REGULATORY SQUEEZE SPELLED OUT FOR PRODUCERS IN CALIFORNIA

California's thicket of government regulations has contributed significantly to the steep decline in that state's upstream petroleum industry. The high cost of excessive regulation affecting production operations in some regions is rendering those operations uneconomic. Excessive and often redundant regulation governing upstream operations adds to California operating costs far beyond those in other states.

April 19, 1993

9 min read

California's thicket of government regulations has contributed significantly to the steep decline in that state's upstream petroleum industry.

The high cost of excessive regulation affecting production operations in some regions is rendering those operations uneconomic. Excessive and often redundant regulation governing upstream operations adds to California operating costs far beyond those in other states.

The effect of the added costs goes beyond shut-in production and a sliding active rig count. The upshot is thousands of lost jobs and hundreds of millions of dollars in lost state revenues.

Further, as drilling and production activity declines in California in tandem with skidding oil production in Alaska, source of half of California's oil, the Golden State soon may find itself increasingly dependent on oil imports from outside the U.S.

Those are among the key findings of a landmark study conducted for the California Department of Conservation (DOC) by Foster Economics Inc., San Francisco.

STUDY FINDINGS

The study details regulatory costs for each of California's key oil producing regions and develops recommendations to streamline the state's oil and gas rules aimed at:

Reducing the cost of regulatory compliance to enable California producers to compete for world market share.
Reducing the cost of California's state government to reflect lower state budgets.
Requiring more evidence that environmental and health benefits exceed the costs of regulation.

DOC Director Ed Heidig ordered the study, conducted by Foster Senior Vice Pres. William W. Wade along with DNA Associates' David Arrieta, Resource Decisions' Marvin Feldman, and California Environmental Resource Associates' Randy Ward.

An advisory committee of federal and state government agencies, industry associations, and environmental groups was expected to review the study late last month and comment on the report's recommendations (OGJ, Apr. 5, p. 15).

Because California Gov. Pete Wilson's fiscal 1993-94 budget suggests a substantial reorganization of government functions will occur in the coming fiscal year, the study's authors formulated a number of recommendations to streamline California oil and gas production regulations.

"The single most salient finding of our research," Wade said, "is that local, state, and federal agencies have imposed complex regulatory controls on the petroleum industry-costing more than $325 million in 1991-with little or no requirement to demonstrate that the regulations provide incremental benefits to society to match the costs."

Heidig said, 'These figures confirm the impact overregulation has on the future of California's economy and how we must simplify the regulatory process to assist businesses with compliance.

"Ensuring safe and environmentally sound extraction of oil and gas reserves in California can happen simultaneously, but we must streamline the regulatory process now. The oil industry is at a crossroads, and we must begin implementing many of the report's recommendations immediately to maintain protection of the environment and jobs."

California Sec. of Trade and Commerce Julie Wright said, "Our environmental standards should be descriptive, not prescriptive; results-based, not rule-based. We need to give business the flexibility to meet these standards in ways best suited to their operations. We should set limits, not mandate how businesses reach those limits."

STUDY RATIONALE

Foster noted that California relies on oil and gas for 88% of its energy needs, exceeding the U.S. average.

Because the state's petroleum sector continues to sustain declines in production and employment comparable to the downturn in its manufacturing sector, DOC retained Foster to study producers' regulatory compliance costs, determine whether those costs are contributing to the downturn, and make recommendations.

The backbone of the report is a survey of oil and gas producers in California's five producing regions to confirm environmental regulations and determine their costs.

Foster noted California crude production has fallen 23% and natural gas production has dropped 31% since peaking in 1984-85 and that producing wells and new wells drilled in 1992 were at their lowest level in recent history. The decline in producing oil wells in 1992 vs. 1991 was the steepest single year drop in a decade.

There are regional disparities in the state's production profile. Production declines in the coastal producing areas have outstripped the U.S. average, while San Joaquin Valley production has held up better than the rest of the U.S. Correspondingly, state regulatory compliance costs are highest in the coastal districts and lowest in the San Joaquin Valley.

WHAT'S AT STAKE

Foster found that California's oil and gas production industry accounted for a $1.45 billion direct payroll in 1990 at an average annual salary of $45,000.

Links to other state business sectors accounted for a total a of $2.75 billion related to the industry. Direct employment in California's oil and gas production industry fell 11% during 199092, causing a loss of almost $160 million in personal income to the state with an attendant loss of personal income tax revenues.

Total tax fee, and royalty payments to state and local governments amounted to more than $600 million in 1990, or more than 10% of wellhead production value.

The decline in production, prices, and employment since 1990 has caused payments to state and local governments to plunge by about $100 million, the study found.

