A discussion of California plugging and abandonment rules
US oil and gas plugging and abandonment rulesOn April 27, 2020, the West Texas Intermediate price of oil closed at $12.78 per barrel.[1] Brent prices were not far behind, closing at $19.99.[2] Analysts expect prices to remain low.[3]
Such low prices are especially troubling for shale drillers many of whom require more than $45 per barrel to break even.[4] It is also troubling for traditional American producers that often stop drilling wells when oil reaches $25 per barrel.[5] But low prices are not exclusive to oil operators.[6] Experts expect natural gas prices to remain low too.[7] [8]
Amid this uncertainty, operators will look to avoid significant costs. Plugging and abandoning wells can be such a cost.
Although these requirements apply regardless of the current low cost environment, a discussion of these rules may be helpful for current operators and those who may soon become operators through distressed sales or foreclosures – non-compliance with these rules may subject an operator to fines, foreclosures, and limitations on operations.[9]
Moreover, plugging and abandoning rules are distinct from provisions in oil and gas leases that govern shutting-in wells and ceasing production, although all may involve non-productive wells. While restrictions on shutting-in wells and ceasing production are generally lease specific, as mentioned, plugging and abandoning rules apply regardless.[10] Those considering shutting-in wells or ceasing production are encouraged to become familiar with plugging and abandoning requirements. This may allow them to avoid becoming subject to plugging and abandoning requirements despite complying with their leases.
In a previous article, available here, we outlined the plugging and abandoning rules in Texas. This article follows the same outline to discuss plugging and abandonment requirements of onshore oil and gas wells in California. As with Texas, this article also examines ties among these requirements and bankruptcy.
1. Governing body and overview
Governing body. The California Geologic Energy Management Division (CalGEM) recently replaced California’s Division of Oil, Gas, and Geothermal Resources as the state’s oil and gas regulator.[11] The primary sources of plugging requirements are found in Division 3, Chapter 1 of California’s Public Resources Code, and Title 14 of its Code of Regulations.[12]
Overview. An idle well is a well that has not produced oil or natural gas for 24 consecutive months.[13] An operator of an idle well must pay an annual fee for each of its idle wells or file a plan that provides for the management and elimination of all its long-term idle wells.[14] Plugging operations are complete when California’s Oil and Gas Supervisor[15] (the “Supervisor”) is satisfied that all proper steps have been taken to (1) isolate oil-bearing or gas-bearing strata encountered in the well; (2) protect underground or surface water; and (3) prevent later damage to life, health, property, and other resources.[16] Plugging rules burden operators, but they can also burden mineral interest owners and previous operators too.[17]
2. Identifying to whom plugging and abandoning rules apply
Well classifications. A well may be classified as compliant, idle, long-term idle, or deserted. Each classification imposes different obligations on operators and potentially others.[18] An idle well is a well that has not, for 24 consecutive months, (1) produced oil or natural gas; (2) produced water to be used in production stimulation; or (3) been used for enhanced oil recovery, reservoir pressure management, or injection.[19] A long-term idle well is a well that has been an idle well for eight or more years.[20] A deserted well is a well that the Supervisor has order abandoned.[21] Accordingly, a well that is shut-in may become idle, but its status as “shut-in” for purposes of a lease may not in itself answer whether the well would be classified as idle for purposes of plugging.
Operators. An operator means a person who has the right to drill, operate, maintain, or control a well or production facility by virtue of its ownership, the authority of a lease, or another agreement.[22] A mineral interest owner or preceding operator may also be an “operator” for the purpose of determining if a well is properly plugged, regardless of how that mineral owner’s lease or previous operator’s agreement with the current operator classifies that party.[23] Finally, the acquirer of an idle well will not be considered its “operator” until (1) the current operator notifies the Supervisor of the well’s transfer, (2) the acquirer notifies the Supervisor of its plans to acquire the well, and (3) the acquirer posts its required bond amount.[24]
3. Operator’s responsibilities
California’s rules on plugging fall into three categories: (1) duties of operators with idle wells; (2) methods for plugging; and (3) timing requirements.
Operator’s duties. Apart from the sweeping requirement to plug and abandon wells according to plugging rules, operators of idle wells must observe other duties too. For example, an operator must (1) maintain financial securities for the wells,[25] (2) communicate with and obtain the Supervisor’s approval to enter different phases of operations;[26] (3) mark its operations,[27] (4) maintain wellhead controls,[28] (5) prevent waste,[29] (6) keep and submit accurate records,[30] (7) file an intention of a notice to abandon;[31] (8) comply with the submitted plan or testing requirements;[32] and (9) conduct an engineering analysis on an idle well that has been idle for 15 years.[33] These obligations are separate from contractual covenants and common law duties.
Methods for plugging. Plugging requirements can be split into two phases: planning and execution.
