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Colorado operators to face most-stringent drilling setbacks in US

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Platts Global Alert - Oil

Colorado operators to face most-stringent drilling setbacks in US

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Setbacks to extend from 500 feet to 2,000 feet

Regulations to impact oil-rich Denver-Julesburg Basin

Gas production flat despite improved oil prices

Denver — Colorado producers on Jan. 15 will face the most-stringent drilling setback rules in the US, when buffers quadruple to 2,000 feet as a backlog of 6,000 pending permits have built up in state regulatory offices over the past year.

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Last week, the Colorado Oil and Gas Conservation Commission approved an overhaul of state oil and gas permitting rules. The vote capped off months of hearings on regulations stemming from Senate Bill 181, which re-prioritized the mission of the COGCC from one of fostering mineral development to environmental protection.

"The rules not only meet the spirit and mandates of SB 19-181, but they were done so with a unanimous vote and largely with consensus from all sides," said COGCC Chairman Jeff Robbins.

The rules will apply to future permit applications starting Jan. 15. Oil and gas companies will have to re-apply with new permits to replace still-pending applications submitted under the prior rules.

Nearly 6,000 pending drilling permit applications have been built up at the COGCC, according to state data. Companies have until March to update applications. The COGCC will try to hasten decisions on the updated permit applications.

The new rules not only increase drilling setbacks from homes and businesses from 500 feet to 2,000 feet, but also give local governments more voice in approving new permits.

"While we agreed with many of the changes enacted by COGCC commissioners, there were several points of contention," said Dan Haley, CEO of the Colorado Oil and Gas Association. "Commissioners approved unprecedented 2,000-foot siting requirements, largely based on the precautionary principle, as no scientific evidence was presented that showed such an extreme distance was necessary. In fact, all of the testimony from toxicologists during the hearings included data showing that the previous 500-foot setback was protective of public health, safety, and the environment."

D-J impact

The regulations look to have the most dramatic effect in the oil-rich Denver-Julesburg Basin, where operators interact with the sprawling suburbs north and northeast of Denver. Colorado ranks fifth nationally in crude oil production and sixth in natural gas, according to the US Energy Information Administration.

Rig counts in the DJ Basin have doubled since the start of October, currently sitting at eight rigs in the basin, in part driven by strengthening WTI crude pricing, up by nearly $7/b since early October to just over $45/b.

Although WTI is at its strongest level since mid-April, internal rate of return remains near 8% for regional operators in the DJ, near breakevens, and would require a stronger pricing environment in order to incentivize incremental drilling activity and production. Platts Analytics IRRs are based on a half-cycle, after federal corporate tax analysis, which excludes sunk costs such as acreage acquisition, seismic and appraisal drilling.

Gas output flat

Despite better crude pricing, operators haven't experienced an uptick in gas output, as sample production out of the DJ Basin has remained relatively flat to October's levels, averaging 2.39 Bcf/d in November, according to S&P Global Platts Analytics data.

Most shale operators have historically placed their crews on holiday in the fourth quarter of the year to conserve cash and come in under their annual budget. This has likely played a role in a lack of production increase despite rigs slowly returning as operators continue to maintain capital discipline throughout the balance of 2020.

Platts Analytics anticipates gas production declines will likely extend through most of next year, prior to slowly increasing beginning in September, as forecasts indicate production out of the DJ will average 2.15 Bcf/d through 2021, a year-over-year decrease of approximately 200 MMcf/d.

With the passing of the new regulation, it is possible drilling activity continues to ramp up as operators potentially aim to drill some of their most at-risk permits, building up DUC counts prior to Jan. 15.

"Colorado oil and natural gas operators are exceedingly adaptive, which is why we produce some of the cleanest molecules on the planet, but they also need a workable set of regulations to further drive innovation and investment," Haley said.