Regulatory legislation traditionally follows abrupt economic transformation. How it is tailored has a profound impact on future industry expansion, and reflects the government's ability to align private interests with public benefits. Ohio Senate Bill 315 is no different.
The recently approved energy legislation in Ohio regulates the natural gas industry by instituting oversight that Governor Kasich regards as the toughest in the United States. Senate Bill 315 has provided momentary closure to regulatory uncertainty and articulates state standards for more responsible drilling and distribution practices. Despite being what the Governor regards as "the most aggressive, clearest, fairest and strongest fracking standards you can find anywhere in the country", the natural gas industry has embraced the legislation and welcomed state oversight . In a recent press release, the Executive Director of the Ohio Petroleum Council, Terry Fleming, praised the legislation and commended the state government's efforts to accommodate public interests in accordance with industry practices. Daniel Alfaro of Energy In-Depth Ohio, an advocacy group for oil and gas drilling, believes the legislation to be "something Ohioans across the board should be proud of" and hopes that it sets a regulatory standard for other states . While industry cooperation is preferred to private sector opposition, its support for the "most aggressive" state fracking legislation in the country warrants further analysis.
Beyond disclosure requirements, Senate Bill 315 does little to modify industry practices. These changes are marginal and include; increases in the level of required liability insurance maintained by horizontal drillers, water tests within 1,500 feet of horizontal wells prior to drilling, and the adoption of a Road Use Maintenance Agreement in cooperation with local governments. Ultimately, the Bill doesn't restrict fracking but fosters a sense of safety by making the process more transparent. Fortunately for oil and gas drillers, the state government hasn't taken on the authority to overrule proven practices. Rather it aims to promote drilling by eliminating regulatory uncertainly and by providing political oversight for preexisting practices. "We are pleased to see the new regulations partially reflect industry best practices developed by the American Petroleum Institute (API)" says Fleming . The Bill acts in the public interest by holding the industry to the standards outlined by the API and ensuring that drillers are accountable for meeting these guidelines. By consolidating oil and gas regulation under the newly established Division of Oil and Gas Resources Management [Section 1509.02], the Bill promotes more effective oversight by streamlining the bureaucratic hierarchy. From a public safety perspective, creating a centralized data collection and processing authority will promote more effective monitoring of drilling activity. Ultimately, the Bill is about disclosure, transparency and assuring the people of Ohio that the government is monitoring industry growth in a way that manages economic development with regard to public safety.
While generally open about their practices, drillers remain hesitant to publicize the .5 % of the chemicals used in the fracking process that are classified as trade secrets. Disclosure of these controversial chemicals remains one of the most divisive issues among state legislators, and represents a point of contention between industry interests and public safety concerns. Under Section 1509.10 of Senate Bill 315, within sixty days of completing a well, drillers are required to disclosure all relevant information including "a list of all chemicals…intentionally added to all products fluids or substances". However, in accordance with federal and state proprietary laws, companies can withhold substances categorized as trade secrets. Under the state's definition of trade secrets in Chapter 1333 of Ohio Uniform Commercial Code , fracking chemicals are protected as "information, including the whole or any portion or phase of any scientific or technical information" that "derives independent economic value, actual or potential, from not being generally known". However, also under Section 1509.10, is a provision that entitles medical professionals to "the exact chemical composition" of substances classified as trade secrets "in order to assist in the diagnosis or treatment of an individual who was affected by an incident associated with the production operations of a well". In effect, the state is respecting industry interests until they are blatantly in violation of public health. While some argue that requiring chemical disclosure after an individual has already been poisoned is too little too late, the state has faith in protective measures designed to defend against water contamination.
Industry protection against chemical disclosure is evidence that the Ohio state government has enough confidence in safe drilling procedures to gamble on the economic benefits of natural gas exploration. While some argue this confidence is misplaced, the industry track record suggests chemical usage can be effectively contained. In his testimony before the House Public Utilities Committee, Jim Zehringer, Director of the Ohio Department of Natural Resources (ODNR), outlined state and federal standards for fracking and brine disposal. He draws similarities between vertical and horizontal drilling and points out that "Approximately 80,000 vertical wells have been hydraulically fractured in Ohio since the method was introduced in 1951". He demonstrates the industry's proven ability to frack safely and is confident that similar safety standards can be easily appropriated to horizontal drilling. His testimony inspires confidence, but more importantly indicates a respect for industry expertise held by regulators within the Ohio government. Senate Bill 315 is consistent with this perspective, and identifies the private sector as best suited to determine drilling and storage techniques. It simply requires that more of the process be disclosed in an effort to calm political opposition and to regain public trust in the oil and gas industry.
