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BLM's Fracking Rule Found Costly to Producers, States

Complying with the Bureau of Land Management (BLM) proposed hydraulic fracturing (fracking) rulemaking for drilling on public lands would cost as much as $180,250/well, or $370 million annually, according to economists with Oklahoma City University (OCU).

Devon Energy Corp. commissioned the 24-page report, which was written by OCU's Russell R. Evans and Jacob Dearmon. Evans is executive director of the Steven C. Agee Economic Research and Policy Institute at the university; Dearmon is an economics professor in the Meinders School of Business.

Oklahoma Gov. Mary Fallin sent a copy of the report on Monday to the White House Office of Management and Budget (OMB) to review as it considers the proposed rulemaking.

BLM in early 2012 proposed requiring drillers on public and Native American lands to disclose the chemicals used in fracking operations, including their formulation (see Shale Daily, Feb. 6, 2012). The agency last May then indicated that companies would have to disclose the information after operations have been completed (see Shale Daily, May 7, 2012). The proposed rule has drawn criticism from across the energy industry because of the costs of compliance and because many view it as duplicative of rules already in place at the state level.

What the OCU researchers found is that the higher costs may prompt operators to "reallocate wells from federal lands to nonfederal lands," which in turn would reduce royalty payments and employment in those states with a "larger fraction of BLM lands."

Evans and Dearmon noted that the BLM proposal is to ensure the public has "useful information" and more assurances that fracking would be conducted in a way that "adequately protects the environment."

However, "no attempt is made to monetize the value of the additional information," noted the duo. "More concerning, no attempt is made to estimate the reduction in the probability of an environmental incident from their baseline levels of 2.7% for a minor incident and 0.03% for a major incident nor monetize the benefits to society from such a reduction (if it were achieved).

"The absence of a careful consideration of the benefits generated from implementation of the proposed rule violates the central tenets of welfare economics in regards to natural resource management -- that social improvements occur incrementally, with careful and considered evaluation required of every proposed change to determine its social desirability."

The economists used a custom, multi-stage Monte Carlo process to estimate the average additional costs per well imposed on producers by the rule. Monte Carlo is a computational algorithm that relies on repeated random sampling to obtain numerical results.

"The process flow of the model, as well as the cost distribution parameters, are informed by reported practices and costs of one of the nation's largest independent producers," they wrote, referring to Devon. "We find average additional costs per well for the rule of $129,194. A sensitivity analysis of the baseline case compared to alternative reasonable scenarios finds average additional costs per well as high as $180,250. Given our baseline scenario, this additional per well cost would imply $370 million in total costs from 2012 alone from operations on BLM lands."

Shifting production capital from the BLM-heavy states to other areas "shifts nontax sources of revenue and employment opportunities away," said the economists.

"The shift may be greater than would be expected from the increase in average well costs, as significant uncertainty still remains as to how the rule will be implemented and enforced over time. This uncertainty will be priced into allocation decisions, causing a second layer of capital allocation away from BLM energy states to ensure equalized risk-adjusted rates of returns across competitive investment opportunities."

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