Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

Microsoft powerpoint managing environmental risk in investing in shale plays


Published on

  • Login to see the comments

  • Be the first to like this

Microsoft powerpoint managing environmental risk in investing in shale plays

  2. 2. SPEAKERScott DeatherageEnvironmentalOffice: (214) 2
  3. 3. OUTLINE OF DISCUSSION• What Are the Economic Opportunities in Lending and Investing in Shale Plays?• What Actually Occurs During Shale Drilling and Hydraulic Fracturing?• What Environmental Risks Must Be Managed During This Process?• What State and Federal Statutes and Regulations Apply?• What Litigation Has Been Filed Alleging Environmental Damages?• How Can Lenders and Investors Evaluate and Manage Environmental Risks in Investing in US Shale Plays? 3
  5. 5. Shale Plays in the US 5 5
  7. 7. DEFINITIONS• Fracking is a process of pumping water, chemicals and sand into a well to unlock the hydrocarbons trapped in shale formations. Opening cracks (fractures) in rock allows natural gas or oil to flow from the shale into the well.• Shales are fine-grained sedimentary rocks that can be rich sources of petroleum and natural gas.• Shale gas is found in shale “plays" -- shale formations containing significant accumulations of natural gas that share similar geologic and geographic properties. 7
  8. 8. SHALE UNITS CAPABLE OF PRODUCING NATURAL GAS IN LARGE QUANTITIES• Shale plays and percent of US resources: • Northeast: primarily the Marcellus (63%) • Gulf Coast: Haynesville, Eagle Ford (13%) • Southwest: Barnett & Barnett-Woodford (10%) • Mid-Continent: Fayetteville, Woodford (8%) • Rocky Mountain: primarily Mancos and Lewis (6%). 8
  9. 9. EMERGING NATIONAL ENERGY PROSPECTS IN SHALE GAS• The Energy Information Administration (“EIA”) projects in its 2012 Annual Energy Outlook (“AEO”) pertaining to the period 2010-2035: • Natural gas production will increase throughout period. • Growth in natural gas production will mostly be driven by technological advances that continue throughout the period. • Drilling in shale plays with high concentrations of natural gas liquids and crude oil will have a higher value in energy equivalent terms than dry natural gas. • Shale gas resource base is lower than in 2011 AEO, but shale gas production estimates increased between the 2011 and 2012 AEO. 9
  10. 10. TRENDS THAT MAY ULTIMATELY LEAD TO HIGHER GAS PRICES • "The U.S. could become the next Qatar, i.e. the largest LNG producer in the world," said Thierry Bros, a senior analyst at Société Générale. "The U.S. is at a turning point.” • “There are 8½ million 18-wheelers in the United States. That’s 2½ million barrels of oil a day. So that cuts OPEC in half if you had all the 18- wheelers,” T. Boone Pickens said. “Is there any obstacle from that happening? Not that I know of because the fuel is so cheap.” 10
  11. 11. MOTIVATION TO INVEST IN SHALE• U.S. is huge energy consumer, and natural gas usage expected to increase every year.• Shale gas production expected to increase from 5.0 trillion cubic feet in 2010 (23 percent of total U.S. dry gas production) to 13.6 trillion cubic feet in 2035 (49 percent of total U.S. dry gas production). Slide 6 depicts this increase.• Increased production is driven by lower drilling costs and continued drilling in shale plays with high concentrations of natural gas liquids and crude oil.• Investment returns in large part is a function of price of gas at sale and fully-loaded costs of production, including lease payments and regulatory compliance.• Investors and lenders will finance shale plays to capture a return stemming in part from dry gas displacement of other energy resources, and more profitable extraction of oil and wet gas. 11
  12. 12. POTENTIAL PROFIT FROM SHALE INVESTMENTS• Even at current gas pricing, operators can strategically site operations that can still make a profit or at least cover costs, but search is mostly for oil and wet gas.• Operators and partners can invest in shale for long-term in anticipation expansion of types of usage of natural gas (i.e., fuel fleets of cars, buses and trucks (e.g., 18-wheelers)).• Shale gas trading, buying and hedging opportunities exist on assumption that gas prices will rise in long-term.• Larger operators have chance to acquire smaller shale interest holders (i.e., industry consolidation) to achieve well-priced acquisitions of shale assets for future gains.• Technology is rapidly enhancing recoveries, increasing efficiency and reducing operating costs that together can widen profit margins.• Gas can be converted to LNG and other products for export, but the market has not sorted out the complex issues associated with LNG, including demand, production, infrastructure, pricing and shipping. 12
