Alberta’s energy regulator owes investors answers on Sequoia Resources

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The Sequoia Resources Corp. bankruptcy is an ugly mess, not least for Alberta’s energy watchdog.

Among the many threads in the case – in which an insufficiently financed gas producer left a clean-up bill of $225-million – the Alberta Energy Regulator (AER) has much to answer for. And a difficult task to change its ways.

What’s become clear since Sequoia failed in March is that the legislation AER operates under has a gaping loophole that has allowed financially weak companies to bypass the regulator’s usual scrutiny and take ownership of assets burdened with high environmental liabilities. Most of Sequoia’s assets were acquired in one transaction that used that loophole.

The AER’s chief executive, Jim Ellis, acknowledged the gap last week and said work was underway to close it.

That’s good, but it’s not the only problem that has helped create an oil-patch version of a subprime crisis. Mr. Ellis has yet to explain why another of Sequoia’s asset purchases, which was subject to AER’s financial stress test, got its approval even though the company did not meet the minimum standard.

The test, known as the liability management rating (LMR) has proven to be highly problematic. When it was last toughened, in 2016, investment bankers worried that it would halt the trade in properties just as the oil patch struggled to recover. As it happened, some deals that should have been prevented were not.

Sequoia is where many of the system’s faults seem to have converged. It was set up by investors with strong links to China to buy aging gas wells and use some of the cash flow from them to decommission them as they petered out. The business plan was flawed, as it relied on gas prices rising. They fell.

This isn’t just an academic legal exercise. The case has implications across Canada’s energy sector, which thrives on trading assets. It also affects Alberta taxpayers, as the provincial and federal governments have provided financial backstops for the overburdened industry fund used for cleaning up orphan wells. Further, besides being the overseer, the AER is the largest creditor in the case, and has made a claim for the abandonment and clean-up.

This month, Sequoia’s bankruptcy yielded a $217-million lawsuit, filed by the insolvency trustee against Perpetual Energy Inc. and its chief executive, Susan Riddell Rose. It seeks to unwind Sequoia’s takeover of a Perpetual subsidiary that held the company’s high-liability gas wells in 2016, essentially asking a judge to turn back the clock.

The issue for the AER is the deal’s structure. Rather than transferring the assets to the buyer, which would have required the regulator to rule on its suitability for taking on at least $130-million worth of liabilities, Perpetual sold the shares in the subsidiary to Sequoia for, essentially, pocket change.

The trustee, PricewaterhouseCoopers, alleges Ms. Riddell Rose knew the business was doomed and would sink the buyer. Perpetual says it is being unfairly targeted and that the claim is without merit. It has has hired advisers and plans to defend itself vigorously.

But the fact remains that Sequoia, led by directors Wentao Yang and Hao Wang, acquired the wells when the deal would have been unlikely to pass muster as a straight transfer of assets. Sequoia acquired about three quarters of its wells in the deal.

“For the AER, this situation has exposed a gap in the system and raised questions with respect to how we better manage liability in the future,” Mr. Ellis said in a statement last week.

But another transaction Sequoia did in 2016 is troubling for another reason. It bought assets from bankrupt Waldron Energy Corp., and was exempted from the toughened LMR rules so the deal could be completed.

The Globe and Mail reported in March that Sequoia participated in a conference call with the regulator and Waldron’s receiver in October of that year. The company later submitted “a request to the AER to apply discretion” in relation to a toughened solvency test, according to court documents. The regulator must explain why it bent the rules in this or any other case.

Last week, the AER said it was starting a process to come up with a new system to gauge whether buyers of oil and gas assets can handle growing environmental liabilities. But any system is only as good as its enforcement.

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