SB 319-SHALLOW NATURAL GAS: LEASING & DISCHARGES  CHAIRMAN TORGERSON announced SB 319 to be up for consideration. MR. DARWIN PETERSON, staff to Senator Torgerson, told members: SB 319 is an act related to shallow natural gas leasing. Shallow gas leasing was originally proposed as a program that would enable exploration and production of shallow natural gas deposits. One of the features of the program is to encourage a new energy supply to villages, mines and other rural users. The program is fully operational with over 100 leases processed and nearly 200 more pending. The program has become a vehicle for commercial gas development in Fairbanks, Big Delta, Mat-Su Valley and the Lower Kenai Peninsula. SB 319 is intended to advance the program into a more robust and viable commercial program that should benefit all parties. Because the program has become more commercial in nature, increasing revenues from application fees and annual rental fees is appropriate. The program will still neither involve competitive bidding nor require bonus bids. However, application fees for shallow gas leases have been increased from $500 to $5,000 and an annual rental fee has been increased from $0.50 to $1.00 per acre. The increased fees are designed to increase revenue and pay for the program costs while not discouraging parties of genuine interest and ability from developing shallow natural gas resources. The requirement that DNR annually notify a lessee by certified mail of rent due has been deleted. Rent would automatically be due on the date determined in the lease. Deadlines have proved to be unworkable and do not recognize the work required by DNR to prepare leases in areas that are populated and may have complex land ownership patterns. The limitation on depth to 3,000 ft. has been replaced with the requirement that some portion of the field must be within 3,000 ft. The total amount of acreage that may be held by shallow natural gas lessees has been increased from 46,080 acres to an aggregate of 100,000 acres. The acreage increase reflects the fact that large acreage may be necessary as a shallow gas program. The requirement that the applicant conduct a title search will be removed. DNR routinely conducts a title search for land before leases are issued. Additionally, there are no title companies that will conduct a thorough title search of the subsurface estate and warranty title. These changes will improve reservoir management… TAPE 02-5, SIDE B    MR. PETERSON continued: New bonding provisions would demonstrate lessees are fiscally responsible and would help protect surface owners. The lessee must secure the bond as a precondition to obtaining the lease. In the event that the surface estate is owned by a private property, an additional bond may be required if the lessee and the private party cannot reach an agreement. Lessees will have from July 1, 2002 through September 30, 2002, approximately 90 days to convert leases from the existing program to the new program if they so choose. MR. MARK MYERS, Director, Division of Oil and Gas, Department of Natural Resources (DNR), said that DNR strongly supports SB 319, which recognizes that the original intent of shallow gas leasing was to provide rural energy in remote areas. It would take many leases to provide sufficient energy to the rural villages. That was the original intent, but the program quickly evolved into a commercial program. Right now there are pending leases on 1.3 million acres of land. The leases are clustered near fairly large residential areas and communities of Fairbanks, the Big Delta area, the northern Mat-Su area and in the Homer area. Those leases are appropriated for fairly large-scale commercial gas development, assuming there is shallow gas or coal bed methane or both. DNR looks at the program in terms of what it needs to be an effective commercial program as well as to maintain the original intent if it is used by villages in rural and remote areas. About 1.5% of the leases are in higher density population areas. DNR tried to come up with some changes to balance everyone's needs and, to that end, worked with AOGA, Cominco, and other folks who have an interest in seeing a successful exploration or the shallow gas leasing program. MR. MYERS told members that amending the 3,000 ft. depth is a big issue. The problem with 3,000 ft. is that geologic formations for coal or shallow gas typically tip at an angle and often start at 3,000 ft., and continue on below that level. There are fights with the AOGCC over proving the state's rights to get that gas. Another problem is that the 3,000 ft. depth is a surface depth rather than a fixed depth based on sea level, but the terrain undulates. This creates a huge problem from a reservoir management standpoint and furthermore, the coal seams for coal bed methane might extend from a few hundred feet down to depths of 4,500 ft. DNR feels it is fair for the lessee to be able to capture all the reserves in an entire area. For logical development and to maximize production, DNR feels that mineral rights, if the field starts above 3,000 ft., should be for the whole field's accumulation. All parties share this concern. Regarding changing the fee to $5,000, it costs DNR $2,000 to do the title per lease. The current bill does not require DNR to do the title work, but DNR has found that it has to. Private parties cannot get insurance on title work so they have no way to verify the title was done in a reasonable manner without actually retracing it anyway. He pointed out that $5,000 is less than $1 per acre for a lease, which is well under any of DNR's competitive leasing terms. They feel the terms are reasonable and affordable. MR. MYERS