With Congress and the White House mired in partisan gridlock and preoccupied by issues like the federal debt ceiling, the Affordable Care Act rollout, and the Edward Snowden leak investigation, states again took the lead on shale gas issues in 2013. Several states enacted new hydraulic fracturing regulations, with many others completing overhauls of existing rules to account for changing technology and expanded opportunities for unconventional oil and gas plays.
This report examines the key legal developments in the shale oil and gas industry in 2013, with a look ahead to several key issues that will continue to shape this industry in 2014.
Federal Government
Legislative Developments
Congress once again spent the year mostly on the sidelines in the hydraulic fracturing debate, with little if any significant shale legislation reaching President Obama's desk. In June, the President unveiled his proposed Climate Action Plan—a comprehensive strategy to address climate change by reducing domestic carbon pollution, which included a proposal for national carbon emissions standards by the Environmental Protection Agency (EPA). But Democratic lawmakers were unsuccessful in pushing through any significant oil and gas legislation in 2013. For example, Democratic senators introduced a bill—known as the FRAC Act—that would amend the Safe Drinking Water Act to repeal an exemption from restrictions on underground injection of fluids for fracturing operations. The bill never made it to a full vote.
Significant legislative efforts by Republicans similarly stalled before reaching the President's desk. One Republican bill—the Federal Lands Jobs and Energy Security Act (H.R. 1965), which aimed to streamline the drilling permit process on federal lands—passed the House in November, but quickly lost momentum and was never taken up by the Senate. Another Republican proposal—the Protecting States' Rights to Promote American Energy Security Act (H.R. 2728), which gave state drilling laws primacy over federal regulations—also passed the House in November, but was quickly scuttled when the White House threatened to veto any attempt to undermine federal regulatory authority over drilling.
Regulatory Developments
Most of the action on the federal level occurred in the regulatory sphere, with the highlight being the Bureau of Land Management's (BLM) proposed rules on the use of hydraulic fracturing techniques on federal land, issued in May 2013. The rules represent a modified version of drilling regulations proposed by the BLM in 2012, based in part on public comments received by the agency after its initial proposal.
Among other things, the BLM's revised rules would: (i) exempt automatic disclosures of chemicals used in the fracturing process based on trade secret protections and institute a central website, "FracFocus.org," for all public disclosures; (ii) create testing protocols for well integrity, particularly the cement casings on wells and aquifers, maximum injection pressure, and flowback volumes; and (iii) require management plans for the protection of both surface water and groundwater from contamination by flowback fluids, including potentially requiring such fluids to be stored in closed tanks.
Experts have estimated that the BLM's proposed regulations could cost the industry anywhere from $20 million to $2.7 billion each year. The public comment period for the proposed rules, which ended in August, drew over 1 million responses, and the BLM has yet to set a date for issuing a final rule. Among the concerns voiced in the public comments were calls for greater protection of industry trade secrets, since as-written, the rule requires companies claiming protection to provide proprietary information to operators, which conflicts with normal practice and could violate private non-disclosure agreements.
Several new rules issued by the Occupational Safety and Health Administration (OSHA) will also impact the oil and gas industry, including a proposed rule governing acceptable exposure limits for silica dust. The rule, proposed in September 2013, triggered a mandatory 90-day public comment period, which ended in December. No final rule has been issued, but industry experts have warned that any such rule could be particularly costly to drillers using fracturing techniques that depend on the use of silica sand.
In July, the Federal Railroad Administration announced that it would be investigating the safety of transporting crude oil by rail, citing potential safety issues related to improper classification and packaging of crude oil, as well as overloading of tank cars. The investigation came in the wake of a large train crash in Canada involving a 72-car train carrying crude oil. The train was transporting the oil out of North Dakota's Bakken shale formation when it derailed and exploded in the town of Lac-Megantic, Quebec, killing 47 people. If this investigation is any indication, oil and gas companies will likely face increased scrutiny of domestic rail shipments as we move into 2014.
As for the EPA's long-awaited study on the effects of hydraulic fracturing on the nation's drinking water, the agency showed little progress in 2013. While it continued to gather data and assess potential impacts throughout the past year, the EPA has indicated that the first draft of the report will not be available until mid-2014.
State and Local Government
Legislative and Regulatory Developments
State and local governments continued to take the lead in regulating shale oil and gas development in 2013. In fact, Pennsylvania, California, Illinois, and Michigan all passed or proposed new rules regulating hydraulic fracturing last year, with several other states and local governments amending or expanding existing rules.