REGULATORY COSTS

Complying with at least 34 federal, state, and local agencies implementing dozens of regulations cost state producers $326 million in 1991 with air quality districts accounting for almost $180 million of that total.

Total compliance costs among California producers ranged from 55 cts/bbl of oil equivalent (BOE) in the San Joaquin Valley to $2.39/BOE in the Long Beach region, which for purposes of the study included Los Angeles and Orange counties and their respective tidelands (Table).

The steep regulatory costs for Santa Maria area production coupled with transportation costs cause lifting costs to exceed wellhead prices in the region. Ventura production values covered lifting costs at recent prices but left little surplus to cover fixed costs and profits. Only San Joaquin production costs were low enough to conclude that production values clearly covered lifting costs, other fixed costs, overhead, and profit.

"Only part of the much lower cost per barrel of regulatory compliance in San Joaquin represents economies of scale," Foster Senior Vice Pres. William W. Wade said.

"Although coastal production amounted to only 30% of San Joaquin Valley production, the total cost of regulations in the coastal areas exceeded the regulatory costs in the valley.

"The regulatory cost differential between San Joaquin and coastal areas is partly the cause of the distressed state of the industry in the coastal and tideland areas of southern California."

Wade cites the high cost of air regulation in the coastal regions as the biggest factor in the disparity of compliance costs compared with other regions. Another key cost factor in environmental compliance was the very high cost of requiring publicly owned treatment works (POTW) disposal of produced water in the Long Beach and Ventura regions.

"Less than 2% of produced water statewide is disposed of to POTWS, but this disposal requirement accounted for $18.5 million-42% of the $44 million produced water management cost statewide," Wade said.

AGENCY INEFFICIENCY

The study also found a number of key conflicts in regulatory management that impose unnecessary complexity on producers.

"Incrementally developed regulations by multiple agencies have led to overlaps in authority as agencies expanded their sphere of influence to oversee operations believed to be within their responsibility," Wade said. "As a result, layers of regulations now delay approvals for drilling projects and explain part of the high regulatory costs.

"Besides these overlapping agency problems, California oil producers are put at a financial disadvantage to producers elsewhere by California's unique regulations, more stringent than their federal counterparts."

Wade also noted California has no requirement that cost/benefit analysis be used to justify regulations, a useful tool for improving environmental policies.

And California lags the national trend of applying benefit measurement techniques to environmental regulatory policies, Wade said.

"Until either petroleum prices increase or regulatory costs decrease, the California production industry will continue to decline faster than the national average even though the ratio of California's discovered reserves to production exceeds the U.S. average by 35%," Wade said.

"The oil is here, but declining production shows that the incentives to produce it are not here."

RECOMMENDATIONS

The costs of those regulations and the complexity imposed by multiple layers of enforcement create disincentives to operate in the state, thus reducing the ultimate recovery of California oil.

Thus the study made specific recommendations to streamline state oil and gas regulations:

DOC should continue cooperative efforts with the U.S. Environmental Protection Agency and the Ground Water Protection Council to ensure continued Division of Oil & Gas (DOG) regulatory primacy of Class II injection wells.
DOC and affected interests should develop a management strategy to determine the highest value and best use of produced water.
The permitting process for injection wells should be streamlined.
DOC and the Department of Toxic Substances Control (DTSC) should develop a management agreement to transfer inspection and reporting requirements of the DTSC to DOC.
The recycling of nonhazardous Resource Conservation and Recovery Act materials should be encouraged. For example, although tank bottom waste and drilling muds are classified as nonhazardous, California law requires them to be disposed of in Class I landfills.
DOC should coordinate efforts between U.S. Fish & Wildlife Service (FWS) and the California Department of Fish & Game (DFG) to ensure development of habitat conservation plans in oil production and exploration areas. By defining the goals of responsible agencies for protecting species, such plans introduce predictability into industry's decision making.
State and federal agencies should conduct management review of FWS and DFG permitting processes.
Authorizing legislation should be enacted to allow the state to coordinate development agreements, with the DOC the best choice among agencies.
Management of state tidelands oil production operations should be transferred to DOG. The State Lands Commission could continue to oversee leasing and lease management of state tidelands.
Air quality authorities should consider applying cost/benefit analysis to existing and future standards as they relate to criteria pollution controls for heavy oil production. DOC should coordinate efforts with air quality authorities to assess potential for implementing analysis of benefits and costs of further air emissions cuts in conjunction with the current use of cost effective analysis.
Oil spill programs should be consolidated within DFG and DOC.
DOC should conduct a program audit of DOG.
DOC, the California Energy Commission, and U.S. Department of Energy should cooperate in a similar study on the economic status of the downstream oil and gas industry in California.