On 1 May 2012, the New South Wales Legislative Council General Purpose Standing Committee no.5 (Committee) released its report (Report) on certain environmental, economic and social aspects of the coal seam gas (CSG) industry in NSW. The report contains 35 recommendations for action by the NSW Government (Recommendations).  

From a practical perspective, the Recommendations potentially affect every stage of CSG operations and development in NSW. 

This update does not detail every one of those 35 recommendations. Rather, it provides a preliminary overview of a number of the key recommendations made in the Report. It remains to be seen how many, and which, of the Recommendations will be adopted by the NSW Government.

In the meantime, the Committee recommends that no further production licences are issued in respect of CSG operations before a "comprehensive framework for the regulation of the coal seam gas industry is implemented". The timing and key steps in developing this framework remains unclear.

However, given the early stage of development of the CSG industry in NSW and the need for more information on the environmental and social effects of CSG activities, the Report also recommends that the exploration phase of CSG activities be allowed to proceed, albeit subject to tighter control and regulation.

Highlights

The Report proposes comprehensive changes to the regulation and, thereby, the operation of the CSG industry in NSW.  Most notably the Report recommends the following:

  • new environmental and community consultation requirements are proposed at the exploration licence application stage;
  • an ongoing comprehensive community consultation regime be established during the exploration and production phases of CSG operations;
  • a comprehensive land access arrangement regime with landholders be developed (including the development of a template land access agreement);
  • tighter and more robust requirements surrounding water usage, monitoring and storage are imposed on CSG companies (including with respect to aquifers and aquifer interference);
  • scrapping the current royalty holiday (and related tied royalty regime) for CSG projects;
  • introducing a domestic supply obligation whereby a proportion of gas produced from a project is reserved for specifically domestic consumption;
  • continuing the current ban on hydraulic fraccing until the Government considers the assessment currently being undertaken by the National Industrial Chemicals Notification and Assessment Scheme;
  • limiting fugitive emissions from CSG projects to an upper limit of 0.1%;
  • introducing a robust environmental remediation scheme by way of amendment to the Act likely requiring the posting of higher value, longer term security bonds and a higher standard against which environmental remediation obligations will be measured; and
  • the establishment of 2 new Government units for industry oversight.

Each of these Recommendations is dealt with in more detail below.

Applying for an Exploration Licence

Onshore petroleum activities (such as CSG operations) in New South Wales are primarily governed by the Petroleum (Onshore) Act 1991 (the Act). Under the Act, the first step in undertaking these activities is to apply for an exploration licence.

The Report contains a number of Recommendations which will affect the processes and costs involved in applying for an exploration licence in respect of CSG activities in NSW. In particular, the Report recommends that:

  • a solid waste management plan and an Agricultural Impact Statement be required prior to the approval of an exploration licence;
  • the customary Review of Environmental Factors (REF) produced for the purposes of Part V of the Environmental Planning and Assessment Act 1979, be referred to the Office of Environment and Heritage (although it appears that this would likely only formalise a process which already occurs as a matter of policy and practice);
  • local councils be notified once an application for an exploration licence is submitted in respect of a block located in their local government area; and
  • a formalised community consultation process (as outlined in the Draft Code of Practice for Coal Seam Gas Exploration (Code of Practice) is incorporated into the exploration licence application and renewal process.  

Consequently, a comprehensive consultation strategy will be critical for any CSG company applying for a licence. Given the uncertainty surrounding current environmental assessment requirements for CSG projects, it would be prudent for CSG companies to work closely with the NSW Department of Trade & Investment to clarify the exact requirements its REF in support of an exploration licence must address. Although the Committee has recommended that the 'exploration phase' continue, community sensitivity surrounding this issue will mean that REFs are likely to be heavily scrutinised. In the meantime. any decision in respect of exploration licences will be exposed to a risk of challenge if adequate environmental assessment has not been carried out. Consequently, a robust REF will be critical for CSG companies going forward. 

CSG Exploration Activities

A number of Recommendations, if implemented, would affect the manner in which future CSG exploration activities are conducted in NSW.

Community Consultation

As mentioned above, the Committee recommends that the community consultation process outlined in the Code of Practice is followed. The Code of Practice's requirements for community consultation include, where the activity is intended to result in a 'long-term' project (as any petroleum explorer would hope), the establishment of a formal Community Consultative Committee (CCC) consisting of representatives from local government, community, community groups, the explorer and an independent chairperson appointed by the Minister. That initial CCC would be disbanded and replaced with a new CCC once the project reaches production. The Code of Practice also requires that the explorer:

  • appoint a community liaison officer (preferably taken from the local community) as a point of reference to implement its day-to-day community consultation activities; and
  • maintain records of its community consultation activities and:

 

  •  during periods in which exploration activities are being undertaken, provide a quarterly report on its activities to the local government;
  • during periods in which exploration activities are not being undertaken, provide an annual report on its activities to the local government;
  • otherwise report annually to NSW Trade and Investment's Division of Resources and Energy annually on its community engagement; and
  • provide local government with at least 6 months prior notice of its intention to start an exploration programme which would involve it entering into access arrangements with landholders.

