On July 2, 2012, the North Carolina Senate and House of Representatives voted to override Governor Perdue’s veto of Senate Bill 820, known as the Clean Energy and Economic Security Act (the “Act”), legalizing hydraulic fracturing and horizontal drilling within the State but delaying permitting until the General Assembly takes additional legislative action to allow it. The law calls for the creation of a 15-member Mining and Energy Commission to develop regulations governing hydraulic fracturing in North Carolina, and with the passage of the Act, North Carolina is now able to establish a modern regulatory program for the management and development of the State’s natural gas resources prior to any drilling activities taking place.

Gov. Purdue’s veto of S.B. 820 came as a surprise to many political, environmental, and commercial stakeholders, as she initially indicated she believed North Carolina could benefit from hydraulic fracturing, stating that “fracking can be done safely if you regulate it and put fees in place to have inspectors on the ground.”¹ Yet in her veto statement, Gov. Perdue expressed her belief that the bill “does not do enough to ensure that adequate protections for our drinking water, landowners, county and municipal government, and the health and safety of our families will be in place before fracking begins” and instructed the General Assembly to strengthen such protections.²

The Act, however, contains myriad protections. It establishes a regulatory framework to safeguard the environment and preserve landowner rights, requires the disclosure of the trace amounts of chemicals used in the hydraulic fracturing process, places the burden of any potential environmental contamination on the natural gas industry, and creates multiple committees to oversee the development and execution of a modern regulatory program for oil and gas exploration. Most notably, the Act places a moratorium on the issuance of permits for hydraulic fracturing until sound regulations and the proper groundwork are in place, with a deadline for such legislation set for October 1, 2014.

While the Act was being debated among the House and Senate, the U.S. Geological Survey issued an assessment of undiscovered natural gas deposits across the Eastern United States, which estimated the “mean undiscovered natural gas resources in the Deep River Basin in North Carolina to be 1,600 billion cubic feet of gas and 83 million barrels of natural gas liquids.”³ This report, along with the North Carolina Department of Environment and Natural Resources (“DENR”) report, discussed below in further detail, stressed the importance of action on behalf of North Carolina’s legislature to develop a program for energy exploration and production.

The State of Hydraulic Fracturing Prior to Senate Bill 820

North Carolina’s previous regulations prevented hydraulic fracturing and other practices associated with oil and gas exploration. Chapter 15A of the North Carolina Administrative Code Section 5D.0107(e) required that oil and gas wells be drilled within 3 degrees of vertical, essentially prohibiting horizontal drilling, which impinged upon reaching a greater extent of gas-producing shale from a single well. Under North Carolina General Statute 143-214.2(b), injection wells used for disposal of wastes were prohibited, a common technique used in hydraulic fracturing to dispose of fluids produced in the extraction of oil and gas.

Prior to S.B. 820, the General Assembly introduced S.B. 709, also known as the Energy Jobs Act, to address North Carolina’s high unemployment rate and rising energy costs. The Energy Jobs Act did not explicitly allow hydraulic fracturing, but it was North Carolina’s first step toward legalization, as the bill directed DENR, in conjunction with the State’s Energy Jobs Council, to draft a comprehensive report outlining the commercial potential of onshore shale gas resources within the State as well as the regulatory framework necessary to develop those resources, and directed the Governor to work with other states to develop a strategy for offshore oil exploration. Gov. Perdue vetoed S.B. 709, stating that it infringed upon powers assigned to the Governor by requiring her to work in cooperation with other states and North Carolina’s legislature on energy exploration.