said DNR also wants to increase the total acreage from 46,000 acres under the old bill to 100,000 acres maximum per company. The reason is that a coal bed is typically produced in fairly large units of about 70 to 80,000 acres to maximize production. Around a small village this wouldn't be necessary, but in a commercial sense a company typically needs to acquire more acreage. In terms of raising the rents from $.50 to $1 per acre, this is as cheap as they get. The original lease starts at $1, but accelerates $0.50 each year for the term of the lease. This stays at $1, which is affordable and provides more revenues to the state. They feel that the state's oil and gas programs should at least pay for themselves. MR. MYERS said DNR is concerned that a lot of the current shallow gas leases are in areas where the private land ownership is more complicated than on the North Slope or in some areas of Cook Inlet. DNR is concerned about getting an applicant who has a tradition of oil and gas development that may not understand the process of approvals and may actually enter the land or do damage to it without getting the landowner's agreement. Putting the bond amount up front gives extra protection to the surface owners that the department feels is appropriate. The bond would screen out folks who would not be able to afford the leases and who might cause incidental damage by not getting a final operations permit. This is an assurance to private landowners that they do have some protection, partly necessary because this is an over-the-counter program, not a program where the state selects which areas it's leasing. People apply to DNR and a lease is then granted based on the application. SB 319 provides a chance for someone to convert from the old program that limits rights to 3,000 ft. to this new program. Several companies want to utilize these leases for commercial development. He stressed that this is an important program to the state in terms of providing energy to Fairbanks and the Homer area. SENATOR ELTON asked why DNR made the change on page 3, lines 13 and 14, that allows the director to terminate the lease if the renter fails to pay. MR. MYERS replied that he thought the issue was whether the state has the obligation to be sure to mail out the request or whether it is the lessee's responsibility to make sure to pay the rent. He explained: We felt that we're not in the mail order business of doing that. We don't do that with our conventional program. So this is an extra expense on the department that a responsible lessee should have no problem in fulfilling in the existing oil and gas program. SENATOR ELTON asked if DNR still has the authority to terminate a lease if rent is not paid. MR. MYERS replied that it does. CHAIRMAN TORGERSON asked him to explain the $500,000 bonding requirement on page 16. MR. MYERS responded that the $500,000 is a statewide bond for oil and gas activities. DNR feels that requiring it upfront assures, since there are no other qualifications that the lessee has the wherewithal to cover any surface damage caused. If a lessee already has a $500,000 statewide bond, it shows they are responsible and that recourse is available so the lessee is exempted from the extra $50,000 requirement. SENATOR TAYLOR noted that language on page 5, line 23 refers to $25,000 per incident. He asked if he were to go into the shallow gas leasing business, whether he would have to come up with the $5,000, pay the $1 per acre annual fee and also come up with a $500,000 bond. MR. MYERS replied that he wouldn't. He added that there are multiple bonds in the state and this bill deals with some of them in addition to adding another one. However, the additional bond on page 5 is a DEC bond that is based on cuttings and weights and other issues that are related to the operation of drilling, not acquiring a lease. SENATOR TAYLOR repeated his question that if he came up with $5,000 and the $1 per acre fee, would he need to have additional bonding before he could get the permits to actually drill a hole. MR. JIM HAYNES, Permitting, explained that there are three agencies within state government that have bonding requirements. The Alaska Oil and Gas Conservation Commission (AOGCC) requires a $200,000 statewide bond to plug an abandoned well that may be left improperly in place. DEC's bonding requirements range from a low of $25,000 to as high as $121 million, depending on the type of facility. DNR requires a $100,000 bond for a single well and $500,000 for a statewide bond, which would include shallow gas. The bill says if you have the $500,000 bond in place, such as UNOCAL does, no additional bond is required for shallow gas operation. CHAIRMAN TORGERSON asked if the $500,000 statewide bond requirement is existing law and the legislation provides an exemption if a company already has one. They indicated that was correct. He asked if they didn't think that was a little low. MR. HAYNES replied that it hadn't been low so far. SENATOR TAYLOR clarified if he was going to lease to drill for shallow gas, he would need a $200,000 bond for the AOGCC to make sure he would plug up any holes that he would leave, a $25,000 per incident bond, and a $121 million bond to DEC for whatever it construes the risks to be and then, if he was going to drill more than one single hole, he would have to come up with another $500,000 for a statewide bond for DNR, which would include this gas. MR. HAYNES replied that is correct, although he couldn't speak for DEC. The per incident language, if you drill a well with one drilling rig and move it to another hole, is another incident. If you have three drill rigs running, that could probably be construed as three