United States: California Moves To Further Regulate Unconventional Oil And Gas Production: A Review Of Senate Bill 4 And Its Potential Impact On Shale Development In The Golden State

Keywords: California, oil and gas, Senate Bill 4, shale, well stimulation treatment, hydraulic fracturing

Since 2010, more than 20 states have adopted new laws or regulations specific to hydraulic fracturing, a process used to stimulate oil and gas production that involves pumping pressurized fluids and proppants down a wellbore to create or restore fractures in a target geologic formation. Along with horizontal drilling, advanced hydraulic fracturing technologies have given exploration and production (E&P) companies the ability to economically tap into the United States' vast "unconventional" hydrocarbon formations for the first time, particularly low-permeability shale formations.

With the wave of new regulations, it has become increasingly important for operators and oilfield services companies, and their counsel, to keep themselves informed about new regulatory developments affecting the oil and gas industry. This update addresses California's recently enacted Senate Bill 4 and its potential impact on future shale development in the state.

Introduction

California is the third largest oil producer in the United States and home to some of the richest (untapped) oil- and gas-bearing shale formations in the world. California's Monterey Shale is considered the largest shale-oil formation in the United States, holding an estimated 15.4 billion barrels of oil, equivalent to approximately two-thirds of the total recoverable, onshore shale-oil reserves in the contiguous United States. By comparison, the South Texas Eagle Ford Shale holds an estimated 3 billion barrels, and the North Dakota Bakken Shale holds an estimated 4 billion barrels.

Yet, more than 10 years after the "shale revolution" took off in the United States, there has been no large-scale shale development in California, and the state's crude oil production comes largely from conventional sources (with only about 20 percent from unconventional sources). Indeed, California's crude oil production has continued to decline over the past decade while states such as North Dakota are exceeding record production levels year after year.

To date, the single largest challenge to increased shale development in California has been the unique geology of the Monterey Shale. Unlike other major shale formations, the Monterey Shale is tectonically faulted and fragmented. This has complicated the exploration process and, according to published reports, no company has yet been able to "crack the code" to economically tap into the Monterey.

Despite the rarity of hydraulic fracturing in California, its use has nonetheless become a controversial issue in the state. Indeed, Senate Bill 4 was not the first effort to address the use of hydraulic fracturing and other well stimulation methods key to unconventional oil and gas development.1 For several years, the legislature considered numerous bills that would have further regulated hydraulic fracturing, but they all failed to win approval. On a parallel track, the initiation of a rule-making process and publication of draft regulations in early 2013 by the California Division of Oil, Gas and Geothermal Resources (DOGGR) ensured that, even if the legislature failed to act, the regulatory scheme would be modified. After significant debate and several amendments, Senate Bill 4 passed both houses and was signed by the governor on September 20, 2013.

Application of Senate Bill 4

Senate Bill 4 applies broadly to oil and gas activities involving "well stimulation treatments." The bill defines "well stimulation treatments" as "any treatment of a well designed to enhance oil and gas production or recovery by increasing the permeability of the formation ... [including but] not limited to, hydraulic fracturing treatments and acid well stimulation treatments." The bill does not, however, apply to "steam flooding, water flooding, or cyclic steaming[,] .... routine well cleanout work, routine well maintenance, routine removal of formation damage due to drilling, bottom hole pressure surveys, or routine activities that do not affect the integrity of the well or the formation." In addition, the bill does not apply to treatments on wells used at underground gas storage facilities.

No Moratorium

Senate Bill 4 does not contain an express prohibition or moratorium on hydraulic fracturing. Rather, the law requires the DOGGR and other agencies to promulgate new rules and regulations and take other actions that address well stimulation treatments. Until such new rules and regulations are adopted, an operator is allowed to proceed with well stimulation treatments provided that the operator notifies the DOGGR, provides a "complete well history" and certifies compliance with certain sections of §3160.

Senate Bill 4 requires the DOGGR to conduct, by July 1, 2015, an environmental impact report (EIR) pursuant to the California Environmental Quality Act (CEQA). It remains to be seen whether the EIR required for well stimulation activities prior to the enactment of regulations will be used as a reason to effectively prohibit well stimulation prior to that time. Currently, there is ongoing litigation on the issue of whether the language of Senate Bill 4 frees operators from the need to go through CEQA until the DOGGR's EIR is complete. Governor Brown recently signaled that the DOGGR's EIR required under the law may take up to 18 months to complete.

Independent Scientific Studies

In addition to the EIR that the DOGGR must conduct, Senate Bill 4 requires that the Natural Resources Agency (an umbrella agency that includes the DOGGR) undertake and complete by January 1, 2015, an independent scientific study on well stimulation treatments. The study is to cover various specific items, with the goal of evaluating "the hazards and risks and potential hazards and risks that well stimulation treatments pose to natural resources and public, occupational, and environmental health and safety."

