September 16, 2020
What’s the issue?
Colorado is considering new regulations that will establish a statewide standard on the distance that new wells must be from occupied structures.
Why does it matter?
Under a study issued by professors at two Colorado universities, if these “setback” standards are fixed at a distance greater than 1500 feet, the impact on the oil and gas industry in Colorado could be severe.
What’s our view?
It seems that the agency considering these rules is likely to adopt them within the next month, with an effective date of January 1, 2021. While we fully expect the industry to appeal the regulations in the courts, the uncertainty could still limit production in the state as producers shift resources to other basins without such uncertainties. In the meantime, pure play D-J producers will likely amass as many permits as possible with hopes of riding out the uncertainty.
Estimates are that the oil and gas industry represents over 7% of Colorado’s annual economic output, but the industry has been under threat at the polls for years. This has been especially true since 2018, when the industry defeated a ballot initiative that would have required a 2,500 foot setback between a well and any occupied structure. There appeared to be some relief to that constant threat for 2020, when earlier this summer, Governor Jared Polis announced that he had struck a deal with both the environmentalists and the industry to not put forth any ballot initiatives this year. His stated reason for the initiative cease-fire was that he wanted to give his newly appointed Colorado Oil and Gas Conservation Commission (COGCC) time to work through new regulations that were required by legislation he signed into law in 2019.
However, the existential threat to the industry now appears to be coming from the COGCC; in meetings last week, four of the five newly appointed voting members of that commission expressed support for imposing a statewide setback of 2,000 feet, which, as we discuss below, is very close to the 2,500 foot setback rejected by voters in 2018. Today we look at some of the nuances of the regulatory process, and how this question of setbacks will likely lead to substantial litigation, casting a pall over the state’s oil and gas industry, specifically pure play Denver-Julesburg (D-J) basin producers, from which it may never recover.
The New Commission and the New Regulations
In 2019, Governor Polis signed into law legislation that is commonly referred to as SB19-181. This legislation, while keeping the COGCC in place, changed the “mission” of the agency from “fostering” oil and gas development to “regulating” oil and gas development. We discussed the legislation soon after it passed in 2019 in Colorado Passes Anti-Fossil Fuel Legislation; Which Way Will Texas Break?, in which we noted this key change in the agency’s mission, but also a significant change in the composition of the commission members. The first task of this new commission is to completely rewrite the commission’s regulations to adapt them to the commission’s new “mission.” This undertaking is referred to as the “Mission Change Rulemaking” and a key set of rules is the 600 Series rules which govern safety and facility operations and, in particular, Rule 64 Setbacks, which restricts the location of wells based on the well’s proximity to human structures such as houses and schools.
The hearings concerning the 600 Series rules were held over the last few weeks and culminated in a discussion by the commissioners about how they wanted the staff to redraft the staff’s proposed regulations. The staff’s proposal had provided for different setback distances depending on the building use and density, varying from 500 feet to one but less than ten residences, to 1500 feet from ten or more residences or one high occupancy residential building, to 2000 feet to a school or childcare center. All of these distances were measured from the edge of the drilling pad to either the building unit or the regularly occupied area used for a school or childcare facility. Each of these limits could be waived, for instance, by the owner of the residence or the local school board. In addition, the operator could seek an exemption from the commission by requesting a hearing and persuading the commission that the proposed location can be used in a manner that sufficiently protects and minimizes adverse impacts to public health, safety, welfare, the environment and wildlife resources.
The purpose of the commission discussion was to give the staff direction for the next draft of the regulations, and four of the five commissioners seemed to agree on some very significant changes. First, the four seemed to agree that the setback distance should be the same for all categories, whether for one residence, ten residences, or schools and childcare centers. Second, they seemed to also agree that the distance used should be 2000 feet from the edge of the well pad to the building unit, except for schools and childcare centers, where it should still be to the outside area typically used by the school.
