Geological surveys recently discovered that North Carolina's Deep River Basin contains a commercially viable reserve of natural gas with the potential to produce gas for the next 40 years. Following this discovery, the North Carolina legislature directed the Department of Environment and Natural Resources (DENR) to conduct a study on the issue of oil and gas exploration.¹ The study looked specifically at safety and environmental concerns regarding the use of horizontal drilling and hydraulic fracturing for natural gas production. Ultimately, DENR's study concluded that horizontal drilling and hydraulic fracturing could be done safely so long as the right protections and regulations were in place.²

On Monday, July 2, the North Carolina House and Senate voted to override the Governor's veto of S.B. 820 and passed the North Carolina Clean Energy and Economic Security Act of 2012 (the Act).³ The Act's main provisions include: (1) the authorization of horizontal drilling and hydraulic fracturing in North Carolina; and (2) the creation of the Mining and Energy Commission (the Commission) to establish a regulatory program for oil and gas exploration in the state. The Act directs the Commission to pass new regulations on a number of oil and gas exploration issues and to update old regulations to address horizontal drilling and hydraulic fracturing. There are a few notable regulatory requirements included in the Act such as a disclosure requirement for chemicals used in hydraulic fracturing fluids and a presumption of liability for oil and gas operators for water contamination occurring near a wellhead.

Authorization of Horizontal Drilling and Hydraulic Fracturing

The main purpose of the Act is to authorize horizontal drilling and hydraulic fracturing. Prior to passage of the Act, North Carolina prohibited both activities. Though the Act authorizes horizontal drilling and hydraulic fracturing, no permits will be issued until the new regulatory program has been fully established and approved by the legislature. The Act sets a deadline of October 1, 2014, for the Commission to adopt its new rules, likely creating at least a two-year period before the first permits will be issued in the state.

Mining and Energy Commission and Regulatory Requirements

The Act creates the Mining and Energy Commission, a 15-person panel with the authority and duty to adopt regulatory rules for oil and gas exploration.⁴ The Act directs the Commission and other regulatory agencies to pass regulations related to concerns surrounding hydraulic fracturing including:

• Information and data requirements for submitting an oil and gas permit application, including seismic and other geophysical and stratigraphic surveys and testing.
• Requirements for collection of certain data at drill sites, including baseline data on groundwater, surface water, and air quality in areas where hydraulic fracturing activities will occur.
• Updated construction standards for oil and gas wells, including minimum standards for casing and cementing.
• Standards for on-site oil and gas production infrastructure, including storage pits and tanks.
• Setback requirements and identification of areas where oil and gas exploration and production activities should be prohibited.
• Limits on water use and requirements for having a water and wastewater management plan designed to limit water withdrawals during times of droughts and periods of low flows.
• Prohibition on use of certain chemicals for hydraulic fracturing fluid.⁵
• Disclosure requirements for chemicals used in hydraulic fracturing fluid.
• Safety and response protocols for well blowouts, chemical spills, and other emergencies.
• Stormwater controls for sites on which oil and gas exploration activities are conducted.
• Regulations of toxic air emissions from drilling operations, including emissions associated with truck traffic.
• Regulations for the spacing of wells and the creation of drilling units. ⁶

The Act sets a deadline of October 1, 2014, for the Commission to adopt regulations addressing these issues.

Applicants proposing to drill a well must submit a $3,000 fee with their application.⁷ Any person who fails to secure a permit prior to drilling a well or who knowingly violates any regulation established by the Commission may be subject to a penalty of up to $25,000 a day for each individual violation.⁸ The Act also specifies that any person, firm, or officer of a corporation violating the Commission's rules may be guilty of a Class 1 misdemeanor.⁹

Disclosure Requirement

The Act also directs the Commission to pass a disclosure requirement rule. The rule will require the disclosure of chemicals and constituents used in oil and gas development, including hydraulic fracturing fluid, to state agencies and local emergency responders.¹⁰ The rule will grant an exemption to items considered trade secrets or designated as confidential by developers or operators.

