Baker & McKenzie Report on Shale Gas in Australia

INTRODUCTION

Industry background

Australia potentially has one of the world's largest shale gas reserves, with technically recoverable resources estimated at 437 trillion cubic feet (TCF) according to various reports. Asia's increasing demand for cleaner gas-produced energy is driving Australia's exploration of its shale resources and Australia is in the race to be second behind the United States in bringing significant shale resource production on line. Currently, the Cooper Basin straddling South Australia and Queensland is one of the few regions outside the United States commercially producing shale gas.

Australia has the capacity to liquefy and export gas via existing and proposed LNG terminals on both the east and west coasts. Moreover in areas such as the Cooper Basin, existing infrastructure originally built to serve Australia's conventional gas and oil sectors is likely to facilitate the construction of facilities and the transportation of shale gas to market.

This combination of strong regional demand, extensive reserves and significant existing infrastructure makes Australia an attractive shale gas investment destinations globally.

Legal framework

Shale gas is generally subject to the same regulatory regime as conventional gas. The legal framework concerning gas is established and operates on Federal, State, Territory and local council levels. The exploration and extraction of gas are primarily regulated at the State and Territory level, or at the Federal level in the case of offshore developments. Federal laws affect gas activities in all States, including those relating to taxation, native title rights, environmental protection and occupational health and safety. In addition, certain local council laws apply, such as development and planning approvals.

Shale gas is generally defined as a petroleum product in each of the State and Territory jurisdictions. Therefore each jurisdiction's equivalent of the Petroleum Act and accompanying Regulations govern onshore gas activities in Australia.

Ownership of hydrocarbon resources

Federal, State or Territory governments own all hydrocarbon reserves, and the rights to explore and produce hydrocarbons are granted through various petroleum titles and approvals from the relevant government authority. Landholders therefore do not have ownership rights to gas resources, although they may be entitled to compensation for the loss of the use of land due to gas exploration and extraction activities.

Administration

As shown in the schematic below, shale gas activities are governed by the various Petroleum Act equivalents and relevant Regulations in each state.

The relevant State Acts and their accompanying Regulations listed above are administered by the following Departments:

• South Australia Department for Manufacturing, Innovation, Trade, Resources and Energy (DMITRE), Energy Resources Division
• Western Australia Department of Mines and Petroleum
• New South Wales Department of Trade & Investment, Resources & Energy Division
• Queensland Department of Natural Resources and Mines
• Victoria Department of State Development, Business and Innovation (DSDBI)

KEY CONSIDERATIONS FOR SHALE GAS PROJECTS IN AUSTRALIA

Exploration stage

To explore for shale gas resources in Australia, generally a permit is required from the relevant State and Territory authority. An exploration permit will cover a defined area and have an initial term of five to six years. The permit will grant a holder the right to enter land and conduct test drilling and surveying activities. Within the terms of most exploration permits, there is the right to renew the permit or progress to an exploitation lease.

While the terms of the permit vary according to each State, the initial grant of a permit is subject to meeting certain criteria, including relinquishing parts of the original permit area. Exploration permits will also generally specify minimum annual expenditure and development levels to ensure that holders continue to invest in the permit area.

See the table at 2.3 for some examples of the various oil and gas licences and leases in the different States and Territories.

Production stage

The extraction and sale of shale gas requires a production licence from the relevant regulating authority. The term of a production licence varies in each jurisdiction, but is typically at least 21 years. It entitles the licence holder to extract the gas and retain the economic benefit of the gas that has been produced, subject to payment of a royalty to the State. This royalty is generally set at between 10% and 12.5% of the value at the well head, but depends on the State.

Like exploration permits, production licences will generally specify minimum annual expenditure and development levels, as well as setting certain criteria and relinquishments for the initial grant of a licence.

At both the exploration and production stages, secondary licence and approvals may be required, such as development approvals or pipeline licences.

Water resources rights

State and Territory legislation governs access to and use of water. Water rights are administered through legal instruments giving one or more water rights and permissions to its holder, including water instruments, property titles or contracts with a water service infrastructure operator.

Unconventional gas projects typically generate significant amounts of waste water. The management of environmental risks associated with contaminated waste water is therefore usually a condition of a production licence. In addition to such conditions, significant monitoring and inspection regimes apply in each jurisdiction, administered by the relevant government authority.

Flaring

In general, flaring must be in accordance with an environment plan accepted by the applicable State authority and otherwise in accordance with all relevant State laws.

In Queensland, under the Petroleum and Gas (Production and Safety) Act 2004 (QLD), the title holder must not flare gas unless it is not commercially or technically feasible to use the gas commercially under a lease or for an authorised activity for the lease.

Fracking

A significant political issue associated with the unconventional gas industry in Australia is fracking, specifically the use of certain chemicals in the fracking process and associated risks to the environment and groundwater. As a result of community sentiment, most jurisdictions have implemented regulations on the fracking process and the use of certain chemicals.

Western Australia has recently released draft regulations to closely regulate the fracking process associated with shale gas production. Amongst other things, the new regulations provide for detailed water monitoring and well management. In addition, they provide the West Australian Department of Mines and Petroleum with greater enforcement powers.

In Queensland and the Northern Territory, laws are in place that restrict the use of certain chemicals in fracking. In addition, shale gas operators are required to disclose the chemicals used in each project and closely monitor groundwater before, during and after fracking takes place.

In Victoria there is a current moratorium prohibiting all fracking until June 2015.

