David Hackett
Natalie Regoli
Daniel De Deo
Brian Polley
Baker & McKenzie LLP
Chicago, Houston
Oil and gas operations have historically been regulated mainly at the state level, though the expansion of hydraulic fracturing activities has brought with it an expansion in the number and sources of regulations facing operators. At the federal level, the US Environmental Protection Agency (EPA) has launched investigations into fracing activities in Wyoming, Texas, and Pennsylvania and is in the process of a multi-year study on the impact of hydraulic fracturing operations on drinking water, which will presumably set the stage for a new federal law. Meanwhile, at the local level, municipalities around the country have adopted limits or outright bans on fracturing operations that conflict with state rules.
The matrix of rapidly evolving restrictions from federal, state, and local sources means that operators not only need to understand what restrictions currently apply to them, but also must understand the regulatory evolution in other locations for insights regarding what might be coming to them next. Here, we give an overview of the most important developments in the regulatory landscape today.
Federal versus state
The EPA's authority is currently limited by the existence of several exemptions for fracturing operations under federal environmental laws. Perhaps most importantly, hydraulic fracturing is exempt from regulation under the Safe Drinking Water Act (SDWA), provided diesel fuel is not used as an additive in fracturing fluids. Operating within the parameters of that exemption, the EPA issued guidance in February 2014 to states for when diesel fuel is used, describing how the states should regulate the limited number of such wells. But this federal restraint may be coming to an end.
A draft of the EPA's multi-year study on drinking water impact is scheduled to be released later this year. If the EPA study, which is expected to be finalized by 2016, determines fracturing operations are significantly impacting drinking water sources it could influence legislators to act to remove some of the existing exemptions under federal laws. At this point, there has been little indication from the EPA as to whether the study will yield a conclusive result, or whether there will be a federal overlay on the already rapidly expanding body of state and local regulation.
Several states, including Pennsylvania, Illinois, California, Colorado, and Ohio, have recently developed comprehensive regulatory schemes specifically to permit and regulate fracturing activities, while states like Wyoming, Texas, and Oklahoma have added new rules for fracturing to existing oil and gas programs. An even larger group of states has now adopted fracturing fluid disclosure laws. Rather than token changes to prior rules, these state regulations are increasingly stringent and tailored to fracturing operations.
For example, in March 2014, Wyoming instituted one of the nation's strongest requirements for water well testing near drilling sites. Colorado also recently introduced the country's first standards for methane emissions from oil and gas operations, an area that EPA declined to directly regulate when it updated federal oil and gas air rules in 2012. The Colorado rules were particularly interesting because they were the product of collaboration between the state, an environmental non-governmental organization (NGO), and three oil and gas companies that operate wells in the state.
As the federal government continues to debate its role, the clear trend that has emerged in this area is that, rather than waiting for federal regulators to intercede, industry is actively engaging with states and other stakeholders to develop rules that make sense for their operations. The Center for Sustainable Shale Development (CSSD), a collaborative effort between environmental organizations and energy companies, is another example of this type of industry engagement. CSSD has established 15 initial performance standards to address air and water quality concerns relevant to oil, gas, and shale development. Four Marcellus shale operators recently announced they will undergo voluntary audits under a new verification protocol for compliance with CSSD standards.
In the near term, EPA and other federal agencies will continue to act within their limited statutory authority while exploring the areas beyond it. There are several rulemakings currently ongoing at the federal level related to hydraulic fracturing. Most recently, in May 2014, EPA released an advance notice of proposed rulemaking under the Toxic Substances Control Act (TSCA) related to chemicals used in the fracturing process. The notice suggests the EPA may consider developing a mechanism to encourage further disclosure of fracturing chemicals, either by regulation under TSCA or through a voluntary program. EPA's consideration of a voluntary program-a surprise to environmental groups that are pushing for more regulation in this area-may indicate that the EPA is willing to step back from further regulation where state requirements are already sufficiently comprehensive.
At the same time, EPA has demonstrated that it is willing to exercise any authority available to it in the event of a potential environmental emergency related to fracing. For example, despite the exemption for hydraulic fracturing under the SDWA, the statute provides EPA an "imminent and substantial endangerment" response authority, which EPA has used to investigate recent groundwater contamination allegations in Pavillion, Wyo., Dimock, Pa., and Parker County, Tex.
