State of play: shale development highlights from 2012 and predictions for 2013

April 2013 | PROFESSIONAL INSIGHT | SECTOR ANALYSIS

Financier Worldwide Magazine

In 2012, the US Congress took no significant formal action with respect to shale development. Federal agencies did little to supply uniform regulation of shale drilling. But because nature abhors a vacuum, from a legislative and regulatory perspective US states stole the show in 2012. Some states overhauled their oil and gas programs, while others paused to evaluate potential impacts. Key shale states such as Texas, Colorado, Ohio, and New York continue ‘fine tuning’ their shale programs – a trend that will continue throughout 2013. And state courts began addressing disputes over ownership of shale gas rights and demarcating local and state roles for regulating shale drilling. Below we assess some of 2012’s key shale-related developments, and forecast what to expect in 2013.

2012 shale developments

Federal

The Energy Policy Act of 2005 exempted hydraulic fracturing activities from US EPA regulation under the Safe Drinking Water Act, unless the fracking fluids used contain diesel fuel. Congress has been unwilling or unable to pass legislation changing that framework. As a result, the EPA lacks much authority to regulate shale drilling directly. In response, agencies such as the EPA and the US Department of the Interior (DOI) have begun taking action where they have clear statutory authority to regulate shale development.

In May, the DOI proposed rules that would govern hydraulic fracturing on federal/public lands. These rules comported largely with the approaches of many states, but faced heavy resistance from industry organisations and states, which contend that states adequately regulate shale drilling and federal rules would only delay drilling and increase costs. In response, the DOI announced in December that it would reevaluate its proposal and re-issue it sometime in 2013.

Similarly, in August the EPA published final air emission regulations for the oil and natural gas production source category. The rules phase in requirements as of 2015 to use ‘reduced emissions completion’ or ‘green completion’ to capture natural gas that currently escapes into the air (which some states already require). Until then, fractured and refractured wells must reduce their VOC emissions by 95 percent through combustion devices (flares). Predictably, the EPA’s rules drew several legal challenges in federal court. The EPA recently announced that it plans to revise its new air rules in 2013 and 2014.

The EPA also has focused on long-term projects, such as investigations into groundwater contamination claims made by landowners in Dimock, Pennsylvania and Pavillion, Wyoming near shale drilling sites. The EPA found Dimock’s groundwater did not contain levels of contaminants that would pose health concerns to residents. And heavy criticism from Wyoming regulators and industry prompted the EPA to revise its initial report attempting to link chemicals from a Pavillion aquifer and water wells to area gas fields.

The States

State approaches to regulating shale development in 2012 varied and continue to evolve, becoming more nuanced as states become familiar with hydraulic fracturing techniques. But not every state welcomed shale development with open arms. New York and Maryland have temporary moratoria in place. Maryland is developing hydraulic fracturing rules that it should publish in 2013. And New York not only released draft regulations in November, but also recently leaked a draft health assessment indicating that shale drilling can be conducted safely.

Many more states opted to regulate shale development rather than curtail it entirely. Following the lead of early adopter states such as Wyoming, Texas and Montana, in 2012 many key shale states updated their oil and gas programs to address hydraulic fracturing, including: Texas, New Mexico, Pennsylvania, Colorado, North Dakota, Ohio, Oklahoma, and Indiana. Beyond updated well operating and permitting requirements, many of these states adopted expanded requirements for disclosing the contents of fracturing fluids to state regulators.

The Courts

The most noteworthy lawsuit in 2012 arose in Pennsylvania in response to the state legislature’s revision of Pennsylvania’s oil and gas laws via Act 13. One of Act 13’s provisions required localities to amend their zoning ordinances to allow oil and gas operations in all zoning districts – including residential zones. That provision was challenged on the grounds that it forced localities to enact zoning ordinances that are incompatible with their comprehensive plans and neighbouring land usage, effectively making their zoning irrational.

In August 2012, Pennsylvania’s Commonwealth Court in the Robinson Township case overturned the zoning provisions of Act 13, holding that they impermissibly pre-empted local zoning regulation of oil and gas activity in violation of federal and state substantive due process. The State appealed, and the Pennsylvania Supreme Court heard oral arguments in October. Similar pre-emption battles between state and local governments have begun in Ohio and Colorado.

2013 shale developments and predictions

In a sharply divided 113th Congress focused primarily on other issues, the prospects of federal legislative action expanding the federal government’s regulation of shale drilling appear dim. Absent Congressional action, federal agencies will use their existing authority to regulate where they can. President Obama recently nominated new heads of the EPA and DOI whose agendas as to shale development will be revealed through the confirmation process.

The DOI is expected to re-launch its rules for drilling on federal lands this year, and the EPA recently announced that it would revise its oil and gas air rules to address industry and state concerns. And while the EPA recently issued a progress report on its hydraulic fracturing study, the study’s final results will not be available until 2014.

At the state level, Pennsylvania’s Supreme Court will decide the Robinson Township case in the coming months. This decision could reshape the application of state energy and zoning laws to shale drilling. But the Court’s current makeup of eight justices – split 4-4 along party lines – increases the likelihood that the Court will uphold the invalidation of Act 13’s zoning and setback provisions.

We also believe New York will lift its moratorium on shale drilling. New York’s recently-released draft hydraulic fracturing regulations indicate that it likely will reauthorise drilling in some fashion, either statewide or in certain areas.

More states will amend their oil and gas laws in 2013, either legislatively or by regulation. Large states near emerging shale plays, such as California and Illinois, have yet to overhaul their regulations, but bills are pending in their state legislatures to do just that. California’s Department of Conservation also recently released a ‘discussion draft’ of regulations that would govern hydraulic fracturing in the state. And early in 2013, Colorado became the first state to require both pre-drilling and post-drilling groundwater testing for new shale wells.

State taxation of shale development is an issue gathering steam. Ohio is a key flashpoint state in 2013 on this topic. Last year, Ohio Governor John Kasich proposed increased severance taxes on newly-permitted wells. That proposal went nowhere in a Republican-controlled legislature. Undeterred, Gov. Kasich re-launched his proposal in the 2013 legislative session, coupling it with other tax reductions. If he succeeds, governors in other key shale states may be emboldened to propose similar tax schemes.

2013 also likely will see transportation infrastructure begin to catch up with the pace of drilling, particularly in areas such as Ohio where gathering lines, processing facilities and other related infrastructure continues to be a bottleneck to development. In Ohio, several companies have proposed gathering lines, transmission lines, and processing plants, with many more comparable proposals in the works.

Marty Booher is a partner, and Jason Yearout and Cassie Dallas are associates, at BakerHostetler. Mr Booher can be contacted on +1 (216) 861 7141 or by email: mbooher@bakerlaw.com. Mr Yearout can be contacted on +1 (614) 462 5122 or by email: jyearout@bakerlaw.com. Ms Dallas can be contacted on +1 (713) 646 1325 or by email: cdallas@bakerlaw.com.

Marty Booher, Jason Yearout and Cassie Dallas

BakerHostetler