In addition, a study is required to be completed by 2020 evaluating acid matrix stimulation techniques, based on data collected by the state, and establishing "threshold values" for preventing, as far as possible, damage to life, health, property and natural resources. In this respect, the new law is broader than similar initiatives in other states that focus mostly or exclusively on hydraulic fracturing. For reasons that are not entirely clear, acid treatments of wells also became the subject of comment in the press and from interest groups, and so Senate Bill 4 includes coverage for "acid fracturing treatments" and "acid matrix stimulation treatments," as well as hydraulic fracturing. The agency is also required to give a progress report to the legislature every four months until the studies are completed.

DOGGR to Promulgate New Rules and Regulations

Senate Bill 4 gives the DOGGR regulatory authority to promulgate (in consultation with other state and local agencies) new regulations specific to well stimulation treatments, including new rules governing the construction of wells and well casings and full disclosure of the composition and disposition of well stimulation fluids. The DOGGR must adopt and implement these new regulations by January 1, 2015, but the DOGGR is widely expected to finalize the regulations much sooner.

In addition, §3160(c) provides that the DOGGR is required to enter into "formal agreements" with a number of other state and local agencies "clearly delineating requirements associated with well stimulation treatments and well stimulation treatment-related activities, including air and water quality monitoring, in order to promote regulatory transparency and accountability."

Well Permit System as Means for Enforcement

The bill requires an operator to apply for a well stimulation permit prior to performing any well treatments and would prohibit the operator from either conducting a new well stimulation treatment or repeating a well stimulation treatment without a valid, approved permit. The DOGGR will utilize this permitting mechanism as a means of enforcement once it adopts new rules and regulations specific to well stimulation treatments.

In addition to applying for a permit, §3160(d) requires that the operator submit to the DOGGR a significant amount of information about the planned well stimulation activities. At the discretion of the DOGGR supervisor, this permitting process may be combined with other well permitting matters. The operator's application must provide details about the well and stimulation treatment, including the dimensions of the job, the expected chemical composition of the well stimulation fluids, a water management plan, a groundwater monitoring plan and other aspects of the proposed operation. The DOGGR is required to furnish copies of issued permits to various agencies. The bill also requires the operator to provide notice to the DOGGR at least 72 hours prior to the actual start of a well stimulation treatment in order for the DOGGR to be able to witness the treatment.

Before a well treatment can begin, the bill further requires the operator to provide a copy of the approved well stimulation treatment permit to specified tenants and property owners at least 30 days prior to commencing a treatment. The operator is to engage "an independent entity or person" to give 30 days' advance notice and certain information to "every tenant of the surface property and every surface property owner or authorized agent of that owner whose property line location is one of the following:

(i) Within a 1,500 foot radius of the wellhead or

(ii) Within 500 feet from the horizontal projection of all subsurface portions of the designated well to the surface.

The identity of the surface property owner is to be established by reference to county tax records. The statute does not, however, provide a mechanism for determining the identity of tenants.

Unlike other state laws, Senate Bill 4 also gives a property owner the right to request that the operator undertake and pay for water testing and analysis of a surface or well water source that is "suitable for drilling or irrigation purposes." The testing includes follow-up measurements after the well stimulation has occurred.

Well Stimulation Fluid Chemical Disclosure

Like the laws in many other states, Senate Bill 4 requires operators in California to publicly disclose information about all chemical additives that they use in "well stimulation treatments" via FracFocus. FracFocus is an online searchable chemical disclosure registry that emerged in April 2011 to allow operators to voluntarily disclose information about hydraulic fracturing treatments to the public on a well-by-well basis. FracFocus is a joint project of the Ground Water Protection Council and the Interstate Oil and Gas Compact Commission. As of November 4, 2013, there were nearly 56,000 disclosures posted on FracFocus and more than 500 participating companies.

The bill requires that the operator make this disclosure within 60 days of the cessation of a well stimulation treatment. This is in addition to the disclosure the operator must make to the DOGGR officials before commencing the treatment. Ten states currently utilize FracFocus as a means of official state chemical disclosure, including Texas, Oklahoma, North Dakota, Colorado and Pennsylvania.

No later than January 1, 2016, the DOGGR is also to have its own web page for disclosure. Apparently in light of some criticism of the functions of the FracFocus web page, the DOGGR web page is required to allow the public "to easily search and aggregate, to the extent practicable, each type of information required to be collected... using search functions" on the web page. FracFocus recently released a new version of its search feature in order to address many of these criticisms.

