Barring any near catastrophic, unanticipated global event, the U.S. oil and gas industry should see a bottom to the market in 2016, and the beginning of a return to a more balanced and profitable recovery. But that economic recovery will be set against a new global backdrop. The well-documented expansion of oil and gas shale resources over the past 5 to 8 years increased U.S. production markedly. By 2015, the U.S. had become the world’s largest producer of oil and gas. That occurred as the U.S. was recovering from a severe recession, and while global demand for oil and gas held steady. OPEC, Russia, Venezuela and other producing countries all chose not to cut back in production, for fear of losing market share to the new U.S. source of supply. Those facts led to oversupply, and a significant reduction in price for U.S. oil and gas products. The predicted drop in price of crude to $30/bbl occurred in 2015, then dropped below $30 in early 2016. And while the global price of oil and gas remained suppressed, the U.S. supply of stored oil and gas inventory hit record highs by the end of 2015.
The new year portends a return to balance in basic supply and demand for U.S. oil and gas. The return will be choppy, however, as many of the smaller players in the supply chain may not be available or capable of quick resumption of production, and global issues will continue to affect U.S. producers (Iran will add more global supply even as demand from China may decline). Meanwhile, U.S. legislative and regulatory pressure on the oil and gas industry will continue to expand, and public opposition to new pipeline construction will continue, adding new issues and costs to producers and transporters. It is expected that 2016 will therefore be a year of recovery for the oil and gas industry, but a bumpy year, as the supply and demand balance play out. Producers and transporters must maintain vigilance on compliance during this recovery.
Economic: Impact on Energy Infrastructure and Development
The U.S. continues to use more energy per capita more energy per capita than any other country in the world. While U.S. energy demands have remained fairly stable through the recession, global demand has also remained fairly flat, especially in the world’s largest country: China. The global market showed clear over supply in 2015, and all producers – globally – had to decide whether to cut back on production or maintain revenue even at reduced price. OPEC decided not to curtail production, despite the fact it has frequently limited production over the decades to maintain global prices. U.S. producers similarly maintained production through most of 2015, capitalizing on recent discoveries and investments. OPEC and other established producers had much lower break even costs for production, however, in contrast to significant investment costs still carried by U.S. producers.
As the oversupply continued through 2015, some players found the market too crowded, and large numbers of field operators began to close operations or declare bankruptcy. Many of the larger oil and gas companies also made significant budget cuts, deferred or cancelled planned construction projects or upgrades and/or conducted layoffs, and storage hit record highs. At the end of 2015, however, the U.S. repealed a 40 year old ban on crude oil exports, a move which was intended to stimulate the market for U.S. produced-oil by enabling domestic producers to better compete in the global marketplace.
At a global level, no major oil and gas producers blinked at these developments, but many gave pause. Production in the U.S. is slowing, gradually. As all producers and economists know, however, that the basic rules of supply and demand – although clear in concept – are choppy in application. So when production slows in response to decreasing demand, the return is not always so smooth. As inventories are drawn upon and demand recovers, there are many links in the production chain that will need to restart.
Legislative: Reauthorization of the Pipeline Safety Act
Despite reduced demand and market activity, 2016 is likely to bring expanded regulation of pipeline and LNG facilities. Even though PHMSA has yet to satisfy many of the requirements of the 2011 Pipeline Safety Act (PSA) reauthorization, Congress is currently considering a PSA reauthorization bill with significant new mandates.
Key provisions of the Securing America’s Future Energy: Protecting Infrastructure of Pipelines and Enhancing Safety (SAFE PIPES) Act include: (1) regulation of underground natural gas storage facilities; (2) temporary allowances for certified states who are not interstate agents to participate in inspection and oversight of interstate pipelines; (3) PHMSA/State post-inspection briefings and issuance of a final report or enforcement within 30 days of inspection; and (4) regulation of “small scale liquefied natural gas facilities.” In addition, the bill would reauthorize the PSA through 2019, significantly increase authorized funds for pipeline safety programs, and require PHMSA to prioritize statutory rulemaking and submit rulemaking progress reports, among other things.
States have also been active in considering legislation to regulate underground gas storage (i.e., Texas and Kansas), monitoring and remediation of all methane emissions from natural gas pipelines (i.e., California, Massachusetts, and New York), and regulation of aspects of new pipeline construction. A massive leak of methane from a SoCal Gas Company underground storage reserve in California at the end of 2015 focused more legislative and regulatory attention to underground storage generally.