In August 2013, the Pennsylvania Department of Environmental Protection announced new proposed regulations governing (i) protection of public lands and resources; (ii) orphan and abandoned well identification; (iii) pollution containment practices; and (iv) protection of water resources. The regulations—which will likely impose additional regulatory requirements on drillers in the Marcellus Shale formations in western Pennsylvania– were approved by the state's Environmental Quality Board in August, and now must be passed on by the Pennsylvania Attorney General before being opened to public comment.
California's new legislation marks the most comprehensive regulatory overhaul of the past year. In September 2013, California Governor Jerry Brown signed "SB 4"—California's first comprehensive regulation of fracturing activity in the state's Monterey Shale deposit, which has been estimated to hold approximately 15.4 billion barrels of oil. Among other things, SB 4—which took effect starting in 2014—requires: (i) permits for well stimulation activities, including "acidizing" (the use of chemicals to dissolve rock beneath the surface); (ii) notification of neighboring communities of hydraulic fracturing; (iii) public disclosure of chemicals used in well stimulation activities; (iv) groundwater and air quality monitoring; and (v) an independent scientific study of the impact of well stimulation activities on the environment. Notably, the law did not include a proposed "moratorium" on fracturing, which some environmentalists had previously advocated.
The Illinois legislature also passed new regulations to cover hydraulic fracturing in 2013, with Governor Pat Quinn noting that the law offered "the nation's strongest environmental protections." Subsequent rulemaking by the Illinois Department of Natural Resources—which published a first draft of rules for high-volume oil and gas drilling in mid-November—appear to have relaxed some of the strict environmental controls that many had envisioned when Governor Quinn first announced the new law. For example, while the law requires drillers to store fracking wastewater in covered tanks rather than open pits, the rules allow for emergency overflow into reserve pits, which need only be removed seven days after drilling is complete, rather than seven days after discharge.
In Texas, the city of Dallas—which sits on the edge of the Barnett Shale formation—made news in December after the city council passed strict drilling requirements banning hydraulic fracturing within 1,500 feet of any home, school, church, or other protected area, effectively eliminating all hydraulic fracturing within city limits.
Local hydraulic fracturing bans were also big news in Colorado, where voters weighed in on several ballot initiatives proposing local bans of hydraulic fracturing activity. In all, four Colorado cities approved hydraulic fracturing bans during the 2013 election cycle. Colorado also made significant news when its Department of Public Health and Environment adopted new regulations requiring the oil and gas industry to significantly reduce volatile organic compound (including methane) emissions from its operations. By doing so, Colorado became one of the first states to go substantially beyond the requirements set forth in federal regulations. Many believe that Colorado now has the most stringent air quality requirements for the oil and gas industry in the United States.
Ohio likewise faced several ballot initiatives aimed at creating local fracking bans in 2013. Voters twice defeated the same anti-fracking initiative in Youngstown, Ohio—once in May and again in November—by margins of 57-43 percent and 55-45 percent, respectively. Voters in Bowling Green, Ohio also rejected such a measure, this one by a 75-25 margin. However, a third ballot initiative—this one in the small college town of Oberlin, Ohio—did manage to pass.
To the dismay of landowners and industry players alike, the country's largest—and longest—ban on hydraulic fracturing held steady in 2013, as New York continued its "review" of the environmental impact of fracturing. As discussed in the section below, some groups have resorted to lawsuits questioning the legality of the moratorium—or more precisely, Governor Andrew Cuomo's failure to act on the moratorium one way or the other. Most observers believe that Governor Cuomo will attempt to straddle the political divide until after his 2014 re-election campaign.
Finally, states have begun to adjust tax policy to take advantage of increased oil and gas production. In Pennsylvania, a group of legislators proposed a 4.9 percent severance tax on all natural gas production occurring in the state. Similarly, in Ohio, Republican members of the Ohio House of Representatives introduced a bill—HB 375—that would impose a 1 percent severance tax on horizontally drilled and stimulated (i.e., hydraulically fractured) wells during the first five years of production, with the potential to rise to 2 percent for wells producing at a high volume. That legislation represented a compromise from a proposal in Ohio Governor Kasich's budget, which called for a 1.5 percent severance tax, with the potential to rise to 4 percent.
