Shale Gas Issues: Squeezed Between Necessity and Reality

Originally published February 10, 2012

Keywords: shale gas, onshore shale basins, natural gas, shale formations

"Total annual production volumes of 3 to 4 trillion cubic feet may be sustainable for decades. This potential for production in the known onshore shale basins, coupled with other unconventional gas plays, is predicted to contribute significantly to the US's domestic energy outlook." ~ Modern Shale Gas Development in the United States—A Primer, US Department of Energy (April 2009).

"Estimates of these [fracturing] distances...are at best imprecise. Clues about the direction in which fractures are likely to run from the well may be derived from seismic and other data, but virtually nothing can be done to control that direction; the fractures will follow Mother Nature's fault lines in the formation.... One difficulty is that the material facts are hidden below miles of rock, making it difficult to ascertain what might have happened." ~ Coastal Oil and Gas Corp. v. Garza Energy Trust, et al., 268 SW 3d 1 (Tex. 2008).

"For whoever owns the soil, it is theirs all the way to Heaven and down to Hell." ~ United States v. Causby, 328 US 256, 260-261 (1946), citing Lord Coke's approval of the ancient maxim.1

SECTION 1. INTRODUCTION

The relatively recent technological development of combining hydraulic fracturing and horizontal drilling to produce large quantities of natural gas (and liquids in many cases) from shale formations in the United States has and will likely continue to have significant impact on energy production. These developments will influence not only the price of hydrocarbons but also the economics of alternative energy development. At the same time, the prospect of conducting drilling activities, particularly in densely populated areas and those not familiar (at least recently) with oil and gas operations, has focused attention on potential risks associated with these activities. Not surprisingly, then, there has been a great deal of positive and negative excitement due to the current growth in hydrocarbon exploration and production in shale formations. This paper addresses three legal risk areas: (1) environmental regulatory and litigation risks, (2) nearby property owner damage and contamination litigation risks, and (3) securities law risks— with an acknowledgement to the concomitant political risks. While these risks cannot be eliminated, the purpose of the paper is to provide recommendations to those involved in the development and production of shale gas reserves that will mitigate these risks. We focus here on natural gas, but many of the issues will be similar for shale oil.

In Section 2 and 3, this paper discusses the basics of shale gas reserves and the process required for their development. While most of the controversy has centered on hydraulic fracturing, the use of horizontal drilling also plays a role in the current and expected controversies. The current growth in shale gas operations has been accompanied by highly publicized environmental concerns, primarily based on the possibility of groundwater contamination and the large amounts of water required for fracturing operations. These concerns have begun to produce a tentative regulatory response in the form of proposed legislation and regulations by the various state and federal governments. In addition, lawsuits have been filed by public interest groups as well as local landowners. These cases are typically based on the common law causes of action for trespass, negligence and nuisance, with or without a request for injunctive relief, and strict liability for violation of statutory and regulatory prohibitions. Due to their relatively recent vintage, these cases have not yet resulted in reported appellate decisions. The environmental and regulatory aspects of hydraulic fracturing of shale gas formations are discussed in Section 4.

Migration of frac fluids across property lines, resulting in claims of contamination of neighboring properties, can also lead to actions in trespass. Less well known, but immediately apparent upon review of local newspapers and blog sites, is the perceived "lesser twin" of fracing, namely the common concern of nearby landowners and leaseholders about the possibility of the subsurface drainage of oil and natural gas from their property to an adjacent property as a result of powerful hydraulic fracturing of deep shale deposits. This concern, even in regions as distant from Texas as Pennsylvania, often includes dire reference to a 2008 Texas Supreme Court case, referred to around the country as the Garza case. The common law "rule of capture" plays a pivotal role in resolving drainage disputes, and its application (or lack thereof) provides a legal rationale for the differing treatment of drainage and contamination. Section 5 will analyze the common law principles that will play an important part in shaping the claims of nearby landowners with respect to the primary areas of concern, contamination and drainage.