  14. 14. HISTORY OF HYDRAULIC FRACTURING• Use of hydraulic fracturing to increase production from conventional oil and gas wells grew rapidly starting in late 1940s and continues to be used routinely for reservoir stimulation.• Hydraulic fracturing has been used to stimulate approximately a million oil and gas wells.• Improvements in horizontal drilling technologies led to its increased application in conventional drilling starting in the early 1980s. 14
  15. 15. TYPICAL PAD SITE 15Rockwood, Fort Worth
  16. 16. DRILLING AND FRACTURING THE WELL 1.5 miles below surface 8,000 ft Average3,500 feet average vertical lateral length depth 1616
  18. 18. STATEMENT BY AN ENVIRONMENTAL GROUP REGARDING FRACKING• "Liquefied natural gas is not only the dirtiest and most polluting form of gas, but it also requires an increase in fracking; a process we know to be unsafe and dangerous," Deb Nardone, Sierra Clubs director of natural gas reform, said in a statement. "The industry is pushing forward with these export facilities with their profits in mind, not the families who will bear the burden of increased fracking.“ (Emphasis added). 18
  19. 19. IDENTIFYING ENVIRONMENTAL RISKS THAT MUST BE MANAGED• Drilling in shale can be and has been conducted in a safe manner.• Thousands of wells drilled and fracked without environmental impact.• Hydraulic fracturing itself is not necessarily the source of environmental risk.• Key issue is whether and where pollutants can be released from drilling or fracking and related operations. 19
  20. 20. STUDY BY THE ENERGY INSTITUTE, UNIVERSITY OF TEXAS• Fact-Based Regulation for Environmental Protection in Shale Gas Development (Feb. 2012) • “Although claims have been made that ‘out-of-zone’ fracture propagation or intersection with natural fractures, could occur, this study found no instances where either of these has actually taken place.” Id. at 18. • “Particularly in areas underlain by gas-producing shales, methane migrates out of the shales under natural conditions and moves upward through overlying formations, including water-bearing strata (aquifers).” Id. at 19. • “The greatest potential for impacts from a shale gas well appears to be from failure of the well integrity, with leakage into an aquifer of fluids that flow upward in the annulus between the casing and the borehole.” Id. 20
  21. 21. ENVIRONMENTAL MANAGEMENT Flowback Water: Recycling and/or Proper Disposal Protects Surface Water Casing Installation Protects Groundwater 1.5 miles below surface Over 1 Mile of Rock between Fracking and Groundwater: Serves 8,000 ft to Isolate Groundwater from Fracking Average3,500 feet average vertical lateral length depth 2121
  22. 22. WELLBORE INTEGRITY7 layers of protection isolate well bore from its surroundings, preventing any exposure of chemicals, gas, or produced water with the environment:1. Conductor casing2. Cement, sealing conductor casing in place3. Surface casing4. Cement, sealing surface casing in place5. Production casing6. Cement, sealing production casing in place7. Tubing: In the Barnett Shale, for example, the surface casing is drilled to a minimum depth of between 50 to 100 feet below the Trinity aquifer 2222
  23. 23. ISSUES IDENTIFIED IN UNIVERSITY OF TEXAS STUDY• Drill Pad Construction and Operation• Hydraulic Fracturing• Flowback Water Management• Groundwater Impact• Blowouts and House Explosions• Water Consumption and Supply• Spill Management and Surface Water Protection• Atmospheric Emissions• Health Effects 23
  24. 24. EARTHQUAKES• Concern over small earthquakes from injection of wastewater into disposal wells• Approximately 144,000 wastewater injection wells in the US• Question of whether injection causing anything but small tremors, not resulting in damage 24