Litigation
A number of important issues are now beginning to reach the states' highest courts, including several cases dealing with the balance between state and local authority in regulating oil and gas exploration. This issue was highlighted by the Pennsylvania Supreme Court's decision striking down Pennsylvania's "Act 13," which, among other things, preempted local zoning rules in favor of statewide regulation and required local governments to allow oil and gas development in all zoning areas. In a 4-2 decision handed down in December, the Pennsylvania Supreme Court ruled that Act 13 violated the state's Environmental Rights Amendment, thus invalidating the statute's preemption provisions. Drillers operating in Pennsylvania now face the prospect of complying with multi-layered regulation—first at the statewide level, and again at the local level. The decision has cast uncertainty on the future of drilling operations in Pennsylvania's rich shale developments.
In another case involving the power of local governments to regulate drilling through zoning codes, the Ohio Supreme Court agreed to consider the scope of the state's constitutional "home rule" protections in light of a state statute granting the Ohio Department of Natural Resources "sole and exclusive authority" over drilling activities, including the "location" of oil and gas wells. An Ohio town subsequently sued an oil and gas company for failure to comply with local zoning codes, arguing that the statute effectively preempts local zoning power in violation of the constitutional guarantee of "home rule." The Ohio Supreme Court heard oral argument in early 2014, and is expected to rule later this year.
Ohio continued to be a hotbed for oil and gas litigation in 2013, with several important decisions issued at both the trial and appellate levels. For example, a federal district court decided in February that oil and gas leases are not "real estate" under Ohio's real estate broker laws, and therefore the sale of such interests did not entitle the brokers to a commission. And in another case, Chesapeake Exploration LLC v. Oil and Gas Commission, the Ohio Supreme Court divested the Oil and Gas Commission (OGC) of appellate jurisdiction over the permitting process, holding that the issuance of a drilling permit issued by the chief of the Ohio Division of Oil and Gas Resources Management does not constitute an "order" and thus cannot be appealed to the OGC under Ohio Revised Code 1509.36.
Virginia may be poised to join the zoning fray, as the state attorney general issued an opinion last March questioning the legality of local drilling bans when accomplished through zoning ordinances. And members of Colorado's oil and gas industry have filed a number of suits challenging the voter-approved fracking bans on similar grounds, essentially arguing that the local bans are inconsistent with the state legislature's intent to grant regulatory authority to the statewide oil and gas commission.
New York's high court is also considering whether state law can preempt local zoning ordinances in the regulation of hydraulic fracturing. And Norse Energy, the appellant in that case, also filed a separate lawsuit challenging the statewide moratorium on the grounds that delays in completing the environmental review process violated New York law.
That case may soon be joined by another challenge to the New York moratorium. In November 2013, several New York landowners threatened to sue the state and Governor Andrew Cuomo to lift the moratorium, alleging that it amounts to an illegal "taking" under the United States Constitution.
In Pennsylvania, the state supreme court issued a second landmark decision in May 2013 dealing with the right to convey oil and gas rights in property. The case questioned whether the term "mineral" was sufficiently broad to include shale gas in a property deed reserving all "mineral" rights in the land. The court declined to rewrite the "longstanding" rule that oil is by definition not a mineral, holding by an 8-0 vote that the deed did not contemplate natural gas rights.
In Texas, the state's Supreme Court accepted a case that could determine whether landowners in the state can bring a cause of action for trespass when water from underground injection wells migrates onto their property. A decision allowing such claims could expose operators, who often use injection wells for wastewater disposal, to significant liability from neighboring property owners.
International Developments
International efforts to expand the use of hydraulic fracturing were met with mixed results in 2013. Poland continued to set the pace for European shale development, with 44 completed shale gas wells and over 100 exploration licenses issued by the government. The United Kingdom also signaled increased support for shale development, with the British treasury opting to lower tax rates for onshore shale gas production to 30 percent in July 2013.
On the other hand, several European countries showed increased hostility toward hydraulic fracturing. In October 2013, France's high court upheld the country's 2011 ban on hydraulic fracturing as a result of the perceived environmental risks. France joins Bulgaria as the only European countries to enact complete bans on hydraulic fracturing.
In Germany, just seven months after Chancellor Angela Merkel announced that the country would begin allowing fracturing outside of water protection areas, the German government imposed a moratorium on all fracturing activities pending an environmental investigation into the risks to drinking water and seismic activity.
Despite these developments, the European Union has yet to establish a unified policy on the use of unconventional drilling techniques such as horizontal directional drilling and hydraulic fracturing.
Shale development has continued outside of Europe as well. In October 2013, the South African government released draft regulations governing hydraulic fracturing. And in Argentina—already South America's largest producer of shale gas—the state-owned energy company YPF recently contracted with Chevron for a $1.2 billion investment with the goal of drilling 1,500 gas wells by 2017.
