A Change in Direction for Natural Resources Regulation?

January 24, 2011

This article was written for and first featured in Infrastructure Journal

The cultural, economic and political significance of the BP Deepwater Horizon oil spill in the Gulf of Mexico is immense. Regulation of the natural resources industries has become tighter and more environmentally focused in recent years, occupying a more prominent social and political role. This trend will only increase as a result of the furore surrounding this environmental disaster. As recently noted by the UK's Energy Secretary, "What we are seeing will transform the regulation of deep water drilling worldwide".

Oil, gas and other natural resources companies have to contend with a growing array of regulatory hurdles that affect their business decisions on a legal and commercial level. Natural resources regulation establishes the framework within which regulatory programs governing the exploration and development of, for example, oil and gas resources seek to protect the environment. This article provides a summary overview of the most recent and noteworthy directional developments in regulation facing companies today in selected jurisdictions the UK, US and Canada.

UK

The Department of Energy and Climate Change (DECC) highlights its regulatory policy objectives as reducing greenhouse gas emissions, confirming global commitments to tackle climate change and ensuring secure, affordable energy supplies. It was this theme of aiming to harmonise the twin challenges of climate change and energy supply that formed a central part of the recent Economist UK Energy Summit. Focus on the adverse effects that natural resources industries have on our environment has increased vastly during recent years. In light of this shift in public understanding and appreciation, the UK regulatory framework has been updated and transformed significantly.

UK Drilling

In specific response to the BP oil disaster and its cataclysmic, devastating and enduring environmental knock-on effects, the UK government has announced it will increase inspection of North Sea oil rigs, monitoring of offshore compliance and safety standards. The government has also established the Oil Spill Prevention and Response Advisory Group to conduct a review of the UK's ability to prevent and respond to oil spills. Although the DECC believes that the current system in the UK is fit for purpose, the Energy Secretary believes it is necessary to strengthen regulations in light of the recent Gulf oil spill, citing that 'Deepwater Horizon gives us pause for thought and, given the beginning of exploration in deeper waters West of Shetland, there is every reason to increase our vigilance'. The DECC has taken note itself and is increasing its oversight of drilling operations and strengthening regulations by doubling the number of annual environmental inspections to drilling rigs. As soon as a detailed analysis of the factors contributing to the Deepwater Horizon explosion is available, the UK government has said it will review new and existing procedures. In light of recent events, the UK government is transforming its regulatory framework and is focused on preventing such an environmental disaster happening on its watch.

Energy Bill 2010

The main focus of the Bill is on a domestic footing, aiming to improve energy efficiency in British homes and businesses. If passed, the bill will affect companies by introducing powers to regulate carbon emissions from coal-fired power stations, to reform energy markets, as well as implementing a framework to ensure that North Sea infrastructure is available to all companies to ease the exploitation of smaller oil and gas fields. All this should help to achieve its ultimate aim of a marked change in the provision of energy efficiency measures to homes and businesses as well as establishing a framework for secure, low carbon energy supplies.

Energy Act 2010

The Energy Act 2010 (the 'Act') implements some of the key measures required to deliver the DECC's low carbon agenda. With particular relevance to this article, the Act introduces provisions relating to carbon capture and storage ('CCS') and fairness of the energy markets. The new CCS Incentive, due to be operational in April 2011, aims to deliver a new financial incentive to support four commercial scale demonstration projects on coal-fired power stations, as well as to support the retrofit of additional CCS capacity to those projects.

In addition to long term projections, the Act does seek to address a short term plan by empowering the Secretary of State to introduce a licence modification that will enable the Office of the Gas and Electricity Markets ('Ofgem') to use its existing licensing powers to monitor and act on different types of behaviour. Should a company disagree with an Ofgem enforcement decision it can appeal to the Competition Appeal Tribunal. Ofgem has the ability to impose financial penalties of up to 10 per cent of a licence holder's turnover for breaches of licence conditions for a period of up to five years.

Energy Act 2008

The Energy Act 2008 (the 'Act') provides an outline for the regulatory regime of offshore gas storage. It covers offshore gas infrastructure and storage, carbon dioxide storage and All content decommissioning of energy installations (nuclear and offshore renewables as well as offshore oil and gas) amongst other areas. With particular relevance to the oil and gas sectors, it aims to strengthen and clarify certain statutory decommissioning provisions, both for offshore renewables as well as oil and gas installations.

The Energy Act 2008 (Commencement No. 1 and Savings) Order 2009 introduced a number of provisions of the Act relating to Gas Importation and Storage Zones ('GISZ'), Storage of CO2, Nuclear Decommissioning and Decommissioning of Offshore Renewables Installations.

The GISZ (Designation of Area) Order 2009 designates the GISZ as an area which forms part of the continental shelf. It is within the GISZ that rights relating to the following activities have been vested in the Crown:

  • offshore unloading of Liquefied Natural Gas;
  • offshore storage of natural gas; and
  • offshore storage of CO2 for the purpose of its permanent disposal.

The Act also necessitates a licence to carry out any of the following activities within the GISZ, failure of which to obtain or comply with is a criminal offence punishable by a fine or imprisonment:

  • permanent offshore storage of CO2;
  • conversion of a natural feature for such storage;
  • exploration for a CO2 site; or
  • the establishment or maintenance of an installation for any of the above.

European Union

Until recently, oil and gas companies carrying out exploration and production activities in relation to oil and gas in Europe had to comply with public procurement laws. These laws emanated from Directive 2004/17/EC (the 'Utilities Directive'), as implemented in England, Scotland and Wales under the Utilities Contracts Regulations and governed how companies could tender for works, supplies and services in relation to these activities, thus limiting to a certain extent their commercial endeavours and ultimate gains.