State versus local
The federal scrutiny and involvement in fracing activities is complicated by the battle between state and municipal regulatory laws. This battle turns on the question of "home rule" versus state preemption. The "home rule" means that local governments, through an amendment to a state's constitution, have the authority to pass self-governing laws. The level of authority varies from state to state, but disputes arise when a local law contradicts or subverts an existing state law. In the most prominent states with fracturing operations, the home rule has led to conflict as municipalities attempt to utilize traditional zoning powers to restrict operations or enforce a fracing ban in their regions.
In particular, Pennsylvania, New York, and West Virginia have been the focus of recent debate as local authorities in those states have faced challenges in court for those same reasons, in some cases leading to the repeal of local moratoria and ordinances. However, in December 2013, the Pennsylvania Supreme Court issued a ruling in support of the authority of local ordinances by invalidating contrary language in the state's landmark legislation related to hydraulic fracturing operations in the state, Act 13. The court held that the state law provisions conflicted with constitutional requirements because, among other things, they removed a local government's "necessary and reasonable authority" to set zoning and setback limits. More recently, New York's highest court ruled on June 30, 2014, that the state's oil and gas mining law does not trump town zoning laws enacted to prohibit fracing, affirming lower courts that have upheld such bans. In a 5-2 ruling, the court explicitly stated that the statewide Oil, Gas and Solution Mining Law (OGSML) "does not preempt the home rule authority vested in municipalities to regulate land use."
For the industry, the lesson to learn from such stories is the importance of considering whether a local government is regulating the "how" versus the "where" of fracing. "How" regulations-i.e. technical operational regulations-are not upheld when exercised outside the scope of areas of traditional municipal concern. "Where" regulations-i.e. setback requirements-are more frequently upheld when they exercise traditional municipal powers, such as zoning. From an operator's perspective, the biggest challenges will thus be posed by local governmental restrictions that are for the purported purpose of town or city planning.
Conclusion
Despite increasing activity at both the federal and local levels, states have retained primary authority for regulation of hydraulic fracturing. This is partly related to statutory limits on federal authority in the area and local rules being legally displaced by state rules. But a trend is also emerging in which states, often acting in concert with industry and other stakeholders, are taking proactive and aggressive approaches to developing regulations requiring best practices from the industry. The key takeaway from this trend for operators is to remain engaged with state regulators and non-governmental stakeholders to try and develop requirements at the state level that are innovative and practical, but also comprehensive enough to avoid the need for a one-size fits all federal solution and a web of unique local requirements.
The authors
David Hackett is a partner in Baker & McKenzie's Chicago office and currently coordinates the North America Compliance Group, in addition to serving as the North American Practice Group Coordinator for Banking, Finance, and Major Projects. His practice concentrates on the representation of multinationals in US and international compliance and environmental matters, including in the high tech, information management, food, pharmaceutical, and energy industries. He has extensive experience in counseling, negotiation, and litigation on behalf of multinational clients regarding state, federal, and foreign civil and criminal compliance and environmental matters.
Natalie Regoli is a partner in Baker & McKenzie's Houston office and a member of the Major Projects Practice Group. Her legal practice focuses on LNG/gas matters and she has experience throughout the lifecycle of LNG/gas projects, petrochemical facilities, and other major capital projects. Regoli focuses on the development, financing, EPC, and claims and dispute resolution for major capital projects. She has worked with governmental units, project sponsors, shareholders, investment bankers, credit rating agencies, commercial bankers, and corporate trustees.
Daniel De Deo is an associate in Baker & McKenzie's Chicago office and a member of the Environmental Practice Group. He advises US and multinational companies on state and federal environmental laws in the context of compliance, transactions, and major project development. He also provides advice to major oil and gas companies on evolving regulation and policy applicable to the industry.
Brian Polley advises on upstream energy transactions for Baker & McKenzie, with an emphasis on the representation of exploration and production companies in acquisitions and divestitures of producing properties. He also advises clients on LNG, project development, and oil and gas issues related to title instruments and opinions, private equity, and national security reviews of foreign investments.