  26. 26. SHALE DRILLING AND FRACTURING HAS MULTIPLE LEVELS OF CURRENT AND FUTURE POTENTIAL REGULATION• State Oil and Gas Regulation Applied to Shale Drilling and Hydraulic Fracturing• State Activity and Potential Future Regulation• Federal Regulatory System as Applied to Shale• Federal Activity and Potential Future Regulation• Hydraulic Fracturing Fluid Disclosure• Local Regulation 26
  27. 27. STATE REGULATION• The laws and regulations related to hydraulic fracturing are evolving, but states are regulating environmental issues related to oil and gas drilling, which includes drilling that utilizes hydraulic fracturing.• The federal approach has been to leave regulation of hydraulic fracturing to the states, but some in Congress have sought to impose federal regulation of disclosure of fracturing chemicals and federal permitting of hydraulic fracturing. 27
  28. 28. STATE REGULATION• In most states, the drilling of shale gas wells using hydraulic fracturing falls under the statutes and regulations regulating oil and gas drilling. • Texas • Texas Natural Resources Code • The Railroad Commission of Texas regulates oil and gas drilling (“RRC”). • Pennsylvania • Oil and Gas Act • Pennsylvania Department of Environmental Protection (“DEP”) regulates oil and gas drilling through a division called the Bureau of Oil and Gas Management. 28
  29. 29. GROUNDWATER PROTECTION: WELL CASING AND CEMENTING• The critical issue of properly casing and cementing of wells is designed to protect potable groundwater zones. See: • 16 Tex. Admin. Code § 3.8 (Water Protection) (Drilling and Completion Requirements) • 25 PA. Code §§ 78.81-78.86; 58 P.S. Code § 601.207(b)• Proper casing will prevent fracking water and wastewater and any chemicals or contaminants from being released from the well into the groundwater.• These requirements apply regardless of whether hydraulic fracturing is used to stimulate the well. 29
  30. 30. SPILLS AND RELEASES• Any spill or release of waste or wastewater would be regulated by the RRC or DEP. • 16 Tex. Admin. Code § 8 • 25 PA Code § 78.66 (reporting releases), § 91.33 (incidents causing or threatening pollution) 30
  31. 31. PITS• A permit is required to maintain or use a pit for storage of oil field fluids or oil and gas wastes.• Only issued if regulatory agency determines maintenance or use of such pit will not result in pollution of surface or subsurface waters. • See: 16 Tex. Admin. Code § 3.8(d)(6) 31
  32. 32. WASTE MANAGEMENT• Permits are required for those transporting or disposing of oil field wastes. • Tex. Admin. Code § 3.8(d)(5)(A). • 58 P.S. Code § 601.207(b)• Waste disposal on-site without a permit that avoid pollution of surface or groundwater is not permitted.• Such disposal, whether intentional or not, would generally result in an order to remediate and potentially fines. 32
  33. 33. SURFACE WATER• Discharges to surface water are governed by state “Clean Water Acts” • The Texas Commission on Environmental Quality (“TCEQ”) regulates discharges to surface water • The Texas Water Code prohibits discharges without a permit. • Federal Clean Water Act delegates to states National Pollutant Discharge Elimination System program responsibilities. 33
  34. 34. SURFACE WATER• Discharge permits are required for discharges to surface waters.• Operators had been sending waste frack water to municipal and private treatment works, who would treat the wastewater and discharge with other treated wastewater to surface waters.• April 19, 2011, DEP announced that companies cease sending waste fracking water (flow back water) to these treatment works after detecting increased bromide levels in surface waters. 34
  35. 35. AIR EMISSIONS• Air emissions from oil and gas operations are regulated by the relevant agencies under state “Clean Air Acts.”• Example: Texas Clean Air Act and regulations promulgated under the Act prohibits air emissions that would result in a nuisance or otherwise exceed certain levels. 35