One key question the commission was looking at was how many applications would fall within the setback limits it was considering. The staff provided data gathered since 2013 that showed the following:
As seen above, over half of all of the permits granted over this time period were for wells that were more than 3000 feet from the nearest building unit. But more than one-third were for wells within 2000 feet of the nearest building unit. It should be noted that these numbers were based on the prior standard, which measured from the wellhead to the building unit, so the setback being proposed that measures from the edge of the wellpad is likely about 250 feet greater than these. That means many of the applications in the 2001 to 2500 feet range could also be prohibited by the standard that will likely be included in the next draft of the regulations.
Weld County Matters
As we indicated in Beware the Ides of March - Will Colorado Effectively Ban Gas and Oil Development?, the key county for production in the state is Weld County. Under the interim rules that took effect following the passage of SB19-181, the local governments were given substantial authority over limits on development. On the day the act was signed, the County Commissioners of Weld County issued an open letter “to our oil and gas families” stating that “we have your back, and we will do all we can to minimize the negative impacts this new law will have on you.”
When the rules currently being considered take effect, however, the four commissioners all agreed that deference to the local governments would disappear. While local governments would be free to adopt even more restrictive provisions, those like Weld would be prohibited from decreasing the setbacks. In fact, as a demonstration of how omnipotent the commission views its role, the four commissioners even directed the staff to eliminate any ability of the local school boards to waive whatever setback was fixed by the COGCC. Even though the four commissioners indicated that they would allow landowners to waive the setback requirements, if all landowners and all tenants on the land within the setback limits agreed, they did not intend to extend that ability to school boards out of distrust for those school boards’ motives.
The impact on Weld County of a 2000 foot setback is expected to be significant. The one dissenting commissioner noted that under a report prepared by professors at the University of Colorado Boulder and the Colorado School of Mines, any setback over 1500 feet from the wellhead is expected to substantially reduce the areas within Weld County that could be successfully reached assuming a 2-mile horizontal drill. At 1500 feet, the study showed that 98.5% of the county’s subsurface would be accessible, which would result in a loss of only $608 per person per year in revenue, but that at a 2500-foot setback, the lost revenue per person per year would skyrocket to $11,872.
The Path Forward
The Commission has another hearing set for today, during which it will receive a report from the staff on the proposed new draft of the 600 Series regulations, including the setback limits and the exemptions and waiver provisions related to the setbacks. The COGCC will then reconvene on September 21 and hold a day of hearings during which it will entertain comments by the various participants on the revised draft regulations. The COGCC is planning to complete its deliberations on the final rules by September 23, and to issue them with an effective date of January 1, 2021.
If the rules are finalized with a setback that is greater than 1500 feet from the wellhead to the building unit, we fully expect that the industry will appeal these rules in the Colorado state district courts. It appears that the chair of the commission is also aware of that fact and, as a lawyer and close confidant of Governor Polis, he is diligently trying to build a record that can be sustained on appeal. However, this is a new statute and so the court will be charged with interpreting the language of the statute for the first time, and the adoption of a setback greater than 1500 feet may run afoul of the statutory language. While the chair is correct in pointing out that the statute clearly changed the mission or mandate of the agency, it still only directed the agency to regulate oil and gas development “in a reasonable manner to protect and minimize adverse impacts to public health, safety, and welfare, the environment, and wildlife resources,” and the term “minimize” is defined as being only “to the extent necessary and reasonable to protect public health, safety, and welfare, the environment, and wildlife resources.”
Neither Necessary Nor Reasonable
The argument that the industry is likely to make is that a setback greater than 1500 feet is neither reasonable nor necessary, and that the agency certainly has not developed a record to support any such action. Based on the hearings to date, we believe that is a strong argument and may lead to the regulations being overturned -- but that process could take up to two years. There are currently over 400 permit applications pending at the COGCC, and the applicants will probably push to get those that are within 2000 feet approved before the new rules take effect, so that they can rely on those permits to weather the coming period of litigation uncertainty. In the meantime, the uncertainty itself could lead those with the ability to move their investments to other basins outside of Colorado to do just that, which would serve to reduce the overall growth of the industry within the state.