Water

Given the political sensitivities surrounding the use of water, fraccing and aquifers by CSG operations, it is unsurprising that the Report contains a number of recommendations regarding water usage, waste and storage. The Committee recommends that:

  • the requirements of the Code of Practice be tightened in relation to water testing and monitoring (these recommendations include documenting existing water bores, drilling monitoring bores, regularly monitoring water impacts and requiring CSG producers to pay for independent water testing);
  • aquifer interference requirements be introduced for any wells drilled into coal seams, including exploration wells; and
  • the open storage of water and fraccing fluids is banned.

Landholder Rights and Consultation

In response to submissions by landholders and community groups, including suggestions that CSG companies have attempted to pressure landholders for access to land or may in the future, the Committee recommends that landholder rights contained in the Act be strengthened so as to re-balance the rights of landholders and coal seam gas operators relating land access. Notably, the Committee does not suggest that providing landholders with a veto in respect of land access would be appropriate on the basis that to do so would interfere with the Crown's ownership of its resources. 

Additionally, the Committee recommends that the currently undefined term "cultivated land" in the Act be defined in a similar way to the term "agricultural land" in the Mining Act 1992. The potential effect of effectively incorporating that prescriptive definition of 'agricultural land' into the Act would be to broaden the restrictions relating to CSG activities over larger areas of NSW.

Land access agreements

The Report suggests that a template access agreement (covering both exploration and production activities) be developed which would form a standard basis for land access arrangements between landholders and CSG companies as an important step in strengthening landholder rights. The Committee also recommends that:

  • the Act be amended to require a licence holder to enter into an access agreement with a landholder for coal seam gas production;
  • the template access agreement
    • be drafted in conjunction with the NSW Farmers' Association and the Australian Petroleum Production and Exploration Association;
    • include a clear statement about the right of landholders to seek legal advice; and
    • take a default position whereby the landholder be compensated a minimum of $5,000 per well head per annum;
  • CSG companies be required to reimburse landholders for reasonable legal costs incurred in:
    • the review of an access agreement;
    • seeking arbitration to resolve disputes under access agreements.

These Recommendations will increase the time and costs incurred by CSG companies seeking and discovering new CSG reserves. As intended, if implemented, they would also significant re-balance the respective positions of CSG companies and landholders with respect to each stage of CSG operations.

Production of CSG in NSW

The Report also contains several recommendations which, if implemented, would significantly affect the manner in which CSG production activities would be conducted.

Royalties

Currently, CSG companies enjoy a royalty holiday during the first 5 years of commercial production. The royalty payable to the Crown is then set at an annual rate of 6%, 7%, 8% and 9% for the 6th, 7th, 8th and 9th years of commercial production respectively and, thereafter, an annual rate of 10%.

In the Report, the Committee recommends that the royalty holiday and tiered royalty escalation regime be scrapped. Consequently, if this Recommendation was introduced, CSG operators would be required to pay the full 10% annual rate of royalty to the Crown from the date of first commercial production.

The royalty holiday regime was originally introduced to encourage investment into the NSW CSG sector (albeit at a time at which the domestic and international oil and gas markets were significantly different than they are today). 

However, scrapping this royalty holiday regime will reduce the free cash available to CSG companies to repay project debt (which is primarily incurred during the exploration phase of a CSG project), thereby affecting the availability and cost of project finance for CSG projects in NSW (particularly relative to other hydrocarbon projects in other states). Operationally, as it is common for initial CSG wells to be brought into production while exploration activities and new wells are drilled on the same petroleum title using cash flows from producing wells, scrapping the royalty holiday regime will reduce project cash flows, reducing funds available for investment and, thereby, may reduce the speed of exploration and development of CSG resources.

Domestic Supply Obligation

The difference in price between gas sold for export (by way of LNG) and gas sold in the domestic market has created a significant dilemma for Australian governments and regulators. The gap between LNG prices and domestic prices is expected to narrow as large volumes of gas are exported to Asia. Consequently, on the basis of experience of the CSG industry in Queensland and with a view to improving energy security through the diversification of sources of energy, the Committee recommends that the NSW Government implement a domestic gas reservation policy. 

Under that policy, an unspecified proportion of CSG produced in NSW would be reserved for domestic consumption. Over the life of a project, if implemented, this Recommendation would dampen gas prices and therefore CSG company revenues. As the Report does not suggest what an appropriate 'portion' of gas produced for domestic reservation might be, it is not possible to estimate the impact the policy may have either on gas prices or energy security.

