While high-profile regulatory efforts focused on hydraulic fracturing, waters of the United States, sage grouse, and greenhouse gas emissions have grabbed media headlines over the last several months, a potent stew of seemingly mundane technical initiatives has been simmering under the noses of domestic energy companies. Taken individually, narrow regulatory proposals related to oil and gas accounting, permitting and planning requirements, procedural rules for administrative appeals, royalty reporting, weights and measures, bonding requirements, and infrastructure development have been of interest to only a small group of regulatory and legal technocrats. But understood collectively, these less glamorous initiatives have the potential to fundamentally change the scale and nature of oil and gas development in the United States.
I. BROAD REGULATORY INITIATIVES
In just the past three years, the Obama Administration has engaged in rulemaking and enforcement initiatives related to, among other topics:
- The “unbundling” of processing costs necessary to put natural gas into “marketable condition” for the purposes of royalty reporting.
- Permitting and planning for private oil and gas development on National Wildlife Refuge System lands.
- Culpability standards for civil penalties associated with royalty reporting and civil procedure rules for administrative challenges to civil penalty assessments.
- Processing of rights-of-way on Indian lands.
- Royalty rates, annual rental payments, minimum acceptable bids, bonding requirements, and civil penalty assessments for federal onshore oil and gas leases.
- The application of “major portion” pricing for the calculation of royalties derived from production on Indian oil and gas leases.
- Facility measurement points, site facility diagrams, the use of seals, bypasses around meters, documentation, recordkeeping, commingling, off-lease measurement, and the reporting of incidents of unauthorized removal or mishandling of oil and condensate.
- Oil meter technology, proper measurement documentation, recordkeeping requirements, and penalties associated with measurement errors.
- Gas measurement at production facilities.
- Permitting and planning for private oil and gas development within National Parks.
And within the next few months, the Bureau of Land Management (“BLM”) is expected to propose at least one additional rule related to venting and flaring of natural gas from oil wells on federal and Indian lands. BLM had advised the public that the agency “is considering various options for addressing venting and flaring of gas and the loss of gas through fugitive emissions from onshore Federal and Indian oil and gas operations.” BLM’s proposal is expected to include rules governing well completions, production testing, liquids unloading, emissions control, gas conservation plans, and maintenance and repair obligations.
Though segmented in implementation, each of these regulatory measures represents a reaction to a pair of related themes that run throughout the Administration’s energy policy. The first theme is the idea that federal agencies have not kept pace with technological and economic developments that precipitated the contemporary boom in domestic oil and gas production. The result has been, according to the agencies, a proliferation of activities alleged to be either unregulated (or under-regulated), e.g., hydraulic fracturing, and long backlogs for federal permits and authorizations. The second theme is a concern that the current rules for calculating and collecting royalties on production are insufficient to ensure that the American people receive a fair return on development of the federal mineral estate. Regulatory efforts to address those concerns reflect a desire to control where and how oil and gas is produced, measured, transported, and sold.
Beyond the actual content of any individual rule, the actual segmentation itself has important implications for the impact of the Administration’s regulatory program. The value of an oil and natural gas asset derives from the interplay of many aspects. Royalty rates, bonus bids, operational costs, regulatory costs, taxes, transportation, and distribution costs all impact an asset’s value. Adjusting any one of these features in isolation, without consideration of the effect on other features, may have significant impact on an operator’s decision to develop federal resources and is not tailored to optimize the value of the lease to the operator or the government.
Companies’ investment decisions are based on reasonable expectations about what a company will earn from a proposed project. When development costs, operational costs, taxes, regulatory compliance costs, and other obstacles are manageable, higher rates of development can be expected. When operational requirements and regulatory policy undermine profitability, development is unrealistic. The most essential point is that companies choose to develop on the lands that promise to deliver the highest returns.
Nor are tHe government’s returns shielded from the impact of burdensome regulations. Recent regulatory initiatives may produce higher revenue on production that occurs on federal leases, but royalties are paid only when production occurs. If regulatory requirements diminish the overall return producers earn on a project, the most likely result is less production on federal lands. Federal lands are in competition with state and private lands to attract investment and commercial activity; federal policy should therefore ensure that the terms of accessing federal lands encourage development, allowing federal lands to compete favorably with alternative development locations.
II. THE NDFO FLARING DECISION.
While the full implications of these regulatory initiatives are not yet clear, a BLM field office in North Dakota has recently taken action that might provide industry observers with insight into the types of challenges energy companies could face if the Administration’s policies are fully implemented. BLM’s North Dakota Field Office (“NDFO”) in Dickinson, North Dakota, is a subcomponent of BLM’s Montana/Dakotas State Office. The NDFO has management authority over federal and Indian trust mineral estates in the western third of North Dakota. Consistent with that responsibility, the NDFO manages approximately 2,000 oil and gas leases, and has trust responsibility for over 3,000 Indian oil and gas leases located mostly on the Fort Berthold Reservation.
Because of the explosive growth of production from shale, combined with federal budget restraints, the NDFO, like other BLM field offices around the country, has amassed long backlogs for administrative review and approvals of drilling permits, rights-of-way, and other authorization necessary for production. One such authorization often involves requests to vent or flare natural gas from oil wells. Development in western North Dakota is typically focused on production of oil from the Bakken and Three Forks formations. Although Bakken pools producing in North Dakota are oil reservoirs, gas is produced in association with the oil at the wellhead as a by-product of oil production. During oil production, it may be necessary to burn or release this gas for a number of operational reasons, including lowering the pressure to ensure safety. But the current gas-gathering infrastructure in North Dakota is insufficient to accommodate the volume of gas produced in the state because of, among other reasons, “the high liquid content of the gas, the prolific volumes of oil and gas during initial production, increasing pipeline pressure that requires installation of additional compressors, and in some cases undersized pipe.”