Presumption Against Oil and Gas Operators for Water Contamination Near a Wellhead

Importantly, the Act creates a presumption that oil and gas developers or operators are responsible for contamination of a water supply within 5,000 feet of a wellhead that is part of the developer or operator's activities.¹¹ The Act states that pre-drilling testing of water supplies shall be a required term for all oil and gas leases.¹² If water contamination is found within 5,000 feet of a wellhead, the well developer or operator must provide a replacement water supply to the surface owner and other persons using the water supply. In order to rebut the Act's presumption of liability, an oil and gas developer or operator must establish any of the following by a preponderance of evidence:

• The contamination existed prior to the commencement of drilling activities, as evidenced by the required pre-drilling test of the water supply in question.
• The surface owner or owner of the water supply refused the developer or operator access to conduct a pre-drilling water quality test.
• The water supply in question is not within 5,000 feet of a wellhead that is part of the developer or operator's drilling activities.
• The contamination occurred as the result of a cause other than activities of the developer or operator.

Additionally, developers and operators are responsible for any damages to the personal property of the surface owner resulting from oil and gas drilling on the property.¹³ An oil and gas developer or operator must reclaim all surface areas affected by drilling activities no later than two years following completion of operations on the property.¹⁴

Other Notable Provisions of the Act

Other notable provisions of the Act include:

• Maintaining a state registry of all "Landmen" in the state.¹⁵
• Directing the North Carolina Department of Labor to develop rules establishing health and safety standards for workers engaged in oil and gas operations in the state.¹⁶
• A minimum royalty payment of 12.5 percent for oil and gas leases.¹⁷
• Directing various state agencies to identify appropriately levels funding to address local infrastructure and administrative costs associated with increased drilling and hydraulic fracturing, including permit fees, bonds, taxes, and impact fees.¹⁸
• Coordination between the state and local governments to allow for reasonable local regulations of hydraulic fracturing including required setbacks, local infrastructure repairs, and light and noise restrictions in a manner that does not conflict with state law.¹⁹
• Require operators to provide surface owners with a copy of relevant consumer protection laws and publications from the North Carolina Department of Justice.²⁰
• Limiting the primary term of oil and gas leases to no more than 10 years.²¹
• Minimizing impacts to the surface owner and damage to the land through the selection of alternative locations of wells, roads, pipelines, or production facilities where such alternatives are technologically sound, economically practicable, and reasonably available to the operator.²²

What This Means to You

The Act represents a comprehensive overhaul of the state's oil and gas laws. Although the first drilling permits are likely two years away, oil and gas operators looking to drill in North Carolina should continue to closely monitor how DENR and the soon-to-be-formed Mining and Energy Commission choose to develop and implement the Act's directives. Finally, the state's presumption that oil and gas operators are responsible for groundwater contamination within 5,000 feet of a well represents a significant development for industry and could ultimately increase the risks of drilling in populated areas should other states adopt similar provisions.

Footnotes

1 2011 N.C. Sess. Laws 276.

2 A summary of the DENR's study is available at: http://portal.ncdenr.org/web/guest/denr-study

3 2012 N.C. Sess. Laws 143.

4 N.C. Gen. Stat. § 143B-293.2. The Commission is comprised of members of various state agencies, appointees of the governor and General Assembly, members of industry, and representatives of local governments in the Deep River Basin. Each member may serve no more than two consecutive three-year terms.

5 The law explicitly directs the Commission to consider prohibiting diesel fuel in fracking fluid. Id at 113-391(a)(5)g.

6 Id. at 113-391.

7 Id. at 113-395(a).

8 Id. at 113-410.

9 Id. at 113-380.

10 Id. at 113-391(a)(5)h.

11 Id. at 113-421(a).

12 Id. at 113-423(f).

13 Id. at 113-421(a1).

14 Id. at 113-421(a2).

15 "Landmen" includes any person that in the course and scope of a person's business, performs any of the following activities: (1) acquires or manages oil or gas interests; (2) performs title or contract functions related to the exploration, exploitation, or disposition of oil or gas interests; (3) negotiates for the acquisition or divestiture of oil or gas rights, including the acquisition or divestiture of land or oil or gas rights for a pipeline; and (4) negotiates business agreements that provide for the exploration for or development of oil or gas. Id. at 113-425.

16 Id. at 113-391(d).

17 Id. at 113-423(c).

18 2012 N.C. Sess. Laws 143, sec 2(j).

19 Id. at sec. 2(k).

20 N.C. Gen. Stat § 113-423(a).

21 Id. at 113-423(b). The limit does not apply if the well is still in commercial production at the end of the primary term.

22 Id. at 113-423.1.

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