incidents, but he didn't know how DEC would interpret that. He stated, "We're concerned with $500,000." SENATOR TAYLOR said the very least he could get by with is $725,000 in bonding before he could drill a shallow gas hole. MR. HAYNES said that is correct. SENATOR TAYLOR indicated that was maybe too much. MR. HAYNES replied that the question is what is being bonded. Some of the bonds are to make sure the well is abandoned properly, some of them are to protect the surface estate, and others are to deal with oil spill clean-up issues. He explained, "It's not a combined pool that's usable for all these purposes. They are individual bonds for specific purposes that are all different." MR. MARK SEXTON, President and CEO, Evergreen Resources Alaska Corporation, said that currently Evergreen has 46,080 acres of shallow gas lease applications located in the Willow area pending with DNR. He supports SB 319, which removes obstacles to Evergreen's ability to explore for and develop shallow natural gas. He told members: Evergreen Resources Alaska's functional specialties extend to Alaska the main focus of Evergreen Resources, which is unconventional natural gas extraction such as coal bed methane extraction and other shallow natural gas development. These activities require at least 100,000 acres to establish the necessary economies of scale for an initial developing program. We strongly support increasing the depth limitation to one that relies on science and geology for the specific geologic play in concept. We're certain we can drill, complete and produce natural gas wells below 3,000 in a safe and environmentally responsible manner using the currently existing technologies that we already employ every day. Finally, Mr. Chairman, the shallow natural gas program is the primary reason Evergreen is in Alaska and we're grateful that the legislature is making this program possible as well as improving it. The changes proposed in this bill do provide us the necessary latitude to operate in an economically sound and environmentally safe manner and we acknowledge the Division of Oil and Gas for collaborating with us and other stake holders. This is in our mind an excellent example of how state agencies and industry can work together to the benefit of all interested parties, including and particularly the public. Thank you for allowing me to testify today. MR. SEXTON said John Kanegawa, Alaska Projects Manager, and Jack Engstrom, Public Affairs, would be in Juneau Thursday and Friday to provide further information. SENATOR TAYLOR asked if he could give the committee a comparison of the bonding requirements required from a company like his in other states where there is shallow gas. MR. SEXTON replied that it varies from state to state and in general it's quite a bit less in Colorado, which requires a $25,000 statewide bond. There is a separate $25,000 bond for operating within federal units. SENATOR TAYLOR asked if the requirements in other states are that dramatically less than in Alaska where the minimum bonding requirement to punch the first hole is $725,000. MR. SEXTON said that is right: But it really has come down to the fact that even as large as those numbers are, when you look at the cost of bonds, bonding really represents a small portion, just a few percent of the total cost to drill, complete and produce a shallow gas well. If an operator cannot afford a bond, even if it's just a $500,000 statewide oil and gas bond, it's probably unlikely that they will have the financial resources to successfully drill and produce a single exploration well, much less implementing a full multi-well program in an orderly development way I think the state wants to see.... The operators who can afford to do this type of program could easily afford this type of bonding. SENATOR TAYLOR said that is why he is concerned, because through this guise, the state may very well be excluding this activity to a limited club of operators who can afford to do the drilling. He understands that over 30% of the oil produced in the United States today comes from wildcatters and a higher percent than that comes from wildcatters drilling for gas. He didn't think it encouraged them to go out there if the only boys that can play in the game have to have a million dollar check before they can show up. MR. SEXTON responded that it is going to be more costly to do business in Alaska. Evergreen has taken the approach that to do this right, it has to plan to develop at least 100,000 acres to get the proper economies of scale. He said that in populated areas such as the Mat-Su, infrastructure and services are generally available as opposed to the effort that would be required to drill a few wells in outlying villages where the market is limited. Alaska should deal with well-financed ethical companies that are going to be able to do it right, because while the cost for Alaska can be quantified relative to drilling wells in Oklahoma or Kansas, the reality is the cleanup costs in Alaska, especially in remote areas if someone doesn't do it right, would be greater than down south where services and equipment are more readily available. He reminded members that Evergreen is planning to bring in specialized drilling rigs and specialized fracture stimulation and completion equipment to do the work in Alaska, which currently doesn't exist. CHAIRMAN TORGERSON said that Senator Taylor is making a comparison to one well and there is no such thing as a one well methane shallow gas field that he knows of. He offered, "There's maybe 1,500 wells to a field… and $500,000 is a bargain." MR. SEXTON said that he was looking forward to proving that statement true. MR. DAVE LAPPI, President, Lapp