The Bill clarifies disclosure requirements and demonstrates a state commitment to minimal government intervention. Yet one issue that continues to threaten oil and gas producers is the modification of the state severance tax on fossil fuel extraction. While not addressed in the recent legislation, Governor Kasich hopes to balance income tax reductions with a more comprehensive oil and gas tax. In a policy proposal, the governor argues "Ohio hasn't been a major oil and gas producer in the past century, so our state's 40-year-old tax system for oil and gas production-the "severance" tax-has never been comprehensively modernized". Kasich hopes to capitalize on continued industry growth and to generate state revenue under an updated tax structure. Current Ohio oil and natural gas tax rates are some of the lowest in the country. They amount to 20 cents per barrel of oil, 3 cents per 1,000 cubic feet of natural gas, and no tax on natural gas liquids. Kasich has proposed increasing these rates such that oil and liquefied natural gas extraction would be taxed at 1.5% for the first year and at 4% for every year thereafter, a 166% increase from the first year. This would more closely align Ohio severance tax rates with other states while keeping them comparatively low. Not surprisingly, the oil and natural gas industry is opposed to rate increases and worries that Kasich's proposal would threaten job creation and industry growth. For example, Chesapeake Energy Corp. hired seven Ohio state lobbyists in 2011 to influence energy legislation and to mitigate unfavorable taxation. This is especially notable because between 2005 and 2010 there were no Ohio lobbyists on the Chesapeake payroll  . While modifications to state severance tax rates were not included in the recent Bill, it remains a primary objective for the Kasich administration. Framed as a counterbalance to income tax reductions, the debate will incorporate fiscal hawks, environmentalists and industry advocates. Despite aggressive lobbying efforts to preserve the status quo, industry tax reform will become increasingly relevant as drilling operations continue to expand.
While easily dismissed as private sector greed, there is validity to the natural gas industry's concern regarding higher taxes on industry growth. Last week Reuters reported that the US natural gas rig count reached a thirteen year low, and that the horizontal drilling rig count has continued to decline for the past month. Overzealous companies invested heavily in natural gas extraction but are finding profit margins too thin to justify continued operations. Reaching more profitable market equilibrium requires constraining supply and increases in consumer demand. Given already tight margins, natural gas producers are especially sensitive to regulation that increases their cost of production. Fortunately, Senate Bill 315 establishes a regulatory framework without requiring additional expenses. While the new standards are "aggressive", as described by Governor Kasich, they are not a threat to profitability. With natural gas prices fluctuating near $2.50 per million BTUs, state regulators will have to carefully balance increases to public revenue with a fragile natural gas market.
Ohio is working to address the economic and social implications of becoming an oil and gas state. In an effort to foster an environment that yields public benefits from private interests, political leaders continue to define the public interest in terms of industry growth and job creation. Senate Bill 315 is a manifestation of this sentiment, and reflects the prioritization of public economic benefits over public health and environmental risks. Baring a catastrophic industry failure, state governments are likely to continue framing legislation based on this definition. This creates a strong incentive for drillers to stringently abide by industry safety standards, and to ensure that their contributions to public welfare continue to outweigh their attributed social cost.
Drillers are largely undaunted by regulatory threats, and continue to demonstrate confidence in future profitability. The gradual increase in consumer demand will benefit those companies that have positioned themselves to effectively produce and distribute natural gas. The share of American electricity generated by coal is expected to drop to below forty percent this year (the lowest since 1973), as utilities continue their transition to comparatively cheaper natural gas. This year natural gas is expected to generate thirty percent of domestic electricity, a ten percent increase from 2008. With natural gas reserves becoming more accessible and federal pollution standards, such as the EPA's Cross-State Air Pollution Rule, demanding the implementation of carbon capture technology, coal is becoming politically and economically unpopular. The growing transition away from coal will benefit companies with established natural gas infrastructure. Beaten down forty two percent over the past year, Baker Hughes (BHI) is significantly undervalued and is well positioned in the Utica Shale region. In February the company further expanded its presence, and announced a $340 million investment in its Ohio regional headquarters. With a PE of just over 10 and a high earnings growth rate relative to price, BHI appears to be oversold. Despite recent investments, BHI remains more than capable of paying off its debt with a Current Ratio of 2.9, well above the industry average. Given its strong debt to equity ratio, undervaluation and growing strength in the Utica Shale region, BHI is well positioned to capitalize as natural gas becomes a larger portion of America's energy infrastructure.
Liquefied and compressed natural gas have also infiltrated the transportation market. Companies such as Clean Energy Fuels (CLNE) are expanding their natural gas fueling network to over 300 fueling stations across 33 states. The President and CEO, Andrew Littlefair, argues that trucking customers who switch to natural gas make back their investment in a year. It is not only cheaper than traditional gasoline, but also makes trucking more timely and cost effective relative to rail. Currently in agreements with 500 of the nation's largest trucking and transportation fleets, CLNE is well positioned to continue expanding into the 30 billion gallon market for goods movement. Senate Bill 315 facilitates this transition by demanding the energy analysis of government purchases, and requiring that state motor vehicles comply with federal fuel economy standards. In February of this year, CLNE opened its first Liquefied natural gas fueling station in Ohio to service Dillon Transport, a major freight carrier for Owen Corning. Currently fueling 25,200 vehicles, CLNE has continued to expand "America's Natural Gas Highway" and is the largest provider of natural gas for transportation in the United States. Having entered into agreements over the past six months with Saddle Creek Corporation, Green Energy Oilfield Services and Navistar International to provide natural gas fueling stations, CLNE is leading a national transportation transformation.