OTHER GENERAL REGULATORY CONSIDERATIONS

Environmental and planning considerations

Shale gas exploration and production operations are subject to significant laws and regulations governing environmental protection. Violations may result in the issuance of injunctions limiting or prohibiting operations, as well as administrative, civil and even criminal proceedings.

The relevant laws and regulations may:

• restrict the types, quantities and concentrations of various substances that can be released into the air, land and water as a result of drilling, production and processing activities;
• regulate the manner in which certain substances, including waste, are transported;
• suspend, limit or prohibit construction, drilling and other activities in certain lands lying within wilderness, wetlands and other protected areas; and
• require remedial measures to mitigate pollution from historical and on-going operations such as the use of pits and plugging of abandoned wells.

Environmental regulators can require a project operator to prepare and implement a plan to improve the environmental performance of a project, and may also amend the conditions on an existing environmental approval.

At the Federal level, the Environment Protection and Biodiversity Conservation Act 1999 (EPBC Act) establishes a regime for protecting the environment, flora and fauna biodiversity and Australian national heritage.

Under the Act, any person taking an action which could have a significant impact on matters of national environmental or heritage significance must refer the proposed action to the Federal Minister for the Environment for consideration and potential assessment. Project proponents are required to assess their projects to determine whether an action is likely to have a significant impact on matters of national environmental significance. This assessment will be subject to a public referral process, and the results of that process are considered by Minister in deciding whether the project should be assessed under the Act. Whether this requirement would capture a shale gas project would depend on the scale of the project and its proximity to areas of national environmental significance, such as national parks or wetlands.  However during 2013 guidelines have been issued which provide that impacts on water resource can automatically be deemed to fall within the scope of the EPBC Act

Native Title considerations

Native Title is the term used to describe certain rights held by indigenous Australians in respect of traditional land and water. Native Title can only exist in relation to land or waters where the claimant group has and maintains a traditional connection with the land,

There are no Native Title rights to minerals, but Native Title rights may include the right to possess, occupy, use, have access to and enjoy an area. If Native Title rights exist over a proposed production lease they must be taken into account and certain procedures must be complied with. In some cases compensation may be payable.

The Native Title Act 1993 (Cth) and State legislation implement a national scheme governing the validity of land dealings affecting Native Title and establishing a process for Native Title claims. A register of Native Title interests is kept, and searches may be obtained from relevant courts and the National Native Title Tribunal to establish whether a parcel of land is subject to a Native Title claim or interest.

Royalty considerations

As discussed above, royalties are payable on shale gas in Australia. There are three main types of royalties levied in Australia:

• unit based - under which a fixed monetary rate is applied on a physical rather than financial basis, for example, a set amount of dollars per cubic metre of gas extracted;
• value based (ad valorem) - under which a uniform percentage of the value of the resource is charged as a royalty, for example, 10% of the post-wellhead value of gas recovered by the project; and
• profit based - under which a percentage is applied to the profit realised by the project, for example 10% of profits achieved by a particular project.

Fiscal regime and tax incentives

The Petroleum Resource Rent Tax (PRRT) is a profit-based tax which is levied on petroleum projects. From 1 July 2012, the PRRT was applied to all Australian onshore and offshore oil and gas projects.

Currently, shale gas projects may also be subject to the Carbon Pricing Mechanism (CPM) in Australia, which levies a charge on greenhouse gas emissions, including those resulting from extractive industries such as shale gas. Details of the CPM and current developments concerning its potential repeal are discussed below.

MARKET UPDATE

Recent developments

The Clean Energy Act 2011 (Cth) sets out a carbon pricing scheme which is designed to transition into a flexible price cap and trade emissions trading scheme from 1 July 2015.

Shale gas extraction activities (including flaring) may attract unit surrender liability under the CPM. The CPM requires that eligible emission units be surrendered to the Clean Energy Regulator in respect of emissions of covered greenhouse gases by facilities which exceed 25,000 tonnes of carbon dioxide equivalent in an Australian financial year (1 July to 30 June). The carbon price payable per tonne of carbon dioxide for the 2013/2014 compliance year is AUD$24.15.  

Under the scheme extractive facilities will be liable for:

• fugitive emissions; and
• combustion of fossil fuels used in equipment and on-site vehicles.

Surrender liability for a facility is imposed on the entity which has operational control of the facility, but liability can be shared between joint venture partners or transferred within corporate groups or to reflect O&M or financing arrangements.

In addition there may be indirect costs through increases in electricity (Scope 2 emissions) and fuel costs, as well as a potential pass-through of costs from other suppliers depending on relevant contractual terms.

Following the September 2013 federal election the new Coalition Government has said that it intends to repeal the CPM as soon as possible. This is expected to occur after  1 July 2014 when the new Senate is sworn in, as opposition parties are using their current Senate majority to block the passing of repeal legislation. The Government has said that it intends to replace the CPM with its Direct Action policy under which the Government will purchase emission reductions from the market. This policy is not expected to include legal obligations to surrender units.

Key shale reserves

The image below shows the location of Australia's shale gas reserves as well as existing infrastructure that may be utilised to transport shale gas to market.

Companies

The following companies are currently involved in shale gas operations in Australia:

Baker & McKenzie contacts:

John Mollard, Partner, John.Mollard@bakermckenzie.com +61 3 9617 4450

Zoe Rafter, Senior Associate, Zoe.Rafter@bakermckenzie.com +61 2 8922 5485

Jeremy Thomas, Senior Associate, Jeremy.Thomas@bakermckenzie.com +61 2 8922 5426

Matthias Thompson, Associate, Matthias.Thompson@bakermckenzie.com +61 2 8922 5552