With limited exception, oil-well gas produced in the development of federal and Indian minerals “may not be vented or flared unless approved in writing by [BLM’s Area Oil & Gas Supervisor].” Because producing valuable Bakken oil is often not possible without releasing natural gas, operators in North Dakota frequently seek the Supervisor’s authority to vent or flare gas from their oil wells. Under the controlling Notice-to-Lessees, NTL-4A, the Supervisor may approve venting or flaring based on the submission of:
(1) an evaluation report supported by engineering, geologic, and economic data which demonstrates to the satisfaction of the Supervisor that the expenditures necessary to market or beneficially use such gas are not economically justified and that conservation of the gas, if required, would lead to the premature abandonment of recoverable oil reserves and ultimately to a greater loss of equivalent energy than would be recovered if the venting or flaring were permitted to continue or (2) an action plan that will eliminate venting or flaring of the gas within 1 year from the date of application.
Particularly where gas cannot be gathered, transported, and sold economically, the Supervisor’s approval is essential to oil and gas producers because no royalty obligation is incurred on gas that is “vented or flared with the Supervisor’s prior authorization or approval during drilling, completing, or producing operations.”
On August 25, 2015, the NDFO issued a Record of Decision (the “ROD”) effecting a summary disposition of 2,211 backlogged Sundry Notices, dating back to at least 2011 and still pending before the NDFO. Each of the Sundry Notices subject to the ROD either provides notice of the operator’s intent to engage in authorized venting or flaring of natural gas consistent with the terms of NTL-4A § III or requests authority to vent or flare individual wells based on satisfaction of criteria articulated in NTL-4A § IV. The ROD mandates how the NDFO will treat two categories of Sundry Notices that request to flare gas from “Federal and Indian oil wells in the western portion of North Dakota”: (i) pending Sundry Notice requests “that flared oil-well gas”; and (ii) pending Sundry Notice requests “with ongoing flaring and future flaring requests.”
For Sundry Notices involving wells that flared in the past, the ROD provides that, “[i]f the well flared oil-well gas for seven days or greater, the gas flared during the first six days would not be royalty bearing and the gas flared from day seven and beyond would be royalty bearing.” For Sundry Notices concerning wells “with ongoing flaring and future flaring requests,” the ROD indicates that the NDFO will determine whether “flaring requests are avoidable loss or unavoidable loss in accordance with NTL-4A.”
There are questions regarding whether there is a sufficient legal basis for the NDFO’s ROD. The ROD creates without explanation a per se cut-off for royalty accrual. The ROD neither considers the operational parameters of any individual well nor identifies any legal or regulatory authority supporting the categorical imposition of a royalty obligation after six days of venting or flaring. And the ROD makes no findings to determine whether any venting or flaring that occurred was the product of operator negligence, is eligible for Supervisor approval, or has been determined to be “avoidable” or “unavoidable” under NTL-4A. It is not surprising that several legal challenges have been filed seeking to have the ROD set aside.
III. PREDICTING THE REGULATORY FUTURE.
More important than the legality of the ROD is what the ROD might foreshadow about federal regulatory policy in the future. Each of the themes driving the Administration’s ongoing regulatory initiatives is reflected in the NDFO’s decision. The NDFO’s inability to complete the administrative review of Sundry Notices in a timely fashion required a blanket disposition of Sundry Notices. The ROD’s categorical treatment of wells with distinct operational parameters suggests both an attempt to overcome BLM’s lack of resources and expertise and an effort to clear a major backlog of administrative tasks that BLM does not realistically have the capacity to complete. As many of the Administration’s proposed rules are finalized, operators should expect more bright line rules that are only loosely related to the operational and logistical details of any particular wellsite or project.
The ROD also represents an aggressive attempt to increase the federal government’s take of the revenue associated with oil and gas production on federal and Indian lands. Unlike NTL-4A, which accounts for economic and engineering factors that may require the release of natural gas, the ROD attaches a royalty obligation to all natural gas that comes out of a well after more than six days after completion, regardless whether that gas is marketable and without considering whether oil can be produced without venting or flaring. As such, the ROD’s approach is entirely consistent with regulatory efforts aimed at producing, measuring, capturing, and accounting for gas in a manner that ensures the government a revenue stream from any gas that is produced during any phase of the production process, regardless how that gas is used or sold.
One consideration that appears to be missing from the ROD’s analysis, of course, is the economic impact the deviation from NTL-4A is likely to have on oil and gas producers in western North Dakota. Given the limited infrastructure and high development costs in North Dakota, it is not unreasonable to assume that generally applicable restrictions on venting and flaring could undermine the profitability of at least some federal and Indian oil wells– particularly in the depressed commodity price environment that operators currently face.
Similar impacts can be expected in conjunction with the Administration’s regulatory agenda. Disguised as narrow, logistical, and even “boring” regulatory updates, the Administration’s current regulatory agenda could have sweeping implications for domestic producers and consumers. And even before all the regulations are finalized, anecdotal evidence from operators across the country suggests that the legal, operational, and accounting costs associated with the new regulations have impacted the bottom line, threatening the economics of developing federal lands. While no operator can ignore the splashier regulatory activity that steals the media headlines, prudent operators will not underestimate the impact of more mundane, but no less important, policy initiatives that have the potential to reshape domestic oil and gas production.