Planning. The operator planning to plug its well must (1) notify the Supervisor of these plans;[34] (2) coordinate plugging operations with CalGEM because some operations must be observed by a division employee;[35] (3) identify water strata;[36] (4) identify production horizons and oil-bearing or gas-bearing strata encountered in the well;[37] (5) ensure proper materials are used;[38] (6) clean the well;[39] (7) make plans to recover casing;[40] and (8) plan remediation.[41]
Execution. Operators cannot deviate from their approved plugging and abandoning plans, except in emergency situations.[42] Specific rules govern the following plugging methods, processes, and well types: (1) surface cement pours;[43] (2) open holes;[44] (3) casing shoe;[45] (4) surface plugging;[46] (5) removing casing;[47] and (6) remediation.[48] Special requirements may also exist for particular types of hydrocarbon zones, such as (1) fractured shale or schist; (2) massive sand intervals; (3) any depleted productive interval more than 100 feet thick; and (4) multiple zones completed in a well.[49] Additionally, even if the operator contracts for a third party to plug and abandon its wells, the operator is still responsible for complying with plugging requirements. [50]
Timing. Once the well becomes idle, the operator must decide if it will either (1) pay an annual fee for the well, or (2) place it in a plan that manages and eliminates all long-term idle wells.[51]
Payment. Annual fees depend on how long the well has been idle: payments may be as low as $150 or as high as $1,500.[52] Missed payments allow the Supervisor to find the well deserted: plugging operations must then begin in 30 days and continue until completed.[53]
Well plan. Filing a plan[54] can relieve the operator from paying an annual fee, complying with its duty to conduct a fluid-level and casing pressure test, and filing an engineering analysis for wells idle for 15 years or more.[55] The plan and its renewal must cover no more than five years.[56] It is also subject to the Supervisor’s approval.[57] Until the operator has no more long-term wells, the operator is required to properly plug and abandon a statutorily determined percentage of its long-term idle wells each year, if it chooses to file a plan.[58] This percentage may be as low as four percent or as high as six, depending on the number of idle wells to which that operator is registered.[59] Non-compliance with the plan may forbid the operator from filing one in the future; the operator must then either pay the fee or plug the well before it becomes idle.[60]
Partial plugging. Partially plugging a well may relieve operators of certain duties,[61] but these wells may or may not be considered plugged and abandoned for purposes of annual fees or plans.[62] To partially plug a well,[63] operators must follow all requirements for plugging and abandoning wells, except for provisions governing surface plugging,[64] casing recovery,[65] and supervision on surface plugs and environmental inspection.[66] Similar to a Public Resources Code § 3206(a)(2) plan, operators of partially plugged wells are relieved of certain testing requirements.[67] Even though a lease may require an operator to follow partial plugging rules when shutting-in its wells, whether a well is partially plugged is a determination for state authorities. Compliance with a shut-in or cessation of production provisions are issues between parties to leases.
4. Economic and environmental consequence of non-compliance
Economic costs. Not only may the non-compliant party be forced to re-plug an improperly plugged well,[68] but the Supervisor or California’s attorney general may also (1) foreclose on the real or personal property of the operator;[69] (2) levy a life-of-well bond that must be repaid within 30 days;[70] (3) require the operator to submit additional financial securities;[71] (4) deny proposed operations;[72] or (5) impose fees that may be as high as $25,000 or as low as $2,500 per violation, with each day counting as a new violation.[73]
Environmental costs. Unplugged or poorly plugged wells may affect groundwater, methane emissions, and the area around them.[74] Groundwater is infected because oil, gas, or salty water can leak into freshwater aquifers.[75] Unplugged wells may leak methane; methane is a gas that is linked to climate warming.[76] Further, unplugged wells affect the area around them when oil, gas, drilling mud, or salty water rises in the well and spills onto the ground.[77]
5. Bankruptcy/lender considerations
If an operator lacks the funds to plug and abandon a well, mineral interest owners or preceding operators may be ordered to provide funding.[78] Accordingly, mineral interest owners and preceding operators may become unsecured creditors of the operator.
Once a well is properly plugged and abandoned, the operator ceases to be an “operator” for that well. The operator may then have its bonds associated with that well terminated and canceled.[79]
Lenders are not in the business of operating wells. Instead, lenders looking to foreclose on their debtor’s well assets may consider either finding a contract operator before foreclosing, if they seek to continue to operate the wells, or finding a buyer that the Supervisor will recognize as an operator.[80] Otherwise, the lender risks being liable for plugging and abandoning the debtor’s well. Any costs associated with the plugging and abandoning of debtor’s wells may need to be factored into any decisions the lender makes with respect to their strategy to realize upon the debtor’s assets after a default.
Within 30 days after an order from the Supervisor to plug and abandon a well, the owner or operator must commence the ordered work in good faith and continue until completed.[81] If the work has not commenced and continued, the supervisor may perform or contract for the work.[82] Any amount spent may become a lien against the real or personal property of the operator.[83] Additionally, failing to pay a fine can result in a perfected and enforceable state tax lien, which may be levied and which the owner of land may redeem from any execution sale within three years after paying interest, penalties, and charges.[84] Because a lender may be subordinate to the state’s lien, it would be advisable for the noncompliant well or wells to be segregated or dealt with. Other creditors can therefore be affected by an operator’s non-compliance.
