Institute of Law and Finance University of Frankfurt

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1 US Approach To Shale Hydrocarbons Development ( Fracking ) Institute of Law and Finance University of Frankfurt David J. Evans March 27, 2015

2 Introduction 15 years ago, no one would have recognized this topic Combination of two old drilling techniques hydraulic fracturing and horizontal drilling (for simplicity here, "fracking") changed the oil & gas industry (and perhaps the world economy) Today, we will discuss: Why and how the US led the way in the development of fracking; Its impact on the US and world oil markets; and Its future in the US in light of increased public opposition ("fractivists") We will also review the current state of US regulation and litigation involving fracking Clifford Chance 2

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4 Lower 48 States Shale Plays Clifford Chance 4

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8 Global Shale Gas Resources Clifford Chance 8

9 What Makes the US Different? Entrepreneurial nature of domestic oil and gas business Private ownership of mineral rights; alignment of economic interests Developed pipeline infrastructure Access to drilling technology Access to capital Decentralized Federal system - significant policy-making at state and local levels Receptive all-of-the-above national energy strategy Geography and geology Familiarity with oil & gas in some endowed areas and economic need in others Clifford Chance 9

10 US Natural Gas Supply by Source Natural gas production by source, (trillion cubic feet) Clifford Chance 10

11 US Shale Gas Production, Clifford Chance 11

12 Henry Hub Natural Gas Price Clifford Chance 12

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14 Destinations of Contracted US LNG Exports Clifford Chance 14

15 Crude Oil & Refined Products The US currently pumps over 9 MBBLs/d of crude oil; up over 55% from five years ago Current US law essentially prohibits the export of US crude (with some ad hoc exceptions; an average of 95,000 BBLs/d were exported to Canada in 2013) However, there are increasing calls for this ban (which relates back to the oil crises of the 1970s) to be lifted or modified In a series of recent orders, the Department of Commerce has allowed condensate (ultralight shale oil) that had been "stabilized" and "distilled" to be shipped by tanker to foreign buyers; this has been touted as the beginning of licensing regime that will allow oil shipments in spite of the '70s Congressional ban Now codified in Department of Commerce guidelines (December 2014) Clifford Chance 15

16 Oil Products The US is also exporting significant amounts of oil not as crude, but in the form of refined oil products, for which no export approval is needed Exports of US refined products especially low sulfur diesel are up 65% since 2010 US refined products are displacing European sales Significant exports to Mexico Refineries are responding to the availability of inexpensive, "trapped" US crude, and will be adding 400,000 BBLs of crude refining capacity before 2018, and 600,000 BBLs of "splitters" to process ultra-light shale oil, making even more oil products for domestic consumption or export Allowing ultralight shale oil to be shipped directly to foreign buyers (as noted above) may threaten the economic rationale for some planned splitters Clifford Chance 16

17 Relative Prices of Crude Oil and Natural Gas Cushing, OK WTI Spot Price FOB (Dollars per Barrel) Europe Brent Spot Price FOB (Dollars per Barrel) Price of Liquefied U.S. Natural Gas Exports (Dollars per Thousand Cubic Feet) Henry Hub Natural Gas Spot Price (Dollars per Million Btu) Source: created from data sets published by U.S. Energy Information Administration Clifford Chance 17

18 So Where Are We Now, Given The Crash In Oil Prices? Cancellation or postponement of large projects, such as SASOL GTL, new liquefaction facilities Shut-in of shale wells; idling of drilling resources (reduced, but not reversed, production levels) Individual producers making decisions at the margin level of hedges; debt coverage considerations; different price outlooks; ability to squeeze production costs Certainly an effective "shot across the bow" by Saudi Arabia BUT The domestic natural gas market is not entirely tied to oil prices (not stranded gas, as in some countries) Sales of natural gas to residential, industrial, process and power consumers continue US refining capacity now more closely matched to US crude; benefit of cheap oil products will continue "Nimble" industrial nature of fracking lends itself to ramp-ups and ramp-downs; the "snap back" could be sharp US as the de facto swing producer (or balancing agent) Clifford Chance 18

19 Environmental Impacts of Fracking Contamination of acquifers Disposal of waste (recovered) water Impact on infrastructure GHG (primarily, methane) releases Seismic activity (UK, Oklahoma, DFW) Clifford Chance 19

20 Barnett Shale Timeline Clifford Chance 20

21 DFW Seismic Activity Clifford Chance 21

22 Fracking Regulation and Litigation Applicable oil & gas regulation depends on site state law for private land, US Bureau of Land Management for Federal lands (large part of Western US) Some states (notably, New York) have banned fracking or placed a moratorium on fracking US Environmental Protection Agency and state environmental agencies developing regulations relating to Public disclosure of chemicals contained in fracking solutions Disposal and treatment of returned drilling fluids used in fracking Impacts on water supplies, including acquifers Methane emissions for new wells (40% reduction by 2025) NEPA considerations in Federal decision-making; how remote are the impacts required to be considered under CEQ Guidelines (BLM case; FERC LNG decisions; GHG Directive) But largest regulations may be local zoning and permit decisions of local governments Clifford Chance 22

23 Fracking Regulation and Litigation (cont d) Unless preempted by Federal or state law, local regulations control the place and impact of oil & gas drilling (although not methodology or taxation) Thus, the battle has been whether (favorable) state oil & gas law preempts (less favorable) local regulation / home rule rights The answer is mixed (and subject to change as legislation is enacted and court decisions interpret the legislation) State law preemption found: West Virginia; Ohio; Colorado State law does not preempt local regulations: New York; Pennsylvania; California Issue pending: Texas New York State-wide moratorium on health and environmental bases likely will be subject to numerous taking challenges Clifford Chance 23

24 Take-Away Conclusion Shale hydrocarbon development is critical to the US economy, and will continue to be Further production and development will be determined by microeconomics, not national energy policy The US may be fairly unique in its ability to exploit shale hydrocarbons; what works in the US may not be a world-wide model There is a balance to be struck between shale oil & gas development and better environmental practices forcing producers to absorb externalities will increase costs, but those can be accommodated in the existing domestic market and expected LNG market US will play a larger role in world energy balance both in natural gas and oil exports Clifford Chance 24

25 Clifford Chance, 31 West 52nd Street, New York, NY , USA Clifford Chance 2013 Clifford Chance US LLP