Fraccing

Although it has been used in the oil and gas industry for over 60 years, the practice of hydraulic fracturing is one of the most controversial aspects of CSG operations. In the Report, the Committee makes a number of recommendations relating to fraccing, including:

  • continuing the current ban on fraccing until the NSW Government has considered the results of an assessment currently being undertaken by the National Industrial Chemicals Notification and Assessment Scheme of fraccing chemicals for their intended use and toxicity according to international standards;
  • banning the open storage of fraccing fluids; and
  • requiring CSG companies to store fraccing fluids securely prior to treatment and disposal.

The Recommendation to continue the ban on fraccing until the National Industrial Chemicals Notification and Assessment Scheme has completed its assessment is not unexpected. If implemented, given the importance of fraccing in CSG exploration and production, the ban would significantly limit (or effectively restrict) CSG operations in NSW until such time as the ban had been lifted.

Fugitive Emissions

Although the primary objective of CSG operations is to capture and sell natural gas, as with any method of extracting hydrocarbons, those operations do result in the release of some fugitive emissions.

The Committee recommends all licences require that CSG production operators minimise fugitive emissions from a project to an upper limit of 0.1 per cent.

Although some efficiency gains may be achieved from prescribing a minimum level of fugitive emissions, measuring the exact volume of fugitive emissions released from a project is difficult and costly and, consequently, will affect the economics of CSG projects in NSW.

Decommissioning and Abandonment of CSG Facilities

Decommissioning and abandonment of hydrocarbon facilities is one of the most costly aspects of conducting oil and gas operations. It is also one of its most controversial aspects as the environmental effects of CSG operations have the potential to outlive the CSG project by some considerable time.  Unsurprisingly, the Report includes a Recommendation that the NSW Government develops an effective model to ensure that CSG companies are held responsible for covering the full costs of remediating any environmental impacts, particularly any long-term environmental damage caused the project.

Currently, the bulk of a CSG company's environmental remediation obligations are contained in its licences. The Report suggests that the more comprehensive framework recommended be implemented by way of amendment to the Act. Although no specific guidance is given as to what might be included in the proposed remediation model, the Report's discussion does note that there is some support for arguments that:

  • security bonds posted by CSG companies in respect of their expected environmental rehabilitation obligations:
    • be appropriately valued such that they adequately cover those costs; and
    • outlast the relevant project's life by some time on the basis that some environmental damage caused by CSG operations may take many years to become evident (the NSW Irrigator's Council argued that a security bond should not expire before 20, 30 or 50 years from decommissioning);
  • in amending the Act to 'hardwire' a comprehensive environmental remediation regime into its provisions, an appropriate definition of 'rehabilitation' is used as the basic test against which compliance with that regime may be established (with the suggestion that 'rehabilitation' be defined such that it required the area to be restored 'to original or better condition').

A more comprehensive regime based upon the above Recommendations will, if implemented, significantly increase the upfront and ongoing costs associated with conducting CSG operations. However, it is worth noting that the proposals regarding the value of security bonds to be posted by CSG companies and the standard against which an area should be 'rehabilitated' (as briefly described above), reflect emerging international trends for environmental compliance in the international oil and gas industry.

CSG Industry Regulation and Oversight

Finally, the Report contains a number of Recommendations designed to increase the regulatory oversight of the CSG industry in NSW. Those Recommendations include establishing:

  • an 'Industry Unit' within the Division of Resources and Energy in the Department of Trade and Investment, Regional Infrastructure and Services to provide a coordinated response to coal seam gas developments in New South Wales, including issuing licences for coal seam gas development;
  • a 'Compliance Unit' within the Environment Protection Authority made up of specialist compliance officers located in CSG exploration and production areas to undertake regular monitoring of coal seam gas operations, and address community complaints, investigate incidents and take enforcement action where required; and
  • a 'Complaints Hotline' from to which the Compliance Unit within the Environment Protection Authority would answer calls from community members seeking to report concerns about potential environmental pollution or the behaviour of coal seam gas companies, and refer information received for investigation and possible action by the Compliance Unit within the Environment Protection Authority.  

Conclusions

It is not yet known which, or how many, of the Recommendations will be implemented by the NSW Government. However, each of the Recommendations will affect the operations and economics of CSG companies and projects in NSW. In particular, the extent to which the Government implements each of the Recommendations will determine the extent to CSG companies are required to absorb the additional time and costs which will flow from the Recommendations when undertaking CSG projects.

Increased costs and time delays will primarily arise from the proposed access arrangements that proponents will be required to enter into with landholders. CSG companies will need to ensure that they have effective resources, management and mitigation measures in place to comply with any new conditions in their licences or requirements under law coming out of the implementation of any of the Recommendations. Increased regulatory scrutiny may also expose CSG companies to compliance and reputational risk issues.

Finally, given the Minister's broad powers to refuse exploration licence applications, a CSG company's environmental track record is likely to be a significant factor in its ability to successfully participate in the CSG industry in NSW.