North Carolina DENR Study

Over a year prior to the legislature’s legalization of horizontal drilling and hydraulic fracturing, the General Assembly passed Session Law 2011-276 (House Bill 242), which directed DENR, the Department of Justice, and the Department of Commerce, in conjunction with the nonprofit Rural Advancement Foundation International, to “study the issue of oil and gas exploration in the State and the use of directional and horizontal drilling and hydraulic fracturing for that purpose.”⁴ More specifically, DENR was to address oil and gas resources present in the Triassic Basins and other areas of the state, methods of exploration and production, potential environmental, social, and health impacts, and potential oversight and administrative issues associated with an oil and gas regulatory program. In addition, the Department of Commerce was to consult with DENR and gather information on economic impacts, including job creation and regulatory costs. Finally, the Department of Justice was to make findings on consumer protection and legal issues associated with oil and gas exploration, specifically mineral leases and landowner rights.⁵

The final report, published on April 30, 2012, concluded that “information available to date suggests that the production of natural gas by means of hydraulic fracturing can be done safely as long as the right protections are in place.” DENR recommended that North Carolina adopt adequate safeguards in the form of “regulatory standards and a strong compliance and enforcement program” before issuing permits for horizontal drilling and hydraulic fracturing.⁶ The report concluded with many recommendations for the General Assembly which shaped the substance of the Act.

North Carolina’s Clean Energy and Economic Security Act: The Substance

Effective August 1, 2012, the Act permits drilling wells “for the purpose of exploration or development of natural gas through use of horizontal drilling in conjunction with hydraulic fracturing treatments,” superseding North Carolina’s current prohibition of such techniques. Apart from legalizing these drilling activities, the Act also creates a regulatory framework to protect landowners, places the burden of any potential environmental contamination on the industry, creates multiple committees to oversee the development and execution of a modern regulatory program for oil and gas exploration, and prohibits the issuance of permits for hydraulic fracturing until sound regulations and the proper groundwork are in place, with a deadline for such legislation set for October 1, 2014.

Regulatory Commissions

The Act creates the North Carolina Mining and Energy Commission (the “Commission”) to ensure a thorough regulatory scheme is developed prior to the issuance of permits allowing hydraulic fracturing. The Commission will be composed of 15 members – four appointed by the Governor, four appointed by the Speaker of the House, and four appointed by the President Pro Tempore of the Senate. The last three positions will be filled by industry experts knowledgeable on North Carolina’s natural resources and geological make up - the chair of North Carolina State University Minerals Research Laboratory Advisory Committee, the State Geologist, and the Assistant Secretary of Energy for the Department of Commerce. Each member will serve a three year term, with members appointed on a staggered basis.

The Commission is given rulemaking authority to develop a comprehensive program to regulate North Carolina’s oil and gas exploration initiative, and DENR is entrusted with the authority to enforce the Commission’s rules. In addition, the final provision of the Act creates the Joint Legislative Commission on Energy Policy (the “Energy Policy Commission”), which is a 10-member committee with five members appointed by the House and five appointed by the Senate. The purpose of the Energy Policy Commission is to monitor and evaluate the programs, policies, and actions of the Commission, in addition to any other matters related to energy policy that could affect the Commission’s fulfillment of its mandate.

Regulatory Parameters and Environmental Protections

Pursuant to Section 113-391 of the Act, to establish a “modern regulatory program for the management of oil and gas exploration and development,” the Commission must adopt rules for all of the following purposes:

• Regulation of pre-drilling exploration activities;
• Regulations of drilling, operation, casing, plugging, completion, and abandonment of wells;
• Prevention of pollution of water supplies by oil, gas, or any other fluids used in oil and gas exploration and development;
• Protection of air, water, and soil quality among other environment resources;
• Regulation of horizontal drilling and hydraulic fracturing treatments, which includes at a minimum, regulations on information and data associated with permit applications; baseline data for groundwater and surface water; siting standards for wells and other gas production infrastructure; waste management protocol; limits on water use; disclosure of chemicals and constituents used in drilling; safety protocol for well blowouts, chemical spills, and other emergencies; measures to mitigate impacts of infrastructure; and financial assurance for proper well-closure, site reclamation, and post-closure monitoring;
• Requirement of surveys upon application of any owner who has reason to believe a well has been unlawfully drilled into land of the owner without permission;
• Requirement of reports showing location of oil and gas wells;
• Regulation of “shooting,” perforating, and chemical treatment of wells;
• Regulation of secondary recovery methods;
• Regulation of the placement and spacing of wells and drilling units; and
• Any other matter the Commission deems necessary to implement a thorough regulatory program to protect the interests of the State and its citizens.

