Regulation for Exploitation and Commercialisation of Unconventional Gas

Naturgas Conference14-15 April 2011

David Aron

Managing Director

Petroleum Development Consultants, UK

Contents

• Introduction

• Requirement for regulation of unconventional gas

• International experience of regulation of unconventional gas

• Colombia experience of unconventional gas

• Economic considerations

• Requirement for Colombian regulation of unconventional gas

Introduction

• Petroleum Development Consultants (PDC) is a UK based oil and gas consultancy

• PDC has been appointed by El Departamento Nacionalde Planeación to carry out a study on unconventional gas and oil for the Ministry of Mines and Energy. This followed an initial study prepared by AD Little for the National Hydrocarbon Agency (ANH)

• The PDC study has three phases:• Phase 1 Initial review of unconventional oil and gas resources in Colombia

• Phase 2 Review international experience and lessons for Colombia

• Phase 3 Prepare contractual framework and technical regulation

• PDC has just completed Phase 2 and Phase 3 is to be completed in May 2011

Requirement for regulation ofunconventional gas

• Different for tight gas, coal bed methane (CBM) and shale gas

• For tight gas existing regulations for conventional oil and gas are usually suitable

• For coal bed methane there is a tension between coal mining activities and gas production and this requires additional regulation

• Shale gas production can take place over very large areas and requires a large number of wells. Regulations for conventional may well need adjusting to take account of the differences

International comparisons

• Consultant studied regulations for both oil and gas – only gas to be covered in this presentation

• Countries covered in this presentation:• USA: shale gas and CBM

• Canada: shale gas and CBM

• Australia: CBM and tight gas

USA

• The USA is very much at the forefront of exploitation of unconventional resources and particularly gas from shale and CBM

• Natural gas is forecast by the Energy Information Administration to make up 24% of the USA’s energy supply, of that, 45% will come from shale gas and 7% from CBM

• 52% of US dry gas production will come from unconventional resources and if tight gas is included, the figure rises to 74% of US gas production.

USA unconventional gas

USA shale gas plays

USA shale gas regulation

• Generally the framework for shale gas is identical to that for conventional oil and gas with the responsibility being allocated between federal and state level

• The Texas Railroad Commission, for example, regulates the development of the Barnett shale

USA CBM

USA CBM regulation - 1

• Numerous regulations designed to control conventional natural gas development can and do apply to CBM exploration and production

• Specific CBM regulations have been drafted by federal, state and local agencies to meet various concerns

• CBM ownership has been a point of contention since the early 1900s

• A determination was made by the Department of the Interior’s solicitor stating that U.S. reservations of coal do not include the CBM

• However, Federal reservations of gas do include the CBM found in coal deposits

USA CBM regulation - 2

• CBM is therefore disposable as a gas under Section 17 of the Mineral Leasing Act (DOI 1981)

• Where the coal and oil and gas are federally owned, federal oil and gas lease regulations cover the CBM and are subject to the regulations governing conventional oil and gas drilling and production operations

• The Mineral Leasing Act was determined in 1981 by the DOI solicitor to refer only to gas or natural gas, without excluding CBM

• Therefore, since 1981 CBM gas has been developed under the oil and gas leasing provisions of the Mineral Leasing Act

USA CBM regulation - 3

• The DOI Solicitor also concluded that the coal leasing requirements of the MLA do not grant the coal lessee the right to extract minerals associated with coal

• A coal lessee has no right to extract CBM, other than the venting of gas required to maintain a safe working atmosphere

• The oil and gas lease holder does not have the right to extract the CBM utilising a method that would harm the coal deposit or generate hazardous conditions for later coal mining operations

• In conclusion, the Solicitor affirmed that the rights of an oil and gas lessee would be restricted to the rights not previously granted to the coal lessee

USA regulation lessons

• There are many aspects of the unconventional gas industry in the US that have significant relevance to Colombia

• However there are significant differences between the two countries. The two most important are that the US has a market based gas price and that the gas transmission infrastructure in the US is much more developed than that of Colombia

• Some policies that have been implemented in the US that are relevant to Colombia. The main one is the regulatory allocation made for CBM between the owner of the coal and the owner of the CBM. Conversely the US experience suggests that regulation of shale gas can follow conventional oil and gas practice

Canada

• In Canada, 90% of the gas that is produced is classified as conventional. Tight gas and unconventional gas resources in Canada are growing, particularly in two key geological areas: Montney and Horn River located in northeast British Columbia

• As development of these resources increase and other conventional resources decline, there is a shift of natural gas production from Alberta to British Columbia

• The future development of gas production is very influenced by the expected gas price which is controlled by the Henry Hub price

Canada – British Columbia shale gas

Canada – British Columbia shale gasregulatory framework - 1

• The British Columbia Oil and Gas Commission provides the implementation of Petroleum and Natural Gas Act1996 and the Drilling and Production Regulations of British Columbia, 1998. There are no specific requirements in this legislation for shale gas

• The BC Oil and Gas Commission regulates oil and gas activities in British Columbia, including exploration, development, pipeline transportation, facilities and reclamation

