Seismicity triggering more regulation

OIL AND GAS INDUSTRY MAY FACE INCREASED REGULATORY, TRANSACTIONAL, AND LITIGATION RISKS

JOEL MACK AND ALICIA HANDY, LATHAM & WATKINS, HOUSTON
JAMES BARRETT AND KIMBERLY JONES, LATHAM & WATKINS, WASHINGTON, DC

ADVANCES IN oil and natural gas production operations, particularly hydraulic fracturing and horizontal drilling technology and processes, have resulted in significant increases in oil and natural gas production throughout the United States. With this increase in production has come a corresponding increase in the disposal of produced water and wastewater, including disposal in state-regulated underground injection control (UIC) wells. Certain states are also experiencing higher levels of seismic activity compared to pre-2005 averages, which coincides with the recent increase in oil and natural gas production.

While no direct correlation between the disposal of produced water in UIC wells and seismic activity has yet been found, within the past five years, an increasing number of studies have identified at least some connection between seismic activity and specific disposal locations.

While hydraulic fracturing and horizontal drilling have become widespread throughout numerous producing basins in the United States, there has only been a measured increase in average seismic activity in specific areas within a small number of states, particularly in north-central Texas, southern Kansas, and north-central Oklahoma, suggesting that local geology may influence the rate of seismic activity. The corresponding regulatory response has come mostly from agencies in those states. As a result of increased regulatory activity and litigation, upstream exploration and production companies and disposal companies operating in these affected areas may face increased compliance, operational and financial risks - particularly those companies that are smaller and/or do not have geographically diverse operations.

REGULATORY RESPONSE

Federal

Wastewater injection wells are regulated as Class II wells under the Safe Drinking Water Act of 1974. While Class II wells do not require an evaluation of seismicity risks as a permit condition, federal law allows room for additional conditions to be added in individual permits as needed to protect underground sources of drinking water. In February 2015, the Environmental Protection Agency (EPA) released a management tool that provides a framework for addressing induced seismicity risks on a site-specific basis. EPA Region III also evaluates seismicity risks during the permitting process. Further, in March 2016, the US Army Corps of Engineers (Corps) released a study of the Joe Pool Lake Dam Project in Texas, expressing concern over the "numerous injection wells in the Fort Worth Basin." The Corps stated that "more care should be taken [when] choosing injection well sites" and has created an exclusion zone that prohibits injection wells within five miles of the dam project.

State

The EPA has granted 33 states primacy to regulate Class II wells, including states where there has been an increase in seismic events, including Oklahoma, Colorado, Texas, Kansas, and Arkansas. Some of these states have implemented regulations and policies aimed directly at reducing the risks associated with induced seismicity, while others have either proposed similar regulations, established heightened monitoring requirements or issued area-wide moratoriums.

Oklahoma

In 2013, the Oklahoma Corporation Commission (OCC) adopted a "traffic light" system, as recommended by the National Academy of Sciences, whereby the agency reviews existing and proposed disposal well permits for proximity to faults. The traffic light system is communicated to well operators via a series of "directives" or area-wide plans typically requiring operators to shut in UIC wells or otherwise reduce the volume of produced water that is injected into a well.

Between March 2015 and July 2015, the OCC issued directives affecting more than 500 wells, prohibiting operators from injecting wastewater below the Arbuckle formation, and requiring operators to reduce well depths if they were injecting below the Arbuckle formation. In August 2015, the OCC began taking steps to address seismicity issues in northern Oklahoma County and southern Logan County. On Feb. 16, 2016, the OCC announced its largest volume reduction plan for wells in western Oklahoma, covering approximately 245 disposal wells injecting into the Arbuckle formation, ordering a 40% reduction in daily disposal volumes.

Until now, companies could successfully resist the OCC's directives since the traffic light system was not a part of the state's official regulations. In response, House Bill 3158 was drafted to clarify the OCC's authority to "take whatever action necessary without notice and hearing" to respond to emergency situations. HB 3158 received unanimous support in both chambers of the Oklahoma State Legislature, and it was signed into law by Governor Mary Fallin on April 18, 2016.

The traffic light system also imposes additional requirements on proposed wells within seismically active areas. If the proposed well is within three miles of a stress fault, within six miles of a seismic swarm, or within an Area of Interest (AOI), the operator must explain the induced seismicity risk during a technical meeting. Those wells that would be drilled in an AOI may receive temporary permits with additional monitoring requirements, such as periodic bottom pressure readings. On Mar. 7, 2016, the OCC expanded the AOI, covering about 118 more disposal wells, including some that have not previously experienced seismic activity. By expanding this area, the central Oklahoma response plan seeks to reduce total disposal volumes to 40% below 2014 levels.

