Colorado Regulators Pursue Pseudo Fracking Ban, Understanding The Impacts | Seeking Alpha

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In (somewhat) shocking news, four of the five members of the Colorado Oil and Gas Conservation Commission voiced support for a 2,000-foot setback for homes and schools, a large increase from current levels. The absolutely poor outlook for oil and gas in Colorado has been a persistent cause of selling in companies potentially impacted for several years now. While measures that would have resulted in an outright ban on fracking in the state have failed, it was clear that regulatory change was on the way after the passing of Senate Bill 181 in 2019, a law that changed the mandate of the state regulatory body from fostering oil and gas development to one that zeroes in on how the industry impacts public health and well-being.

Senate Bill 181 paved the way for politicians in Denver to force rules changes on those in rural Colorado; this recent news is an example of that. Current setback rules call for a 200-foot buffer from a well, 500 feet from residential areas, and 1,000 feet from schools. There will not be a vote on the proposed regulation for several weeks, but all signs point to some big changes on the way for oil and gas developers in Colorado.

Potential Collapse In Drilling

While a couple thousand feet might not seem to be a big deal, independent estimates leading up to the public vote on Proposition 112 – which would have mandated a 2,500-foot buffer from occupied buildings like homes, schools, and other “vulnerable” areas – showed that that restriction has rendered between 75% and 85% of current wells as failing the test if those permitting rules would have been in place, basically forcing drilling onto federal lands where those rules did not apply. The difference here is that the newly proposed Commission rules would impact those areas around city limits the hardest. Proposition 112 also included setback rules from lakes, rivers, and streams, basically rendering all acreage as undrillable. In this case, the closer your acreage is to city limits, the higher the likelihood that you cannot drill.

Who is impacted here? Anyone with operations in the DJ Basin, which basically means Weld County, Colorado, for all intents and purposes. Since 2017, there have been more than 3,700 well completions in Weld County. The second-largest county by activity in the DJ Basin is Laramie with a little more than 200. At its core, the DJ Basin is all about the liquids-rich rock under Weld.

Occidental Petroleum (OXY), PDC Energy (PDCE), Noble Energy (NBL), and Extraction Oil and Gas (XOG) are the largest publicly traded drillers in the DJ Basin, making up two-thirds of overall drilling permits and completions over the past few years. These upstream assets are supported by midstream firms like DCP Midstream (DCP), ONEOK (OKE), Western Midstream Partners (WES), and Noble Midstream (NBLX). As upstream goes, so does midstream once contracts expire and volumes drop.

However, not everyone will share equal pain. Who has the most to lose? Occidental Petroleum, by far, owns the most acreage near city limits; PDC Energy is in a similar situation. By comparison, Noble Energy owns far less that would be impacted, and privately held Bonanza Creek would see limited to no impact in comparison. Investors have to be careful not to sell these companies indiscriminately. For some, it is as simple as drilling on unimpacted lands until the inevitable court battle can be worked out. For others, not being able to drill is as good as a death sentence.

Supermajor Weight, Legal Outlook

What I find to be the most interesting facet to this story is Noble Energy. Recently acquired by Chevron (CVX), it remains to be seen how committed management is to drilling in the DJ Basin. Given how cheap Noble Energy was, it remains to be seen if that purchase was more about Noble Energy assets outside the DJ Basin, like its holdings in the Permian or international holdings in the Mediterranean and West Africa. That is pretty important to the midstream story here, as Noble Midstream is far, far more reliant on the DJ Basin for its earnings and valuation than Noble Energy was. Will Chevron leave its newly acquired midstream partnership out to dry?

On the other hand, consider if Chevron wants to fight this battle. Having Chevron as a fellow litigant would be massively beneficial. Occidental Petroleum, while large, is in dire financial straits. It does not have enough cash flow to keep production stable, with any and all dollars lost to legal battles also a lost dollar when it comes to addressing its looming debt maturities. The story is similar for other smaller players. PDC Energy is still digesting the SRC acquisition (and associated leverage). Extraction Oil and Gas is, quite literally, bankrupt and going through its restructuring. Chevron, by comparison, is in great financial shape and can better afford to hire busloads of lawyers to descend upon Denver to fight for its interests.

It will be an interesting case once the lawsuits fly. Remember that alongside Proposition 112 was Amendment 74, a measure designed to amend the state constitution to require property owners be compensated for any reduction in property value caused by state laws or regulations. While it failed to pass just as Proposition 112 did, Amendment 74 is simplistically a more direct interpretation on the Takings Clause of the Fifth Amendment.

The US Constitution states that private property shall not be taken for public use without just compensation. Eminent domain is the classic example most readers are familiar with. Prior Supreme Court rulings have supported that regulations can fall under that verbiage. While the Supreme Court has not taken on an oil and gas case specifically citing the Takings Clause, there is some precedent case law specifically within oil and gas in Michigan (Miller Brothers vs. Department of Natural Resources). Expect upstream firms to immediately challenge any far-reaching regulation with the express goal of either having the rule revoked or having the state of Colorado recoup companies for losses.

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Disclosure: I am/we are short OXY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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