This position has now changed following an application by Shell UK Limited to the European Commission (the 'Commission'). The Commission has granted all oil and gas exploration and production utilities operators awarding contracts in the UK an exemption from the application of the EU procurement rules.

Under Article 30 of the Utilities Directive parties are able to apply to the Commission for a decision that certain activities (which would otherwise be caught under the Utilities Directive) are exempt because they are already directly exposed to competition in unrestricted markets. The Commission found that oil and gas exploration and production in the UK is directly exposed to competition on markets to which access is not restricted. Shell's request related to the following:

  • exploration for oil and natural gas;
  • production of oil; and
  • production of natural gas,

with 'production' also encompassing 'development', allowing for future production of oil platforms, pipelines and terminals.

In light of the Shell decision, companies carrying out the above activities are no longer required to comply with the Utilities Directive when carrying out tenders for exploration and production.

Although this regulatory burden has now been lifted, companies should not remain too comfortable. Following on from the BP Deepwater Horizon oil spill and the UK's swift and responsive review of its regulatory regimes, the EU has asked companies operating in EU waters to provide assurances that they are working as hard as possible to ensure safe practice and maintain high standards and that they assume full responsibility for environmental and other damage if such a catastrophic incident were to occur.

USA

A lack of regulatory oversight is widely being blamed for the BP Deepwater Horizon oil spill disaster. It is not an easy task to assess the effectiveness of the US regulatory regime that governs the natural resources industries to determine the extent to which it should share the responsibility, and it is certainly beyond the scope of this article. What is certain is that legislation regulating, for example, oil and gas related activities in the US differs significantly from laws in Europe.

Oil and gas rights are most often owned privately in the US as opposed to state ownership elsewhere. Due to the US federal system, its sheer geographical size and the disparity of availability of natural resources between states, the content of regulation varies significantly from state to state. It is this disparity that could be a root cause of criticism.

According to the Energy Information Administration (EIA), thirty-three states produce either oil or natural gas. Of these, twenty-seven represent the vast majority of all oil and natural gas produced in the US, each with its own approach to regulation.

Although the US government is public in voicing its damning criticism of BP, it is taking note itself. President Obama has openly criticised the government's relationship with federal regulators, such as the Minerals Management Service, as 'cosy and sometimes corrupt'. In comparison with the UK the US government has announced new regulations to mitigate future oil spill disasters. It will be suspending several offshore drilling activities including exploration of platform locations in Alaska, pending lease sales in the Gulf and Virginia, and the drilling of 33 deepwater exploratory wells in the Gulf of Mexico.

It also plans to suspend the issuance of new permits to drill deepwater wells for six months and has signed an executive order establishing an independent commission to investigate offshore drilling. All these changes have been ignited by the sheer magnitude of the environmental effects and the social and political uproar stemming from the Deepwater Horizon oil spill which has now surpassed Exxon Valdez as the worst oil spill in US history.

Canada

On a high level, Canada's regulations appear to be far more comprehensive and consolidated than America's, and geared towards a more long term approach of disaster prevention and recovery rather than to regulate commercial gains and activities in the short term. Under the Canada Oil and Gas Operations Act, no drilling project is approved unless the operator's drilling plans include robust safety, emergency response and environmental protection. These must meet the National Energy Board's (NEB) approval. Every single project that is authorised by the Board must be safe for workers and the public and must protect the environment.

The Canadian Environmental Assessment Act and the Canada Oil and Gas Operations Act ensure that applications for offshore drilling projects are subject to a full and comprehensive environmental assessment. This is viewed to be a thorough and rigorous process that considers all relevant factors, including potential impacts from the project, accidents and malfunctions, as well as measures to prevent, mitigate and monitor those impacts. Furthermore any operator authorised under the Canada Oil and Gas Operations Act has full and primary responsibility to anticipate, prevent, mitigate and manage accidents and oil spills of all shapes and sizes.

In contrast to President Obama's very vocal reaction to the BP Deepwater Horizon oil spill, Canada has not imposed a moratorium on future offshore deepwater drilling, with its Environment Minister citing the non-occurrence of such events in Canadian waters as an indication of 'the strong regulatory environment that we have had with the National Energy Board (NEB)'. Nevertheless, the government has ignited a review to be carried out on the risks of offshore drilling and has issued a halt on Arctic drilling.

An interesting effect of the Deepwater Horizon oil spill can be found when looking at Canada's famous oil sands, the reserves of which (containing a substance known as bitumen) are second only to Saudi Arabia. The oil sands have one large problem associated with them it is far more polluting to extract than conventional sources. However, in light of the effects and costs associated with the BP oil spill, the environmental costs associated with bitumen are relatively manageable in comparison.

The bottom line is that environmental costs stemming from land based extraction remain localised and are manageable. Not only has the Deepwater Horizon oil spill spurned a change in direction of regulation, but many people are beginning to view what was once regarded as a 'toxic and polluting' source of natural energy as potentially the preferred option. Nowhere better than this marked shift in opinion is the extent of the social, economical and environmental knock-on effects of the BP oil spill exemplified.

Conclusion

Inevitable disparities exist between different countries' approaches to the regulation of natural resources industries. However, there is an across the board consensus that the recent BP Deepwater Horizon oil spill disaster has and will lead to a number of changes in regulation to prevent such an environmental disaster occurring again. Disaster recovery regulation is viewed and highlighted as an area that is lagging in most countries and because it is impossible to completely prevent accidents from occurring; greater focus will be placed on this. These changes will impact countries and cause organisational changes to regulatory bodies as well as changes to the nature of regulations themselves.

Regulation will continue to evolve rapidly in response to environmental issues and public opinion. Oil and gas companies will be forced to consider regulatory issues as a key driver to their future strategies and commercial viability.


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