While requiring public disclosure, the California law also allows companies to protect certain proprietary information from disclosure by asserting trade secret protection. This is for good reason. E&P companies, oilfield service companies, independent researchers and universities have developed, or contributed to the development of, a wide array of hydraulic fracturing and horizontal drilling technologies. In the highly competitive and diversified oilfield services market, the development of new hydraulic fracturing technologies can confer distinct market advantages to those that use them. In the event that an operator, service company or supplier withholds information on the grounds that it is proprietary trade secret information, then the withholding party must provide the DOGGR with the following information in order to substantiate its claim:

  • The extent to which the trade secret information is known by the supplier's employees and others involved in the supplier's business and outside the supplier's business.
  • The measures taken by the supplier to guard the secrecy of the trade secret information.
  • The value of the trade secret information to the supplier and its competitors.
  • The amount of effort or money the supplier expended developing the trade secret information and the ease or difficulty with which the trade secret information could be acquired or duplicated by others.

In the event that the DOGGR disagrees, the party claiming trade secret protection must seek relief in court or the DOGGR will release the information.Where proprietary trade secret information has been withheld, the withholding party must provide substitute information for public disclosure that includes a list of the chemical constituents of the additive and Chemical Abstract Service (CAS) identification numbers.

The DOGGR is also required to develop a procedure to make trade secret information available to health professionals. This is a common provision in state chemical disclosure laws and mirrors some aspects of federal law.

Senate Bill 4 allows health professionals to obtain proprietary trade secret information in the event of an emergency or to diagnose or treat a patient. The health professional must, however, submit a written statement of need. The health professional can then share such trade secret information with other persons as may be professionally necessary in order to diagnose or treat a patient, subject to certain restrictions, and those with whom he or she shares trade secret information cannot be required to sign a confidentiality agreement.

DOGGR Reporting

In addition to the other interim reporting required of the DOGGR while the new permitting program is being developed and implemented, the DOGGR must make comprehensive annual reports starting on January 1, 2016.

Fines

Senate Bill 4 significantly increases the amount that an operator or service company performing a well stimulation treatment can be fined for a regulatory violation. Previously, an operator or service company engaged in oil and gas production activities, including well stimulation treatments, was only subject to a fine of up to $25,000 per violation of the DOGGR's oil and gas regulations. There was no minimum floor for fines or applicable per diem fine. Now, an operator or service company engaged in oil and gas production activities involving well stimulation treatments is subject to a civil penalty of not less than $10,000 and up to $25,000 per day per violation of DOGGR's regulations specific to well stimulation treatments.

Other Agency Involvement

As noted above, the DOGGR must consult with a number of other state and local government agencies in the areas where the DOGGR is responsible. Senate Bill 4 requires that the State Water Resources Control Board (SWRCB) develop "model groundwater monitoring criteria," to be implemented on a well-by-well basis, or on a regional scale. The stated purpose of these criteria is to "assess the potential effects of well stimulation treatments ... on the state's groundwater resources in a systematic way." These new criteria are to be completed by July 1, 2015. Regional groundwater monitoring programs (based upon the developed criteria) are to be implemented by the SWRCB and regional water boards by January 1, 2016.

To the extent that the DOGGR shares jurisdiction with a federal entity, Senate Bill 4 requires that the DOGGR's rules and regulations apply in addition to all applicable federal laws and regulations.

Conclusion

Governor Brown's signing statement for Senate Bill 4 indicates that he is directing the DOGGR's parent agency, the Department of Conservation, to develop "an efficient permitting program ... that groups permits together based on factors such as known geologic conditions and environmental impacts, while providing for more particularized review in other situations when necessary. The bill needs some clarifying amendments and I will work with the author in making those changes next year." Inasmuch as the Governor's public statements have suggested that he encourages responsible development of the state's oil and gas resources, his signing statement suggests that he intends to develop a workable and practical program for allowing well stimulation treatments in California. Having an effective, efficient and workable regulatory program will be important in the years to come as technology develops and more information is learned about the state's shale potential.

Indeed, California's geologic and technological challenges in the Monterey Shale today are not wholly unlike the challenges faced in the North Texas Barnett Shale 15 years ago or the North Dakota Bakken just five years ago. In each case, the problem was not knowing that there were shale hydrocarbon reserves in those areas—that had been known for decades. Rather, the problem was finding a way to economically extract the hydrocarbons trapped in those formations. In fact, with seemingly insurmountable technical barriers, the industry largely ignored shale for decades. That all changed in the late 1990s and 2000s.

Mitchell Energy, a relatively small, independent Texas exploration and production company, did what nearly everyone at the time thought was impossible—the company developed a way to economically tap into the natural gas-rich Barnett Shale in North Texas. In the following years, different companies further advanced the technology originally used by Mitchell to tap into the Barnett Shale, adapting it to the unique geologies of other shale gas plays through the 2000s and then to shale oil plays starting in 2008. In the end, the real question regarding shale development in California should not be "if," but "when."

Originally published November 4, 2013

Footnote

1 See, e.g., S.B. 4, 2013-2014 Leg., R.S. (Cal. 2013).

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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