Title: New Upstream Pit Permitting Rules
Speakers: Jerry Higdon and Case Towslee
Jerry Higdon (00:07):
Okay, good to see you. Glad you could come out today. Is it just me, or does it seem like there’s been a recent uptick in upstream transactions?
Case Towslee (00:16):
Sure, it’s definitely picking up this summer. It was a slower start to the year. You and I worked together a lot, so getting a new deal started with you this week was a good sign. And I know you’ve been busy as well. You’ve been talking about some new rules and teaching on these new rules with the Railroad Commission. Can you tell us a little bit about what’s going on there?
Jerry Higdon (00:32):
Sure. The Railroad Commission came out with some rules that were effective July 1st, covering lots of things, but most relevant to the upstream industry. The biggest change is they instituted a new permitting and registration process for pits used in the upstream industry.
Those pits are of two types. There are what are called Schedule A pits — those are the pits primarily associated with the installation of wells, so completion pits, workover pits, mud pits, and reserve pits. Then another category of pits are Schedule B pits, which are the produced water recycling pits that operators use to recycle their produced water — not in a commercial sense, just operators on their own account.
Case Towslee (01:21):
With respect to the rule changes, are these applicable only to pits implemented and constructed after July 1st, or is this something that’s retroactively applicable to all pits in existence and those constructed in the future?
Jerry Higdon (01:34):
On July 1st, any new pit is going to have to be either registered or permitted. For pits that were already in the ground on July 1st, assuming they were compliant with the laws that existed, there’s a phase-in period that will apply. For those Schedule A pits, they’re given a one-year phase-in period, and in that year they either have to register or close. For those produced water Schedule B pits, they’re given six months. Within that six-month period, they have to register or close — but if they register, they’re also going to have to post some financial security as part of the registration process.
Case Towslee (02:17):
Interesting. So for new pits, when producers and operators are thinking about these new rules, do they construct the pits differently, or is it just a registration process? What are the nuances going into effect?
Jerry Higdon (02:29):
Good question. The Railroad Commission really spent a lot of time debating what exactly the construction of these pits should look like. What’s really going to determine a lot of it is the depth of groundwater. For those Schedule A pits, if the groundwater is within 50 feet of the bottom of the pit, the pits are going to have to be lined. For those Schedule B pits, if the groundwater is within 100 feet, then those pits are going to have to be monitored with groundwater monitoring wells. So there definitely are going to be some changes as a result of the new rules on the construction process.
Case Towslee (03:06):
In your experience, is the depth of groundwater something that’s already readily available to these operators, or is that additional information they’re going to have to go out and obtain?
Jerry Higdon (03:17):
According to the Railroad Commission, that’s going to be up to the operator to figure out. They can do so either using publicly available information, or they’re going to have to do a subsurface investigation on their property to figure out how deep the groundwater is.
Case Towslee (03:29):
So potentially some big changes. Any other takeaways that producers and operators need to know?
Jerry Higdon (03:35):
All these pits now are going to be subject to very strict closure obligations. The timelines by which they have to be dewatered, emptied, and backfilled are very specific as set forth in the rules. And then for Schedule B pits — those produced water recycling pits — there are also some potential long-term monitoring obligations that can apply for up to five years. So there will definitely be some changes.
You and I, when we were talking about these rules, you mentioned that given the transactions we work on, you could see some effects on those transactions and some of the work that occurs for them. What did you have in mind?
Case Towslee (04:15):
I think that really changes things from a diligence perspective to a degree. From a seller’s perspective, when you’re getting ready to enter into a sales process, you’re going to want to make sure any pits you have are in compliance. By doing that, you can take away any leverage a buyer may have to say they’re excluding that pit, or that they’re going to need some extended indemnity or other obligations that you’ll have to keep post-closing. That’s something sellers would want to avoid.
From a buyer’s perspective, you really want to look at when the pit was installed, whether it’s in compliance, whether it’s potentially being tested, and whether groundwater monitoring wells are in place and have been maintained in compliance with the regulations. Really knowing whether you’re going to step into something that requires a substantial amount of performance assurance or financial assurance — for pits that are essentially just liabilities you’re walking into — could be important.
Jerry Higdon (05:12):
Now, you and I have done enough of these deals. We know that sellers — and buyers too, to some degree — don’t like performing subsurface investigations, or Phase Two studies as they’re sometimes called. But particularly with respect to the Schedule B produced water pits, we know that when they’re closed, there’s going to have to be some sampling. Do you think the whole Phase Two hesitation might change as a result of these rules?
Case Towslee (05:38):
I don’t know that the hesitation will change. I think there could be more to a conversation on whether or not you’re going to do sampling and testing. Naturally, sellers are still going to say they don’t want you to do Phase Two investigations — they’ll say you can come out and do a Phase One, review everything, and look at their permits. But from a buyer’s perspective, there are certainly requirements you want to make sure the seller is in line with, so you’re going to want to lean toward a Phase Two, or at least make the request for one.
Jerry Higdon (06:09):
The other thing that you and I talked about is that as part of these transactions, some of these pits are going to require permits that then have to be transferred. What were your thoughts about the permit transfer process that could be implicated by these rules?
Case Towslee (06:25):
I think the timing is now 60 days to have a permit transferred when it comes to pits, and that’s a pretty long period of time in the course of a transaction. In some instances, signing to close could be 45 days. So there are some extended timeframes at play, and whether you handle that through a transition agreement, or by pushing closing until you know the pit transfer is going to come through, that’s something to really think about.
It’s going to be important to think about the testing that needs to be done and to make sure that if you’re going to assume a pit pursuant to a transaction, the transfer is going to take place — because you don’t want to be stuck with a pit that the seller retains or that the buyer simply can’t get the transfer to, because it wasn’t in compliance with the rules to begin with.
Jerry Higdon (07:12):
You raise a very good point, because one of the things these new rules do is impose a requirement that before a permit is going to be transferred, the compliance of the pit with Railroad Commission rules and Railroad Commission permit conditions has to be verified with a records inspection and a site inspection. Nobody really knows how that’s going to work for these permit transfers. Is that going to be an inspection conducted by the Railroad Commission, or is that going to be an obligation of the parties themselves as part of a certification process that they undertake?
Case Towslee (07:48):
So there’s the potential that the Railroad Commission would be coming out to each site and inspecting pits before they’ll approve a transfer.
Jerry Higdon (07:55):
If you take the wording of the regulations as they’re stated, there’s going to be some inspection of the sites and records before the permit transfers will be approved.
Case Towslee (08:04):
Is that supposed to take place within that 60-day window?
Jerry Higdon (08:08):
Presumably, but again, this is all very new, and it raises lots of issues that nobody has clear answers to.
Case Towslee (08:14):
Sure. I think a transition agreement may be the solution to some of this, but it also raises issues, because environmental obligations are not necessarily covered in transition agreements on a regular basis. Still, it’s a potential solution to something we’re not really sure about.
Jerry Higdon (07:30):
I think you and I can both conclude that times are different, changes are around us, and we’re going to have to work with clients to figure out best practices as these transactions unfold and hopefully get closed.
Case Towslee (08:44):
Well, I look forward to figuring it out with you as we go.
Jerry Higdon (07:30):
Look forward to it, Case.
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