• Companies are required to obtain an Environmental Assessment Certificate from the British Columbia Environmental Assessment Office

Canada – British Columbia shale gasregulatory framework - 2

• The Commission is responsible for ensuring sound resource development in British Columbia and has recently formed a Resources Development Unit to carry out this work in potential basins

• The Commission reports to the Ministry of Energy. The Ministry of Energy is supportive of shale gas development. It is interested in developing a better understanding of this shale gas potential

• To determine this potential, it contracted a study on the Gas Shale Potential of Devonian Strata, North-eastern British Columbia

Canada – Alberta CBM

Canada – Alberta CBMregulatory framework - 1

• The Energy Resources Conservation Board (ERCB) is responsible for most oil and gas functions, but it also covers coal as well. It is responsible for administrating the following relevant statutes:

• Coal Conservation Act

• Energy Resources Conservation Act

• Gas Resources Preservation Act

• Oil and Gas Conservation Act

• Pipeline Act

• Water is regulated in Alberta primarily by Alberta Environment (AENV) through the Water Act, and, like in British Columbia, all rights to water use and water diversion are conferred by the Crown

Canada – Alberta CBMregulatory framework - 2

• The Act requires a government license for all activities, including de-watering and water disposal. However the Water (Ministerial) Regulation explicitly exempts diversions of saline water (defined as exceeding 4,000 mg/l TDS) from the requirement of a government license

• Therefore, an operator who intends to de-water a coal seam in order to extract CBM must first determine the salinity of the water. If it exceeds 4,000 mg/l TDS, the operator can proceed with de-watering without a license

• If a license is required, evidence must be provided by the operator to AENV to show that the proposed diversion will not cause adverse effects on the water supply of nearby users over the short-term or long-term, and will not cause adverse effects on the source aquifer or other aquifers

Canada – Alberta CBMregulatory framework - 3

• While AENV has jurisdiction over water diversions generally, ERCB administers the Oil and Gas Conservation Act, which requires ERCB approval for the gathering, storage, and disposal of water produced in conjunction with oil and gas

• The Board does not distinguish between saline and non-saline produced water, so even if the produced water has already been licensed by AENV, it must also be disposed of in accordance with a scheme approved by ERCB

• Treating produced water and putting it to a useful purpose – rather than disposing of it is permitted by the ERCB, but no preference is given to this option and the onus is on the operator to choose the appropriate method for disposal

Canada regulation lessons

• The main policy which Canada has implemented which is applicable to Colombia is the royalty reduction and credit schemes. These royalty reduction and credit schemes have two vital parts to play

• First, they allow the cost of infrastructure required for the projects to be offset against initial royalty payments

• Secondly they allow companies to amortize project debt faster making projects more bankable

• However royalty reductions will not make projects profitable in Colombia due to the low gas price

• Canada has not developed its own technology but has imported it from USA.

Australia - CBM

• The most relevant unconventional resources in Australia are CBM and tight Gas. CBM development is found in the states of Queensland and New South Wales

• The proven and probable CBM reserves were 24.77 TCF in December 2009. Queensland has the most part of these reserves with 88.1%. The rest are in New South Wales. In terms of basins, the reserves are concentrated in Surat Basin and Bowen Basin with 65% and 23% respectively.

• This figure show an increase in 61.5% compared to 2008.

Australia - CBM

Australia – Queensland CBM regulation - 1

• CBM exploration and production is carried out under the Petroleum Act 1923 and the Petroleum and Gas (Production and Safety) Act 2004 and the Mineral Resources Act 1989

• Leases are an Authority to Prospect (ATP) or a Petroleum Lease (PL) are provided through a call for tender process. The PL allows exploration, production and storage activities, pipeline construction or petroleum processing activities

• CBM is treated differently from Coal Mine Methane (CMM). In New South Wales and Queensland CMM is administered by mineral resources legislation and CBM is administered by petroleum resources legislation

Australia – Queensland CBM regulation - 2

• CBM operators are required to obtain an Environmental Authority from the Department of Environment and Resource Management before starting operations

• The operators must present an environmental management plan for new CBM activities which identify and manage any potential impact on the surrounding environment

• The CBM water management plan must include the expected flow rate, quantity and quality expected to be generated, proposed management (use, treatment, storage or disposal)

• Required are criteria against which the CBM operator will monitor and assess the management of CBM water

Australia – tight gas

Basin Fields Gas in Place Resource

Perth 10 TcfWarro

Gingin

Cooper Moomba8 Tcf

Big Lakes

Onshore Gippsland

Wombat 700 Bcf

Australia – tight gas

Australia regulation lessons

• The Queensland Government is supporting the growth of the petroleum industry by making available geo-scientific information and company exploration data

• Queensland has developed a strategy to promote an export LNG industry. In Colombia this option could be viable in order to guarantee the demand to producers.