  36. 36. AIR MONITORING• Over last few years, the TCEQ has conducted monitoring of emissions from natural gas wells, compressors, etc. in Barnett Shale based on complaints and testing by local governments.• Spring 2009, the TCEQ installed automated gas chromatograph monitors in two locations that are surrounded by natural gas operations—the town of Dish, in Denton County, and near Eagle Mountain Lake, in Tarrant County. • Monitors operate around the clock, measuring levels of more than 45 Volatile Organic Compounds (“VOCs”), including benzene. • Results: After months of continuous operation, there have been no chemicals measured above levels of concern. The results from the monitors are posted hourly on the TCEQ website. 36
  37. 37. PREPAREDNESS, PREVENTION, AND CONTINGENCY PLAN• In Pennsylvania, an operator must submit a Preparedness, Prevention and Contingency Plan. • Must be submitted and improved to obtain permit • Must comply with during drilling and completion process 37
  38. 38. PRESUMPTION OF CAUSATION OF CONTAMINATION AND DEFENSE• The Pennsylvania Oil and Gas Act provides that an oil and gas well operator is presumed responsible for pollution of a water supply if it occurs within six months of drilling and is within 1,000 feet of the well.• One defense against presumption is pre-drilling groundwater testing that shows contamination previously existed.• Statute and Regulations require operator to provide DEP and landowner or water purveyor with results of testing within 10 business days of receiving results, and if not, may not be used to preserve operators defenses under the Act. • 25 PA Code § 78.52(d); 58 P.S. § 601.208(d)(1). 38
  39. 39. PRE-DRILLING TESTING IN TEXAS• Many operators drilling in Pennsylvania have been testing water wells prior to drilling.• Based on that experience, many operators are conducting pre-drilling testing of water wells in Texas and other states. 39
  40. 40. WATER SUPPLY FOR HYDRAULIC FRACTURING• Hydraulic fracturing requires a substantial amount of water. • The average quantity of water used for a shale gas well varies somewhat by the shale gas area: • Barnett (4.0 million gallons (MG)), Fayetteville (4.9 MG), Marcellus and Haynesville (5.6 MG), and Eagle Ford (6.1 MG).• Water supply is thus a critical issue for shale development.• In arid areas, such as Texas suffering a severe drought, water supply becomes even more important. • State law and agencies have so far insured water rights available for oil and gas drilling• State by state issue as water rights generally determined by state law. 40
  41. 41. FEDERAL REGULATION• Hydraulic fracturing is exempt from federal regulation under the Safe Water Drinking Act (“SWDA”).• SWDA is the regulatory program under which hydraulic fracturing would be regulated.• History of regulation stretches back more than a decade.• First issue in hydraulic fracturing was drilling wells to extract natural gas from deep coal seems.• Environmental group challenged EPA’s decision not to regulate under the federal Safe Drinking Water Act Underground Injection Control program (“UIC”). 41
  42. 42. ELEVENTH CIRCUIT OPINION FROM 1997• “Nothing in the statutory definition [of “underground injection”] suggests that EPA has the authority to exclude from the reach of the regulations an activity (i.e., hydraulic fracturing) which unquestionably falls within the plain meaning of the definition, on the basis that the well that is used to achieve that activity is also used--even primarily used--for another activity (i.e., methane gas production) that does not constitute underground injection.” • Legal Environmental Assistance Foundation v. EPA, 118 F.3d 1467 (11th Cir. 1997) 42
  43. 43. EPA STUDY ON ENVIRONMENTAL IMPACT OF HYDRAULIC FRACTURING• EPA study resulted in report in 2004• “Based on the information collected and reviewed, EPA has concluded that the injection of hydraulic fracturing fluids into [coalbed methane] wells poses little or no threat to [underground sources of drinking water] and does not justify additional study at this time.” • U.S. EPA, Evaluation of Impacts to Underground Sources of Drinking Water by Hydraulic Fracturing of Coalbed Methane Reservoirs, National Study Final Report 43
  44. 44. FEDERAL REGULATION• Congress acted to exempt hydraulic fracturing.• Section 322 of the Energy Policy Act of 2005 specifically excluded hydraulic fracturing operations from regulation under the SWDA and the Underground Injection Control (“UIC”) program.• Exemption for: “The underground injection of fluids or propping agents (other than diesel fuels) pursuant to hydraulic fracturing operations related to oil, gas, or geothermal production activities.” • 42 U.S.C. § 300h(d)(1)(B)(ii). 44