Failing to comply with California’s plugging rules can result in that operator being unable to operate newly acquired wells.[85] This may affect an operator’s ability to have its Chapter 11 plan approved.[86]
6. Conclusion
Non-compliance with California’s plugging and abandonment rules can affect an operator’s bankruptcy proceeding and its ability to operate.[87] Accordingly, it is critical to know when and how to comply with California’s plugging requirements. These requirements begin to have increasing relevance when plugging operations are undertaken or when the well becomes idle.[88] Whether a well is idle is determined by state rules, not a lease.
Once operators have determined that these regulations apply, they can organize compliance efforts into a planning and execution phase. Within each of these phases, operators are urged to carefully note and observe notice and method requirements. Careful compliance not only protects operators from financial liability, but it also benefits public health. Given the uncertainty of future oil and gas prices, operators are encouraged to become familiar with plugging and abandonment requirements that may be applicable now or in the future.
[1] Market Insider, Oil (WTI) in USD – Historical Prices (Apr. 28, 2020), https://markets.businessinsider.com/commodities/historical-prices/oil-price/usd?type=wti.
[2] Market Insider, Oil (BRENT) in USD – Historical Prices (Apr. 28, 2020), https://markets.businessinsider.com/commodities/historical-prices/oil-price/eur?type=brent.
[3] Id.; Reuters, U.S. Crude Stockpiles Rise, Fuel Draws Down Despite Pandemic: EIA (Mar. 18, 2020), https://www.reuters.com/article/us-usa-oil-eia/us-crude-stocks-rise-fuel-inventories-down-eia-idUSKBN2152IE; Collin Eaton and Russell Gold, Flood of Saudi Oil Looms as U.S. Drillers Face Supply Glut, Wall Street J. (April 17, 2020), https://www.wsj.com/articles/flood-of-saudi-oil-looms-as-u-s-drillers-face-supply-glut-11587119400?
mod=lead_feature_below_a_pos1.
[4] Fed. Res. Bank of Dallas, Energy Slideshow (Mar. 4, 2020), https://www.dallasfed.org/-/media/Documents
/research/energy/energycharts.pdf?la=en.
[5] Jim Patterson, Saudi Arabia Tanks the Oil Market, Kiplinger (Mar. 16, 2020), https://www.kiplinger.com/article/
business/T019-C000-S010-energy-price-forecast.html.
[6] NASDAQ, Historical Prices, https://www.nasdaq.com/market-activity/commodities/ng%3Anmx.
[7] Jeremiah Shelor, Analysts Slash 2020 Natural Gas Price Forecast; More Cuts Said Needed as Coronavirus Hits Crude, Natural Gas Intel, (Feb. 26, 2020), https://www.naturalgasintel.com/articles/121161-analysts-slash-2020-natural-gas-price-forecast-more-cuts-said-needed-as-coronavirus-hits-crude; Avi Salzman, Natural Gas is in a Tailspin, and Things Could Get Much Worse. Here’s How, Barron’s (Feb. 10, 2020), https://www.barrons.com
/articles/natural-gas-prices-falling-demand-coronavirus-51581119054.
[8] Reuters supra note 5; Sarah Hansen, Oil Bounces Back Up 24% After Trump Says He Would Consider Intervening in Price War, Forbes (Mar. 19, 2020), https://www.forbes.com/sites/sarahhansen/2020/03/19/oil-bounces-back-up-24-after-trump-says-he-would-consider-intervening-in-price-war/#4a4b84cab0e3.
[9] See Cal. Pub. Rec. Code §§ 3203; 3226; 3423 (2020).
[10] See eg, John Lowe, Owen Anderson et at., Cases and Materials on Oil and Gas Law 273-296 (2018, 7th eds.).
[11] Ca. Dep’t of Conservation, California Oil & Gas Regulator Has New Name, Focus, https://www.conservation
.ca.gov/index/Pages/News/California-Oil-Gas-Regulator-Has-New-Name-Focus.aspx.
[12] Despite the replacement, regulatory requirements still read as though the Division is in charge. Throughout the below discussion, where reference is made the supervisor, often a district deputy also has authority to take similar actions or to require the operator to take certain actions.
[13] Cal. Pub. Rec. Code § 3008(d) (2020).
[14] Cal. Pub. Rec. Code § 3206(a) (2020). An operator may be able to file this plan even if it does not have a long-term idle well when the plan is filed.
[15] Cal. Pub. Rec. Code § 3004 (2020) (“Supervisor” means the State Oil and Gas Supervisor). Information on California’s Department of Conservation leadership team is available here: https://www.conservation.ca.gov/about-us/leadership-team.)
[16] Cal. Pub. Rec. Code § 3208(a) (2020).
[17] Cal. Pub. Rec. Code § 3237 (2020).
[18] Cal. Pub. Rec. Code § 3237 (2020).
[19] Cal. Pub. Rec. Code § 3008(d) (2020).
[20] Cal. Pub. Rec. Code § 3008(e) (2020).
[21] See Cal. Pub. Rec. Code §§ 3206; 3237 (2020).
[22] Cal. Pub. Rec. Code § 3009 (2020).