Ohio

On July 10, 2012, Governor John Kasich signed Executive Order 2012-09K after determining that an emergency existed due to the potential dangers of seismic activity. The order allowed the Department of Natural Resources, Division of Oil and Gas to issue amendments to its saltwater disposal injection permitting rules, without needing to follow formal rulemaking procedures. Pursuant to the amended rules, the division has the authority to require pressure fall-off testing, geological investigations of fault lines, radioactive tracer or spinner surveys, maximum injection pressures and automatic shut-off mechanisms. The state also added monitors to its new network of seismic monitors in order to monitor seismic activity near disposal wells.

Colorado

Permit applications are reviewed specifically to evaluate seismic activity. As of 2011, Colorado has required operators to identify potential faults near proposed wells, if earthquakes historically occurred in the area, and to accept maximum injection pressures and volumes based on fracture gradient as conditions to permit approval.

Texas

The Texas Railroad Commission (RRC) adopted a fourth update to its Class II well rules in October 2014. The new rules require applicants to conduct a search of the USGS seismic database for historical earthquakes around a proposed well. The update clarifies the RRC's authority on a variety of issues, including the ability to modify permits or shut-in wells based on scientific data, to require operators to disclose additional information (e.g., geologic cross-sections, pressure front boundary calculations), or to require more frequent monitoring and reporting. The RRC has also taken steps to challenge the Corps' authority to limit disposal well (and hydraulic fracturing) operations near the Jim Pool Lake Dam Project. While the RRC has not yet linked disposal activities to induced seismicity, it has retained a seismologist to conduct research into the issue, who also rejected the idea that recent earthquakes were human-induced. However, on May 18, 2016, a new study by the University of Texas' Institute for Geophysics concluded that more than half of the earthquakes in Texas in the past 40 years were triggered by oil and gas production - 28% were deemed "possibly" human-induced.

Arkansas

In 2011, the Arkansas Oil and Gas Commission permanently shut down four wastewater disposal wells in the Fayetteville Shale and issued a permanent moratorium on injection well operations in the surrounding area.

Kansas

In 2014, Kansas Governor Sam Brownback established a task force led by the Kansas Geological Survey and included representatives from the Kansas Corporation Commission (KCC) and the Kansas Department of Health and Environment. The task force was instructed to study and develop a State Action Plan to address potential induced seismicity risks.

In 2014 the task force proposed a plan reminiscent of Oklahoma's traffic light system. More recently, in March 2015, the KCC ordered operators to limit injection pressure and volumes "in areas experiencing increased seismic activity." The KCC determined that Kansas had experienced the most seismic activity in Harper and Sumner Counties, correlating with an increase in the volume of wastewater injected in those areas. Order No. 15-CONS-770-CMSC established daily injection limits, created monitoring and spacing requirements in those counties, and also required companies to prove that they had not drilled deeper than the Arbuckle Formation.

The monitoring period and injection limits, which were set to expire in September 2015, were extended to March 2016. In February 2016, the KCC staff recommended expanding the volume reductions schedule to cover wells not previously identified in the March 2015 Order. Since the order, the number and magnitude of earthquakes has dropped substantially.

California

In California, the regulatory response is being driven not only by events related to induced seismicity, but natural seismicity as well. For instance, on April 27, 2015, the Assembly Natural Resources Committee passed A.B. 1490 which would prohibit wastewater disposal wells (and all well stimulation treatments) within 10 miles of a fault that has been active in the past 200 years. On February 4, 2016, for the first time, a study linked wastewater injections with earthquakes in the state. The Department of Conservation, Division of Oil, Gas, and Geothermal Resources has subsequently announced that it is considering revising its UIC program and released a Pre-Rulemaking Discussion Draft for public comment.

Pennsylvania

Although the state has not seen a similar increase in seismic activity, Pennsylvania has also taken steps to minimize the risk. Pennsylvania recently decided to reinstate a dormant regulation, Chapter 91, § 91.51, that would review permit applications with a higher level of scrutiny than the EPA, which has primary oversight. Well operators would be required to demonstrate that the well is unlikely to harm the "public interest," which may allow the state regulator to require seismic monitoring as a permit condition. Regulators are also investigating the causes of seismic activity that occurred on April 25, 2016, in New Castle, located near the Ohio border and which has a history of earthquakes linked to oil and gas operations.