Resources, Inc., supported SB 319 and said: The proposed bonding to cover damages to the surface will reduce the cost to the Division of Oil and Gas in administering these provisions while providing good protection to local resources. The 100,000-acreage limitation will allow companies to establish the larger acreage positions necessary to justify the risks and expenses in developing the new resource. He discussed raising the fees to cover the increased administrative costs with the division and he thought it would be nice if monies to cover the increased costs could be raised closer to the source of the expense (the drilling and production phase) rather than at the application stage. He thought it was in the best interest of the state not to shortchange the Division of Oil and Gas, which manages the source of the vast majority of our state's income. He supported changing the exploration level to below 3,000 ft. because it will increase the potential gas resource available under this program while reducing the cost of developing the deeper horizon. He supported language on page 5 that would eliminate reclassifying shallow gas wells to oil and gas wells on leases other than shallow gas leases. He thought the same language should be used on page 6, line 26, to prevent increased bonding costs. MS. JUDY BRADY, Executive Director, Alaska Oil and Gas Association, supported this bill for all the reasons previously heard. MR. KEVIN TABLER, Manager of Land and Government Affairs, UNOCAL, supported SB 319 and told members: UNOCAL is conducting an aggressive gas exploration program in the Cook Inlet area and is very interested in any legislation dealing with gas and gas exploration. The shallow gas leasing program augments the existing area wide leasing program and enhances the access to development of the state's natural gas resources. We're very supportive of this program and other leasing programs providing access to the state's mineral wealth. I have listened today to the remarks of Director Myers at the Division of Oil and Gas testifying in support of this bill and wish to lend UNOCAL's support in passage of this legislation… MS. CHARLOTTE MCKAY, Senior Administrator, Environmental and Regulatory Affairs, Tech-Cominco of Alaska, said Tech-Cominco is partners with NANA Regional Corporation. She wanted to talk about the potential for shale bed methane gas around the Red Dog mine. They employ 400 people, about 60% are NANA shareholders and they produce over one million tons of zinc and lead concentrates per year. She said: To crush the ore and make the concentrate requires about 28 megawatts of power using approximately 18 million gallons of diesel per year that we transport to the port and then up the road by truck on a daily basis. Replacing the diesel consumption with gas would reduce our air emissions by half as well as reduce the risks of the oil transport to the port, the storage and the transfer up to the mine site. She showed the committee a picture of the terrain at the Red Dog Mine, which is not flat like Mat-Su or Prudhoe Bay. It is very rugged and they need a more flexible determination for the depth limitation for the shallow gas lease. It would be very difficult to follow a surface depth at Red Dog. MS. MCKAY said that currently, Tech-Cominco holds four state shallow gas leases for about 23,000 acres and NANA has the adjoining land to the east where there is nearly 100,000 acres. The current lease limitation of 46,000 acres to any one company is not sufficient for the project and they support the 100,000- acre limit as well as the fee changes, if the monies remain within the shallow gas program. Otherwise, they would find it an expenditure that would not be good for business. Development of shallow gas fields in Northwest Alaska have many impediments and location is the major one due to access and the ability to bring large equipment in and out only in the summer months. They do not have access by ice roads in the winter months. She explained: It's very difficult, if not impossible, to test a shallow gas lease within the three years provided in the current lease when work is so seasonal. Logic would say a lease should be at lease five years for a primary term with renewal options as provided in the current lease. Although this is not provided in the legislation, we would support a five-year term with renewal options. Development of a shallow gas field is much different than a conventional field in Cook Inlet or on the Slope. Instead of 2 to 5 holes to develop a gas field, it would take 50 to 100 holes and the cost per hole needs to be kept at a minimum or a field becomes uneconomic quickly. To date, Cominco has opportunistically piggy-backed on the mineral exploration effort in the Red Dog area as a tool to defray the costs and delineate the areas for potential gas resource. The methane gas we have found is low pressure and is located lateral to and underlying the ore zones. Extensive work has been completed to date using the mineral exploration tools, but the next phase is to conduct the flow test to see if that gas will let loose. This flow test cannot be supported until the depth below the surface of a field is better defined. We have already found gas down 2 - 3,000 ft. and we know it's at least that deep and the geologic structure indicates it will go considerably deeper. Arctic operations will always present numerous challenges not present elsewhere. Tech-Cominco Alaska and NANA address these each and every day at Red Dog. By passing this legislation, you will help us address some more. SENATOR TAYLOR asked if she wanted a five-year term. MS. MCKAY replied yes. SENATOR TAYLOR explained that the legislature does not have the ability to dedicate funds so keeping the revenues within the shallow gas program may be beyond their capacity. Even program receipts are subject to the appropriation by the next legislature. SENATOR LINCOLN said the bill addresses wells "within" 3,000 ft. of the surface and asked if that language is a problem. MS. MACKAY replied that this bill would allow a well to go deeper if they are within the same resource unit. MR. MYERS said that there is also discretion to add three years to the five-year term. He said that production on a larger scale would be from unitized production, particularly in their area where there are two different subsurface owners. 