  45. 45. REGULATION OF SALT WATER INJECTION WELLS• Salt water disposal wells, used in the oil industry to dispose of water produced from drilling and production, are currently regulated under the UIC.• In Texas, this program is delegated to the RRC.• In Pennsylvania, program is not delegated. 45
  46. 46. EPA STUDY OF HYDRAULIC FRACTURING FOR SHALE GAS• Congress provided funding for EPA study on hydraulic fracturing.• Feb. 2011, EPA submitted hydraulic fracturing study plan to the EPA Science Advisory Board (“SAB”) for review and comment and made it available to the public.• EPA stated that the scope of the study will include full lifespan of water in hydraulic fracturing, from acquisition of water, mixing of chemicals, actual fracturing, management of flowback and produced water, and ultimate treatment and disposal.• April 21, 2011 and May 19, 25, 2011, SAB held conference call to discuss EPA plan. 46
  47. 47. EPA STUDY OF HYDRAULIC FRACTURING FOR SHALE GAS• On April 28, 2011, SAB released draft comments on plan, generally thought appropriate, concerns as to: • ability to meet study design by time frame set; and • specificity in study as to actual research that will be conducted• 2012: EPA proposed year to release interim results• 2012 to 2014: Additional results to be released as particular investigations completed• 2014: EPA proposed year to release another report 47
  48. 48. HYDRAULIC FRACTURING FLUID DISCLOSURE• Congress • Bills have been filed to require disclosure of chemicals added to water used for hydraulic fracturing. • Attempts to end exemption under the SDWA and require EPA permitting of hydraulic fracturing. 48
  49. 49. HYDRAULIC FRACTURING FLUID DISCLOSURE• Several states have passed laws requiring disclosure• Texas disclosure law has gone into effect 49
  50. 50. DIESEL USE• Congressional investigation alleged that companies were using diesel fuel in hydraulic fracturing.• EPA has taken position that such use subjects process to UIC regulation under the SDWA.• EPA plans to issue guidance on diesel use in fracking fluid.• Question has been raised whether EPA must promulgate regulations to impose a permitting requirement. 50
  51. 51. EXAMPLE OF LOCAL ATTEMPTS AT REGULATION• Texas, Barnett Shale • City of Fort Worth rules on drilling • City of Dish attempted to block drilling • City of Dallas to consider drilling requirements 51
  52. 52. LOCAL ATTEMPTS AT REGULATION• Pennsylvania, Marcellus Shale• In 2005, Salem Township sought to regulate hydraulic fracturing through zoning ordinances. • State Supreme Court ruled that local regulation was prohibited by the Oil and Gas Act • Independent Oil and Gas Association of Pennsylvania, et al v Salem Township, Commonwealth of Pennsylvania, 931 A.2d 101 (PA. Commonwealth Court 2007).• Borough of Oakmont designated well locations using zoning districts. • State Supreme Court ruled that zoning is not covered in the Oil and Gas Act, and, therefore, as has traditionally occurred, the local government retained the ability to designate which areas drilling may occur; but local regulations to provide drilling permits is preempted by the Oil and Gas Act • Huntley & Huntley, Inc. v Borough Council of the Borough of Oakmont, 929 A.2d 1252 (PA Commonwealth Court 2007). 52
  53. 53. A LOOK AHEAD• States have promulgated regulations governing the environmental issues related to hydraulic fracturing and shale gas drilling in the form of general oil and gas regulations.• Additional regulation at the federal level may not provide any additional environmental protection not already occurring. 53
  55. 55. TYPES OF ENVIRONMENTAL LITIGATION ARISING OUT OF SHALE DEVELOPMENT• Groundwater contamination • Gas migration • Fracturing fluids• Water storage and disposal• Air emissions/noise• Earthquakes 55
  56. 56. GROUNDWATER CONTAMINATION: GAS MIGRATION• Fiorentino v. Cabot Oil & Gas Corp., No. 3:09-CV- 02284-JEJ (M.D. Pa. filed 2010). • gas in water wells • contamination and pressure • property damage and personal injury• U.S. v. Range Production Co., No. 3:11-CV-00116-F (N.D. TX Filed 2011) • gas in water wells • injunction • civil penalties of $16,500 per day per violation • shallow gas/deep gas 56
