Economic Yardsticks for the End of Economic Life: Holdback and Its Adjuncts

Abstract

Traditional economic measures use chiefly net present value to compare on-going net revenue to plugging liabilities and other retirement liabilities, but operators onshore in the US plan to pay for plugging costs from cash flow. Liabilities have accumulated and continue to accumulate as operators defer plugging. At the same time, production declines, and cash flow tapers and becomes riskier. When retirement liabilities become significant compared to thinned cash flow, traditional yardsticks obscure the risk of ultimate insolvency. Future cash flow becomes insufficient to fund liabilities years before the present value flags the inversion. Recognizing the cash shortfall – which can occur surprisingly early when liabilities are allowed to accumulate – can fundamentally change the way the investment is viewed, valued, and managed. Planning, therefore, requires new economic yardsticks to characterize the nature of cash flows with large retirement obligations, what can be called "holdback" and its adjuncts. These yardsticks look differently at the timing and risk of asset retirement obligations, namely backward from the end of the projection. "Holdback" is analogous to payout but in reverse from the end of economic life. Related measures similarly use other conventional yardstick concepts in reverse to characterize the situation more fully and to help an operator avoid orphaning its abandonment liabilities to be paid by taxpayers.