety Bonds wants to help all businesses and individuals during this difficult time. We work with most major surety bond companies and can advise customers in all situations. We hope for a quick end to this pandemic but we are here to assist in any way we can. Reach out to us anytime.