LITIGATION

State

In addition to the regulatory response, lawsuits have been initiated in at least two states - Arkansas and Oklahoma. Most of the lawsuits have been filed in state court and have generally asserted causes of action related to real property torts, such as interference with the use and enjoyment of property, nuisance, strict and absolute liability, negligence, gross negligence, and trespass. The Arkansas cases were voluntarily dismissed by plaintiffs. Five cases have been filed in Oklahoma, two of which have attempted to characterize wastewater injection wells as an "ultra-hazardous activity," a characterization which has so far failed in hydraulic fracturing-related lawsuits.

Federal

On Feb. 16, 2016, the Sierra Club filed a lawsuit in the US District Court for the Western District of Oklahoma against Chesapeake Operating LLC, Devon Energy Production Co. LP, and New Dominion LLC just days after a magnitude 5.1 earthquake struck in Fairview, Okla. The suit was filed pursuant to citizen suit provisions of the Resource Conservation and Recovery Act (RCRA) seeking declaratory and injunctive relief to enjoin alleged "imminent endangerment" arising from wastewater injection activities. Citing numerous scientific studies connecting seismicity with wastewater injection wells, the complaint alleges that wastewater is a "Production Waste" that presents "an imminent and substantial endangerment to public health and the environment" under 42 U.S.C. § 6972(a)(1)(B), requiring abatement.

Applying RCRA in this context is novel, and plaintiffs appear to have a heavy burden to carry. The Supreme Court has ruled that an endangerment finding can only be "imminent" if it threatens to occur immediately. Despite the science strengthening the correlation, imminence may be absent in light of the USGS's position that most injection wells are not associated with earthquakes. Only some wells have been implicated in published studies, and this strategy may only be viable in states that have administratively required specific sites to reduce disposal volumes immediately following a seismic event. Imminence could also be particularly difficult to prove in cases where the science has not determined the timeframe or geological conditions under which injection activity could trigger a seismic event. Defendants filed motions to dismiss arguing that the complaint falls outside RCRA's "zone of interest," emphasizing that any court action would interfere with the OCC, which maintains primary jurisdiction.

While New Dominion regards the link between seismicity and disposal activity a "fallacy," Devon Energy does not dispute the correlation, and Chesapeake Energy believes the link needs further study. How the companies' differing views will factor into the court's decision remains unclear.

CONCLUSIONS

Increased seismic activity, scientific research, and state regulators' aggressive regulatory action could have significant consequences for both the owners/operators of the disposal wells and the upstream companies that use UIC wells (or contract with third-party operators) to dispose of wastewater from their operations. From an operational perspective, disposal well owners/operators may be required to comply with more stringent construction standards, be subject to increased financial assurance requirements, or be required to scale back or to entirely shut down operations, in addition to complying with permit conditions imposing limits on injection pressures and volumes. A lack of data and demonstrated causal nexus between particular disposal wells and particular seismic events makes technological solutions more complicated. Upstream companies might be forced to look for new disposal options if regulators require wells to reduce the amount of wastewater that can be injected or are otherwise ordered to shut in.

Disposal well owners/operators also might be subject to increased litigation as experts generate more studies on seismicity and are able to tie particular wells to particular seismic events or fault systems. Plaintiffs (or reviewing courts) may be less inclined to dismiss claims in states such as Oklahoma where the OGS "considers it very likely that the majority of recent earthquakes, particularly those in central and north-central Oklahoma" are human-induced.

Parties should also consider operational and litigation risks in the context of merger and acquisition, capital markets, and financing transactions. Companies that provide disposal services and the upstream companies that own or rely on those services should evaluate the comprehensiveness of their environmental disclosures in public filings. Banks underwriting these transactions should evaluate the comprehensiveness of these disclosures, as well.

Securities laws require the disclosure of a company's material regulatory, operational, enforcement, and litigation risks. While public disclosure trends are still emerging, companies that provide and use these disposal services, particularly in areas experiencing increased seismic risk, are beginning to disclose the potential risks related to induced seismicity (including increased regulatory compliance obligations and litigation) on their operations and financial position.

Lenders may also be interested in due diligence on the risks presented by specific borrowers operating or relying on disposal well capacity in affected areas. Lastly, companies looking to purchase disposal well or upstream assets should consider the potential impacts of increased regulation, moratoriums, or other prohibitions, and litigation on the short- and long-term value of those assets.

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