  57. 57. GROUNDWATER CONTAMINATION: FRACTURING FLUIDS• Hagy v. Equitable Production Co., No. 2:10-CV- 01372 (S.D. W.Va. filed 2010). • fracturing fluids allegedly contaminated water supply • inadequate or improper casing • injunction • remediation • property damage and personal injury 57
  58. 58. GROUNDWATER CONTAMINATION: WATER STORAGE AND DISPOSAL• Scoma v. Chesapeake Energy Corp., No. 3:10-CV- 01385-N (N.D. TX filed 2010). • storage and injection of produced water • allegedly contaminated water wells • heavy metals and other chemicals • color, odor, taste 58
  59. 59. AIR EMISSIONS/NOISE• Scoggin v. Cudd Pumping Services, Inc., No. 4:11- CV-00678-JMM (E.D. Ark. filed 2011). • venting • equipment • flaring • fracturing fluids • gasses • noise 59
  60. 60. EARTHQUAKES• Hearn v. BHP Billiton Petroleum, No. 4:11-CV-00474- JLH (W.D. Ark. filed 2011). • class action • theories that fracturing “excites” faults • theories that disposal through injection wells triggers earthquakes 60
  62. 62. ENVIRONMENTAL DUE DILIGENCE• Engage experienced environmental attorneys and consultants in oil and gas matters• Develop due diligence plan appropriate to size of play, which can be as large as 600,000 acres• Have environmental attorney explain how data and information collected may affect potential liability, and value of investment or collateral 62
  63. 63. EXAMPLES OF QUESTIONS THAT SHOULD BE EVALUATED• How is the operator casing its wells?• How are fracking chemicals being managed?• How is wastewater being managed?• Have there been notices of violations or enforcement actions brought against the company in the relevant field or other areas of current or historical operation?• Have groundwater wells been tested to establish an environmental baseline?• Have any lawsuits been filed against the operator in the current or other fields? 63
  64. 64. NO “INNOCENT PURCHASER” DEFENSE • Relevant federal laws may not provide such as defense as is found under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). • State statutes governing oil and gas environmental liability generally do not include such a defense. • Joint Operating Agreement may contractually bind non-operating interest owner (discussed more later). 64
  65. 65. ENVIRONMENTAL LITIGATION RISK MANAGEMENT• Litigation due diligence • business partners (track record, stability of management) • contractors • neighbors• Politics and education• Baseline testing• Monitoring and reports• Best practices• Insurance• Agreements (allocation of risk) 65
  66. 66. CONTRACTUAL PROVISIONS• Indemnities • Care to ensure environmental claims are covered— beware of drafting issues• Representations and warranties• Appropriate environmental definitions• Covenants• Insurance requirements• Provision of environmental reports and due diligence opportunities—access and adequate time for review 66
  67. 67. IMPACT OF JOINT OPERATING AGREEMENT ON NEW INVESTORS• Once an investor buys into a non-operating working interest, liability may attach to that party.• The Joint Operating Agreement usually assigns liability equal to the ownership interest, unless the operating working interest owner is grossly negligent or engages in willful misconduct. 67
  68. 68. ENVIRONMENTAL INSURANCE• Larger companies have substantial self- insurance retention.• Smaller companies may rely more on environmental insurance.• Evaluate the insurance coverage that may be available to cover environmental claims. • Understand what claims are covered. • Understand pollution and other exclusions.• As an investor, lender or non-operating interest owner, consider whether to purchase own insurance. 68
  69. 69. CONCLUSION• Hydraulic fracturing is not the area of focus for investors and lenders; rather, they should examine other environmental risks.• These risks must be managed by operators.• State, federal and local regulations may apply to these risks.• Future legislation not likely to stop shale drilling or hydraulic fracturing—but may increase costs and delay drilling permits.• Appropriate due diligence and contracting allow lenders and investors to evaluate and manage environmental issues in shale plays. 69