Finally, for publicly traded companies the very recent commencement of shale gas exploration and production, and resulting limitations in the production data available from which to estimate reserves in place and those economically recoverable, create new challenges for securities law disclosures. These requirements raise issues that may prove problematic until shale gas production and its associated technology mature and become better understood. Securities issues associated with shale gas reserves and their development are discussed in Section 6.

SECTION 2. SHALE RESERVOIRS

The United States has very extensive reserves of oil and natural gas locked in large shale formations across the country. These shale formations often overlap conventional natural oil and gas basins, but are typically more than a mile deep. Because of the very low permeability of shale, these formations have only relatively recently been explored, and only a few have begun to be developed, most notably the Barnett Shale in North Texas, the Bakken Shale in the Dakotas and Montana, the Marcellus Shale in the Appalachians, the Eagle Ford Shale in South Texas, the Haynesville Shale in Louisiana and the Woodford Shale in Oklahoma. Development is currently more active in the fields that are rich in liquids because of the current low price of gas in the United States and the high price of oil. Commercial production from these shale fields requires directional drilling, in which a drill goes vertically into the earth for several thousand feet to the desired depth and is then turned so as to drill horizontally to access a larger portion of the reservoir. Since the shale formations are made up of hard, impermeable rock with micro-pores filled with natural gas and some liquids, it is then necessary to crack, or fracture, this rock to allow the gas and liquids to flow back up the wells.2 This technique is called hydraulic fracturing, or "fracing" as commonly known in the energy industry.

SECTION 3. HYDRAULIC FRACTURING IN SHALE GAS FORMATIONS

While hydraulic fracturing is not itself a new technique, the combination of fracturing and horizontal drilling to produce natural gas from tight shale formations only began in earnest in 2002-2003.3 The primary difference between modern shale gas development and conventional natural gas development is the extensive use of this combination of horizontal drilling and high-volume hydraulic fracturing.4 The combination of these two technologies that have been available for decades, coupled with technological advances in equipment and cost reductions, is the key to unlocking the vast reserves of shale gas. A well is typically more than a mile deep and its horizontal, or lateral, length may extend from 1,000 to 5,000 feet. The hydraulic pressure creates fissures, or cracks, in the rock that propagate along natural fault lines in an elongated elliptical pattern up to 3,000 feet from the well bore in opposite directions.

The hydraulic fracturing of shale is typically performed in four or more "stages," with each stage using different volumes and compositions of water-based fluids. The fracturing fluid is primarily water (90%), chemical additives (1-2%) and proppants (8-9%). The chemical additives have included hydrochloric acid (to initiate cracks by dissolution), glutaraldehyde (to act as a biocide), ammonium persulfate (to delay polymer breakdown), dimethyl formamide (to inhibit corrosion), borate salts (to maintain fluid viscosity), polyacrylamide (to reduce friction), hydroxyethel cellulose (to support the proppant), citric acid (to control iron), potassium chloride (to create a brine carrier fluid), ammonium bisulfate (to scavenge oxygen), sodium carbonate (to adjust pH), ethylene glycol (to inhibit scale) and isopropanol (to act as surfactant) among other things.

Behind the water/chemical fluid comes a slurry containing small granules called "proppants"—sand, ceramic beads or bauxite—that lodge themselves in the fissures, propping them open against the enormous subsurface pressure that would otherwise force them shut as soon as the fluid was removed.

The fluid is then drained back out of the well, leaving the fissures and cracks open for oil and gas to flow to the wellbore. Hydraulic fracturing increases the well's effective exposure to the formation, allowing greater production. However, the injection of the fluid is controversial from an environmental standpoint, and the removal of the flowback and produced water requires disposal either by permanent injection into a separate waste injection well or delivery to conventional municipal wastewater disposal systems, or treatment and reuse of the water in oil field operations, such as further fracing.

The technique of hydraulic fracturing, whether in conventional oil and gas fields or shale formations, can implicate the conflicting principles of protection of property rights and groundwater and the full development of natural resources...