5:10 p.m.  MR. KEN BOYD, Oil and Gas Consultant, said he was representing himself, but that he was director of the Division of Oil and Gas when this program was originally established in 1996. He supported the changes in the bill. Extending the 3,000 ft. depth and increasing the number of acres just increases the opportunity to use the bill. The increase in fees is appropriate and the bonding may help by giving the landowners more comfort. 5:12 - 5:16 AT-EASE  SENATOR HALFORD said his concern is that in these kinds of operations, multiple rigs are operating in fairly high densities. He is worried that a $500,000 bond for surface damage will not be enough. He wanted to hear what the Division has to say about the level of the bond when it's applied statewide, because he thought there would be more and more conflicts between the people who own the surface estate and the subsurface. Most people don't understand that they don't control authority over the subsurface estate. He noted, "In fact, it's reversed." MR. MYERS replied that they should keep in mind that the risk wouldn't occur all at once. The $500,000 has to be replenished if there are multiple, simultaneous draws on that individual bond. He thought the bonding issue needed to be reviewed in the sense of their overall oil and gas program where there's oil risk as well. He explained, "I think we're comfortable with the current levels, but if we do look at more, I think it needs to be looked at in regards to the conventional program as well." He said they have the authority to request larger bonds if there is unusual risk. SENATOR HALFORD said there is a difference in the kind of expectations from parcels and the expertise of the people involved when you're dealing with small subdivision lots in small parcels of land. MR. MYERS concurred with that and said DNR needs to be concerned about the economic effect on the industry as well. SENATOR HALFORD asked what he thought the cost of a $500,000 bond would be for a reasonable sized independent company. MR. MYERS replied that he thought it was about 20% of the bond amount. He added that depended on market conditions that change. SENATOR HALFORD asked if that is a cost that is annually earned or an amount that has to remain in escrow. MR. MYERS replied that it is an annual premium. TAPE 02-6, SIDE A    SENATOR ELTON asked if reservations were expressed during the public comment period that the director or the department would be able to negotiate the bond price. MR. HAYNES replied that under AS 38.05.130(a), a surface owner (either party) who cannot come to terms with proposed activity on his land has the right to request a hearing by the director of the Division of Oil and Gas. They had experience with that a few years ago and it was peacefully resolved. They hoped the new legislation with $500,000 in place would allow them to tell someone who wanted a hearing that they are entitled to it, but $500,000 is a pretty high bond and it's in place for the surface owner's benefit. SENATOR TAYLOR asked if they are allowed to exceed that amount if they determine there is a greater risk. MR. HAYNES replied yes. He said that Alaska's oil and gas business is changing and for the first time [companies] are going into areas that are not only residential, but areas with complicated ownership patterns. DNR is aware of it and is dealing with it. SENATOR HALFORD asked if determinations are all made on a very large area before the actual location of where somebody is going to drill is even considered. MR. HAYNES replied no and that there is no best interest finding as the state does with conventional sales or with its exploration licenses. The environmental requirements are adjusted area by area; the bonding requirements are more specific and are geared toward the risks of a particular operation. The lease operation approval process that occurs looks at each individual activity whether it is putting a road in or drilling a well or shooting seismic. SENATOR HALFORD asked if a site could be in a 10-acre lot within a 100,000 acre area wide activity. MR. HAYNES replied that one of the concerns is that the surface owner, should it be different than the state, needs to have clear protection. The up-front bonding requirement provides some protection against surface damage if a person got on that site prematurely with his bulldozer and decided he wanted to clear a path to his well. Secondly, when they went to their final operations, they would have enough protection for that surface owner in addition to the other bonds to deal with the other risks. SENATOR HALFORD commented, "I hope they never get to the point where they end up draining some large recreational lake, because I think they're going to have a lot more money involved." SENATOR TAYLOR moved to delete "competition" and insert "completion" on page 3, line 1. There were no objections and the amendment was adopted. SENATOR TAYLOR moved to pass CSSB 319(RES) from committee with individual recommendations. There were no objections and it was so ordered.