• Mines in the Sydney Basin are using methane drained from mine workings to generate electricity which is sold into the state electricity grid

• Based on the experience of Queensland and New South Wales, Colombia should design and implement community consultation and environmental controls during the approval process

Colombia experience of unconventional gas

• Limited experience to date but CBM licences are in place with Drummond and a shale gas contract with Nexen

• There is a significant conflict between coal mining and CBM

• There is limited gas pipeline capacity and planned expansion is for conventional gas

• The cost of transportation is high and it is noticeable that the Nexen shale gas contract is located near to Bogota potentially eliminating the requirement to use the national gas transportation system

Conflict between CBM and coal

• Virtually all countries, including Colombia support the overall principle that if there is a conflict with another resources owner then both sides must cooperate to achieve an optimal overall result

• PDC proposes a strict timetable for negotiations be imposed, (with full mutual disclosure of development plans and operations

• PDC proposes a joint state appointed dispute resolution tribunal consisting of representatives from the coal regulatory authority (Ingeominas) and the oil & gas regulatory authority (ANH), possibly chaired by a representative of the Ministry of Energy

32

Sistema Nacional de Transporte

B/MANGA

CÚCUTA

CARTAGENA

BALLENA

CUSIANA

VASCONIA

GIBRALTAR

SARDINATA

Limited gas pipeline capacity

• Capacity in 2010 is 1100 mmscfd

• To increase to 1330 mmscfd by end 2011 and 1375 mmscfd by end 2014

• However this is only for conventional gas and there is no current provision for transporting unconventional gas

Economic considerations

• Main issue is the low price of gas in Colombia with gas being sold at $4/MMBTU at the Bogota city gate

• CBM gas is assumed to be consumed by power generation in the mines; however gas from shale will need to be transported

• The cost of transportation from resources to consumer is around $2.5/MMBTU

• Limited gas pipeline capacity which is different to the situation in US and Canada where unconventional gas mainly replaced conventional gas

Colombia shale gas economics

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

$0/mcf $5/mcf $10/mcf $15/mcf

Ra

te o

f R

etu

rn %

Shale_Gas

Current Royalty

Royalty Reduction 10%

Royalty Reduction 30%

Royalty Reduction 50%

Zero Royalty

High Reserves

Colombia CBM economics

Requirement for Colombian regulationof shale gas - 1

• International practice is that it can be included in the conventional oil and gas regulatory structure

• Shale gas development compared to conventional gas, requires a larger resource base and a much longer production profile

• The large number of wells requires a long period of positive cash flow to pay back, often in excess of 30 years

• Conventional gas regulation is based on shorter production profiles and relatively small-sized licence areas and early relinquishment obligations

• There is also regulatory pressure to declare field commerciality as early as possible

Requirement for Colombian regulationof shale gas - 2

• The characteristics of shale gas mean that adjustment of the conventional contract is required so not to raise unnecessary entry barriers to development

• New specifically shale-orientated regulatory bodies are being considered by some US States and Australia (Queensland)

• It is probably premature to consider establishing a shale regulatory authority since the existing regulatory bodies in Colombia already have the relevant experience to deal with the potential new challenges posed by shale

Requirement for Colombian regulationof shale gas - 3

• It is suggested that there may need to be regulatory incentives for pipeline owners to make capacity available to unconventional gas in priority to conventional gas at least in the short term

• Colombian regulatory authorities should perhaps consider some fiscal incentivise to attract service companies and equipment, at least in the initial start-up of the shale gas industry

• This could involve a temporary tax reduction/custom duty exemption for personnel and equipment working on qualifying projects

Requirement for Colombian regulationof CBM - 1

• CBM projects raise many of the same issues as shale gas and most of what was covered for shale gas also applies to CBM developments.

• CBM projects raise two additional challenges:• large volumes of water production

• potential co-existence problems with coal developments,

• There is a general international practice which clearly states the overall principle that if there is a conflict with another resources owner then both sides must cooperate to achieve an optimal overall result

Requirement for Colombian regulationof CBM - 2

• Many countries provide a period of time when the miner and the gas company negotiate a solution between themselves

• Failure to achieve agreement results in state intervention in the national interest, having regard to the existing interests of the parties concerned

• Some countries such as Australia (Queensland) allow the parties to agree between themselves merely notifying the state of their agreement which is then legally binding

• Others (e.g. India) reserve the right to approve the negotiated settlement

Requirement for Colombian regulationof CBM - 3

• The Consultant has recommended that negotiation between the parties should be required

• Agreement confirms to all parties that the amended permit/licence has been officially authorised and removes any uncertainty. It also ensures that existing regulatory and legal duties are properly observed

• A strict timetable for negotiations be imposed with full mutual disclosure of development plans and operations

• There should established in advance an appointed dispute resolution tribunal consisting of representatives from the coal regulatory authority (Ingeominas) and the oil & gas regulatory authority (ANH), possibly chaired by a representative of the Ministry of Energy

Requirement for Colombian regulationof CBM - 4

• Any failure to meet the timetable or any breach of any agreed solution would be deemed to be a breach of the permit/licence

• It is expected that having a state-imposed solution as a sanction for non-agreement, there would be a strong incentive to agree a compromise