Licences issued for awards of acreage in the expected 14th onshore oil and gas licensing round will incorporate new model clauses that make allowance for the wide distribution of shale reserves across licence areas, clarify the process for extensions of time and provide for speedy dissemination of geological data and operational results from hydraulic fracturing.
Until these new regulations, the model clauses applicable to onshore exploration and production had not been specifically adapted to accommodate unconventional oil and gas activities. The most recent clauses are set out in the Petroleum Licensing (Exploration and Production) (Seaward and Landward Areas) Regulations 2004 ("2004 Regulations"). However, the shale gas industry had concerns regarding their application to shale gas exploration and in particular the requirements for surrendering acreage.
Current licence terms require operators to surrender at least 50% of their licensed acreage at the end of the Initial Term (6 years from the date of issue of landward licences). However, shale gas is not concentrated in discrete locations, but is likely to be dispersed in the target rock formation across substantial parts of the licensed area. Consequently, shale gas companies are less likely to be able to easily identify particular geographical areas of low-value acreage to surrender. Significant exploration is also required to ascertain the best areas in which to gather geological data, drill and test gas flow rates, and results from early test wells will inform future areas to target. Operators are therefore understandably keen to be able to retain more than 50% of the licensed area at the end of the Initial Term.
In response to these concerns, on 24 June 2014 the Government issued the Petroleum Licensing (Exploration and Production) (Landward Areas) Regulations 2014 ("2014 Regulations"):
- Schedules 2 and 3 set out the new model clauses for ‘petroleum exploration and development licences’ and 'landward exploration licences' respectively.
- Schedule 1 sets out the lines dividing the landward and seaward areas (and is purely a restatement of the existing position).
The 2014 Regulations will take effect from 17 July 2014 and will apply to any licence granted on or after 17 July 2014. This will include licences awarded under the 14th onshore licensing round, expected to be announced once DECC has concluded its review of responses to consultation on the associated Strategic Environmental Assessment published earlier this year.
They are not specific to shale gas development but designed to accommodate all forms of onshore oil and gas development, whether for example shale gas, shale oil, coal bed methane or conventional drilling. For all licences granted under previous licensing rounds, the existing model clauses will continue to apply.
2. Key Changes
Schedule 2 - Petroleum Exploration and Development Licences
Clause 3 (commencement and continuation of the licence) has been brought into line with the corresponding clause in the model clauses that apply to seaward licences and makes some cosmetic changes to the licence layout.
Licences retain a three-term structure, with an Initial Term in which a Work Programme must be completed if the licence is to continue into a Second Term, and a Second Term in which a Field Development Plan must be approved if the licence is to continue into the Production Period.
For licences under the 2014 Regulations, there will be a slight change to the term lengths from 6+5+20 years previously to 5+5+20 years, although there is no supporting explanation as to why this change has been made. The requirement for a 50% surrender of acreage before the Second Term remains, but is subject to the right to create Retention and Development Areas (see below).
A so-called 'drill or drop' provision similar to that in the offshore model clauses has been introduced. Under clause 4, the licence will automatically terminate before the end of the Initial Term where the operator fails to carry out, or undertake to complete, the relevant part of the Work Programme within the prescribed period. However, DECC has a discretion to waive this and allow the licence to continue.
Extension of Initial and Second Terms:
In clause 6, a clear procedure is set out in case a licensee wishes to extend the Initial or Second Term of the licence. The extension will be effected by a written direction from DECC, rather than by way of a Deed of Variation as was the practice previously. Extension of the Initial Term will have the effect of reducing the length of the Second Term, and likewise extension of the Second Term reduces the length of the Production Period, such that overall the length of the licence period remains unchanged.
Retention and Development Areas:
Clause 16 provides a scheme whereby the licensee may apply for, and the Secretary of State can by notice agree, the creation of Retention Areas (for exploration activities). The licensee must provide a Retention Area Plan with its request for a Retention Area. An expiry date must be set and they can be revoked for failure to carry out the agreed work in the plan by the date agreed. Retention Areas cannot overlap with Development Areas.