The Commission must submit its first report on or before January 1, 2013.

Landowner Protections

In light of the economic impact of hydraulic fracturing, many landowners may choose to lease or convey property right for natural gas development. The Act puts into effect immediately the following provisions to ensure thorough and straight-forward leases to protect landowners’ interests:

• Any lease for oil and gas rights expires at the end of 10 years from the date of the lease, unless oil and gas are being produced for commercial purposes at the end of 10 years;
• Any lease must be recorded within 30 days of execution at the Register of Deeds in the county where the land is located, and a landowner must receive written notice of any assignment of a lease of oil or gas rights within 30 days of such assignment;
• Any lease is subject to a three-day right of rescission whereby either party may cancel the lease;
• Royalty payments to lessors must be at least 12.5% of oil or gas proceeds within six months after the date of the first sale. Such royalty payment may not be reduced by production costs, fees, or other charges;
• Within 60 days of signing the lease, the lessor is to receive a bonus payment and interest of 10% per annum beginning on the due date.

In sum, the Act has the purpose of ensuring landowners are justly compensated for conveying subsurface rights and will be fully notified of all lease provisions and any subsequent changes.

Disclosure and Public Protections

Once a leasing agreement is reached, the Act includes many additional provisions which detail the responsibilities and liabilities of oil and gas developers to the landowners and public at large:

• Before an oil and gas developer can begin any land-disturbing activity, written notice must be provided to the landowner at least 30 days before the desired date of entry onto the property containing a description of the plan, an offer to consult with the landowner, and contact information of the developer;
• Before an oil and gas developer can begin any non-land-disturbing activity (i.e. surveying, staking, measuring), notice must give given to the landowner 14 days before the desired date of entry;
• Before any activity commences, a pre-drilling test of all water supplies within 5,000 feet of the wellhead must be conducted;
• All “landmen,” defined as anyone who acquires or manages oil or gas interests or performs any functions related to development and exploration of oil or gas, are required to register with DENR;
• Any chemicals used in hydraulic fracturing fluids must be reported to the Commission, with the exception of those fluids designated as trade secrets. The Commission is to make any information it receives available to the public.

Liability and Penalties

In order to ensure that any landowner who conveys subsurface rights for oil and gas development is not harmed in relation to both health and finances, the Act mandates that oil and gas developers are presumed liable for purported contamination of any water supplies within 5,000 feet of a wellhead. In addition to other remedies such as indemnification or compensation, the developer is required to provide a replacement water supply to all surface owners using the purported contaminated supply.

A surface owner may not be held liable for any claim related to the developer’s activities on the property including claims of injury or death to any person, damage to a third party’s real or personal property, damage to impacted infrastructure, damage to water supply, or any other violation of federal, state, or local law. Under the Act, it is virtually impossible for an individual who conveys subsurface rights to be held liable for any claim associated with the State’s oil and gas exploration initiative.

Anyone who horizontally drills a well or uses hydraulic fracturing treatment without first obtaining a permit is subject to a penalty up to $25,000 per day for each and every day of such violation, and for each and every act of violation. If one is charged with and pays a penalty, payment of the penalty does not make the activities which caused the violation permissible or allow the individual to continue.

The Next Steps

In order to ensure that North Carolina’s energy exploration and production initiative is developed in an environmentally responsible manner, the Act has instituted a moratorium on the issuance of any permit to allow hydraulic fracturing. The moratorium is in place until further legislation is passed to ensure that hydraulic fracturing is safe and thoroughly regulated. A deadline of October 1, 2014 for the Commission to adopt regulations addressing these issues has been put in place, which means permits most likely will not be issued for at minimum two years.

Because appointments to the Commission are still pending, no further action has been taken since the enactment of Session Law 2012-143. In the near future, DENR and the Commission are expected to take steps to implement the Act’s directives.

Spilman will continue to monitor the progress of North’s Carolina’s hydraulic fracturing program.