Looking Ahead to 2014
After another year of inaction in Congress, sweeping federal legislation on shale gas drilling appears to be off the table for 2014, particularly as politicians shift their focus to the mid-term elections. A decisive victory in November may provide some momentum for new federal legislation, but other issues—like healthcare, immigration, and the economy—will likely continue to dominate the political landscape.
The same cannot be said for federal regulators, however, who continue to push for comprehensive rules for hydraulic fracturing in domestic shale deposits. For example, the Bureau of Land Management is currently considering over 1 million comments to its proposed rules governing hydraulic fracturing, and will likely take further action—possibly issuing a final rule—in 2014. The Bureau of Ocean Energy Management is also expected to continue its efforts to facilitate oil and gas lease sales on the Outer Continental Shelf and it is reasonable to expect that the use of unconventional drilling techniques will continue to increase in federal waters.
The EPA is also poised to issue a draft report of its study analyzing the effects of hydraulic fracturing on drinking water sometime this year for comment and peer review. Congress commissioned the report in 2010, and the EPA last issued a progress report in 2012. The results of the report could potentially spur further regulatory activity both at the federal and state levels.
States will likewise continue developing regulations for the oil and gas industry, especially as shale development continues to spread to new geographic areas. For example, Michigan's Department of Environmental Quality has announced that it is developing new rules for hydraulic fracturing that would add protections for water resources and require additional chemical data submissions from drilling companies. Proposed rules are expected to be released in 2014. This year also marks the beginning of California's new hydraulic fracturing regime, and New York may finally see the dam break after the November elections.
Shale-related issues will continue to percolate in the courts as well. In Ohio, the Supreme Court is expected to issue its long-awaited decision on "home rule" protection for local zoning regulations of hydraulic fracturing. And a federal district court recently certified two questions of law to the Ohio Supreme Court regarding Ohio's Dormant Minerals Act: (1) whether the recorded lease of severed subsurface mineral rights constitutes a "title transaction" under the Act; and (2) whether the expiration of such a lease and the reversion of rights granted under the lease restarts the 20-year forfeiture clock under the Act. Finally, an Ohio appellate court will likely decide the fate of the trial court's decision in Hupp v. Beck Energy Corp. holding that the oil and gas leases at issue were perpetual leases in violation of Ohio's public policy and thus void. A similar case, Oxford Oil Co. v. West, et al., is also pending in another appellate district.
In Pennsylvania, drillers must contend with the impact of the Supreme Court's decision to strike down Act 13, exposing oil and gas companies to both state and local regulation of drilling operations. Elsewhere, land disputes, trespass claims, and regulatory conflicts will continue to develop as drilling operations expand.
Water is likely to be another hot-button issue in 2014, particularly in western states where water can be scarce. For example, Texas—home to the Barnett, Eagle Ford, and Permian Basin shale formations where production is expected to double in the coming years—is in the midst of a near-record draught cycle, potentially limiting the supply of water to the industry as drilling expands. Chesapeake Energy has estimated that a hydraulic fracturing well can require as much as 5 million gallons of water over its lifespan, and a 2013 report by Ceres showed that of the 25,450 wells surveyed, almost half were in areas facing high or extremely high water stress. Water scarcity has already forced many drillers to pay high premiums to guarantee water use, outbidding commercial users in other industries like agriculture.
Despite these challenges, natural gas production surged in 2013, and industry experts project continued growth in 2014, including expansion to less developed shale plays in Ohio and Michigan. The industry also has been focused on increasing available transportation for extracted oil, natural gas, and natural gas liquids.
Studies have continued to link shale gas exploration with economic benefits, including increased tax receipts, higher property values, decreased energy prices, and lower unemployment. At the same time, however, environmental groups have continued to oppose widespread use of hydraulic fracturing, raising fears of groundwater contamination, increased emissions, and potential seismic disruptions, even as scientists have continued to question the purported negative effects of drilling. That conflict will likely define the regulatory landscape for shale and tight sand drilling in 2014 and beyond.
BakerHostetler plans to hold four different Shale Symposium programs in 2014, the first of which was held on March 24, 2014 in Houston, Texas. Speakers included Jorge Leis, Partner and Head of Americas Oil & Gas Practice at Bain & Company, and Kenneth M. Fisher, Executive Vice President and Chief Financial Officer at Noble Energy. In the coming months, BakerHostetler plans to announce additional programs in Denver, Cleveland, and Pittsburgh. The Denver Symposium is slated for early May, with Cleveland and Pittsburgh to follow.
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