Regulatory: PHMSA, NTSB and other Agencies
The year ahead is also poised to bring new pipeline safety rulemaking proposals and other regulatory proposals impacting oil and gas pipeline facilities. PHMSA proposed several extensive rulemakings at the end of 2015. The public comment period for those rules closed in early January 2016, and the Agency must now deliberate on whether to incorporate comments or not. The issues presented are broad, including expansion of certain integrity management (IM) requirements to all liquid pipelines, design review cost recovery, accident notification, operator qualification, etc. In particular, the Agency’s liquid IM proposal would extend applicability of IM assessment and repair requirements, require pipelines under IM to be piggable, expand leak detection requirements to all new hazardous liquid pipelines, and extend reporting requirements to liquid gravity and gathering pipelines, among other things.
In addition, the Agency’s proposed rules regarding natural gas integrity management and valves remain outstanding and are expected to be issued in 2016. The Agency also unfortunately continues to issue more guidance documents, advisories and interpretations than it does notice and comment rulemaking. Similarly, the Agency remains committed to “promote vigorous conformance” to voluntary industry standards, such as API RP 1173, regarding pipeline safety management systems and plans to train inspectors on the standard. A number of enforcement actions are already being challenged because they are based not on rules but on guidance or voluntary standards, which should not be enforceable in themselves. Finally, PHMSA has commissioned a review of performance based regulations with participation from BSEE, FAA and the U.S.C.G., signaling that the Agency may be considering sweeping changes to its regulatory approach, in response to criticism from Congress and citizen groups.
Other agencies are expected to remain active in oversight and regulation of the oil and gas industry. The NTSB’s 2016 Most Wanted List of Transportation Safety Improvements, which was issued in January of 2016, includes several items related to pipeline safety. EPA continues to be more active in the oil and gas sector. In 2015, the Agency proposed regulations applicable to methane emissions from new or modified oil and gas wells and issued a final rule that could increase the scope of activities that require Clean Water Act permits and releases reporting. The latter is currently subject to a nationwide stay, pending further review. In January 2016 BLM proposed rules to cut the amount of natural gas emissions (intentional and unintentional) from oil and gas wells on federal public lands by 50%. The rule proposes to prohibit venting or release of natural gas into the atmosphere and would apply to all wells on federal or tribal lands almost entirely.
We anticipate increased regulatory scrutiny and enforcement activity in the coming year. PHMSA increased enforcement activity in 2015, initiating almost 20 percent more enforcement cases than it did in the prior year, despite the fact that pipeline incidents occurred at about the same frequency in 2015 as in 2014 (and the number of significant incidents decreased slightly). In addition, proposed penalties in the civil penalty cases PHMSA initiated in 2015 increased somewhat (by about 5 percent) over those proposed in the previous year. It is not uncommon now for PHMSA to propose seven figure civil penalty amounts.
PHMSA continues to expand its workforce. PHMSA’s new Administrator Dominguez states that the Agency is in the process of growing by 25 percent, thanks to resources in the 2015 omnibus bill (the Administrator refers to this as a “hiring surge” focused on inspection and enforcement). Dominguez also signaled the Agency’s intent to “identify opportunities to enhance enforcement of the authorities Congress has granted PHMSA.”
This echoes other Agency statements indicating that PHMSA may be looking to expand its use of the Corrective Action Order (CAO), its strongest enforcement tool, or to pursue emergency order authority similar to that exercised by other federal agencies (such as FAA, EPA, etc.). Currently, the CAO potentially allows the Agency to address anticipatory threats: current law allows PHMSA to issue CAOs to any pipeline facility or operation that “is or would be hazardous.” 49 U.S.C. §§ 60112(a),(d). While PHMSA did not issue any “anticipatory” CAOs in 2015, it did initiate almost twice the number of CAO cases than it did in 2014. The Safety Order, another type of enforcement tool that allows PHMSA to prescribe long-term safety measures for an operator’s system, was also used more frequently in 2015 than in the previous year.
While these developments signal increased scrutiny and more enforcement activity in the coming year, in 2015 PHMSA endorsed new guidance intended to clarify the limits of the Agency’s regulatory oversight of midstream facilities. This was achieved through a “Working Group” made up of industry and agency representatives and confirms that PHMSA oversight of midstream processing ends, and OSHA Process Safety Management oversight begins, at the first pressure control device entering a processing facility, with PHMSA oversight beginning again at the last pressure control device leaving the facility.
All these issues and developments make 2016 a bumpy year for a return to balance in the oil and gas industry. Operators can best position themselves for the year ahead by (1) ensuring that budget cuts do not impact regulatory compliance; (2) monitoring legislation and commenting on proposed rulemakings; (3) challenging, as appropriate, agency actions that go beyond established law and guidance; and (4) participating in industry initiatives and working groups on developing issues. Working together, the industry and the government can continue their shared focus on ensuring public safety, system integrity, and protection of the environment.