The operator is required to designate one or more Development Areas before erecting permanent structures for petroleum extraction (as opposed to exploration) when called upon by DECC to produce a development programme. Development Areas can be revoked if the operator fails to achieve production by a set date.
Generally, all of the remaining area not developed as either a Retention or a Development Area by the end of the Initial Term must be surrendered, unless DECC agrees it is necessary for recovery of the petroleum reserves, or the remaining licence area would be reduced below 25km2.
The licensee may then keep its Retention Areas and Development Areas into the Second Term, even when together the area is more than 50% of the initial licensed area. Previously the model clauses limited the licensee to keeping a maximum of 50% of the initial licensed area.
The Impact Assessment accompanying the 2014 Regulations states that the rent payable to DECC for Retention and Development Areas will be at a lower rental rate than currently applies.
At any point in the Production Period, DECC can take back areas falling outside of Retention or Designation Areas (for example areas where designation as a Retention Area has expired).
In clause 32, the general period of confidentiality for specified data of a geological, scientific or technical kind supplied under the licence remains at 4 years. However, a specific exception has been added for data concerning the geology, operations or results associated with hydraulic fracturing of shale or other strata encased in shale which DECC requests to be included in a report from the operator. Such data can be published after six months from the date when the report was due to be supplied to the Minister, or if earlier, the date when the Minister received the report.
Clause 9 introduces the concept of surrendering a three dimensional section of the licensed area, ie a delineated physical volume of the surface and/or subsurface strata, if DECC agrees before notice to surrender is served by the licensee.
Schedule 3 - Landward Exploration Licences
Schedule 3 sets out the model clauses for a new type of onshore licence: a landward exploration licence. This has been designed to fill a gap in the types of onshore licence on offer (although a similar type of licence already exists offshore) – DECC refer to it as an "unintended regulatory obstacle". It is addressed to both production and exploration licence holders wanting to obtain data in an area outside their licensed acreage and information service providers who want to obtain seismic data to be able to sell it, for example to prospective operators and investors.
Landward exploration licences will be non-exclusive (ie more than one operator can explore for data in the same area) and will allow only non-intrusive exploration, principally by way of seismic survey rather than taking geological core samples for example.
DECC's justification for tailoring the model clauses is quite simply that industry had warned that the existing clauses would have seriously inhibited or even altogether prevented the shale gas industry from developing. It believes the effect of the changes it has made are major, will make shale gas development much more economically viable and without them there could have been no take up of new licences. DECC has set as its benchmark for judging the success of the new clauses the award of 30 blocks in the 14th licensing round.
The early stages of exploration for existing licence holders have been slower than originally expected for a variety of reasons, including Government precaution, public opposition and permitting processes. The potential for delays as the industry establishes itself remains. By allowing for extensions to the licence and the retention of undrilled acreage for longer, the new licence terms seek to provide operators with some flexibility to offset the remaining uncertainties, whilst serving the Government's interest in ascertaining the size of the technically recoverable resource and its value to the economy. UKOOG, the UK Onshore Operators' Group who was consulted on the proposed changes has welcomed them.
DECC was concerned that merely allowing operators to retain all of the licensed area could lead to 'landbanking' by operators, whereby areas not actively being used by the operator would remain unavailable for re-licensing to a competitor. The solution chosen in the 2014 Regulations allows DECC to claw back areas not being worked actively. The Impact Assessment for the 2014 Regulations makes clear that an operator's request for the creation of a Retention Area must be supported by a plan amounting to "an efficient proposal to exploit the shale gas potential of the area". Similarly, clawback of acreage falling outside of Retention and Development Areas in the Production Period would be exercised by DECC "where the current licensee does not offer a realistic prospect of exploiting the hydrocarbon resource or where he fails to carry out the work he has agreed with DECC."
DECC expects few Retention or Development Areas to be agreed before the end of the Initial Term.
The reduction of the earliest date at which drilling results from hydraulic fracturing operations may be made public from 4 years down to 6 months is also a significant change, no doubt designed to facilitate market entry and speed up the process of development.
The 2014 Regulations can be accessed here.