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Regulation of Oil and Gas

Regulation of Gas and Oil Industry

The gas and oil industry are regulated by the government due to the inherent danger in the process of exploration and distribution of oil and gas.  Moreover, state regulation of natural gas sales to consumers serves the health and safety interests of the general public by ensuring dependable supply and extended credit.  Various jurisdictions have enacted statutes to avert fires and explosions, prevent fraud and deception in the distribution and supply of oil and gas, and to conserve gas and oil resources.

The constitution of a state empower the state to regulate production of oil and gas so as to prevent waste and to secure the equitable apportionment among landholders of the migratory gas and oil underlying their land, fairly distributing among them the costs of production and of the apportionment.  As such, the state can regulate the space between wells or limit the area of each well as provide provisions for pooling of operations by the various owners in an oil field[i].
Even in a jurisdiction in which the ownership-in-place doctrine is accepted, the state has the power to protect the vested rights of all the collective owners by securing a just distribution of oil and gas.  Courts have held that in the case of oil and gas, the surface proprietors within a particular field have the co-equal right to take from the common source of supply[ii].

The regulation of the gas and oil industry forms part of the police power of the states[iii].  Production of oil and gas is considered a mining operation, which cannot be governed by federal law.  However, courts have taken a different stand in the matter of shipping of oil and gas in interstate or foreign commerce.  For instance, courts have held that Congress carefully divided up the regulatory power over the natural gas industry while enacting  the Natural Gas Act (NGA), 15 U.S.C.S. § 717 et seq., and did not envisage federal regulation of the entire natural-gas field to the limit of constitutional power[iv].  After gas and oil are extracted from the earth, they assume the character of commodities and become subject to sale and exchange and a state may regulate the transportation of gas and oil.  However, the transportation of gas or oil from one state to another for sale or consumption therein is interstate commerce and Congress has control over such transportation.  Even if the purpose of mining is interstate commerce, the state retains control over production.  The fact that a producer’s natural gas is to be sold in interstate commerce will not preclude the exercise of the state’s power to prorate production for the purpose of preventing waste or protecting the correlative rights of owners in the common pool.

A mineral owner’s rights to oil and gas in place under its land is subject to the state’s police power to conserve and develop the state’s natural resources and the owner is prohibited from carrying out the operations in a reckless and negligent manner[v].

Legislation in the interest of the general public is warranted to prevent waste, avoid uncompensated drainage, and assure orderly development and production of natural gas.  The state can formulate regulations to prevent the unfair or inequitable taking of natural gas from a common source of supply.  This concept of equitable recovery of a common pool is known as correlative rights, which means that each owner or producer in a common source of supply is privileged to use the source only in a manner that will not injure the reservoir to the detriment of others, take an undue proportion of the obtainable oil or gas, or cause undue drainage between developed leases[vi].

A state has the power to enforce correlative rights and prevent waste by proration.  Proration is the restriction of the production of oil by allocating the current market demand among the pools of the state and between the wells of each pool in proportion to their potential production in order to secure to each producer his/her fair share of the oil produced from a common reservoir.  It is to be noted that the state’s powers in this respect generally are not affected by the fact that the production is sold in interstate commerce[vii].  Statutes may authorize penalties, fines, and confiscation as punishment for the violation of gas and oil proration legislation.  A state agency may also require the owner that production in excess of allowables must be compensated for by under-production[viii].

The state has the power of licensing of sellers and price-fixing.  Further, a state may prohibit the sale of dangerous oil or the sale of any petroleum products found upon inspection to be objectionable.

According to 42 U.S.C.A. § 6212(a), the President has the power to restrict exports of coal, petroleum products, natural gas, or petrochemical feed stocks.

The government has the power to formulate regulations regarding storage, location of wells, use of reservoir energy, etc.  The government may also provide incentives for recycling and use of used oil.

Preemption of State Law

Federal authorities have exclusive jurisdiction over the sale and transportation of natural gas in interstate commerce for resale.  At the same time, the power to regulate the production or gathering of natural gas, which involves the physical acts of drawing gas from the earth and preparing it for the first stages of distribution is expressly reserved to the states[ix].  It is a longstanding rule that “absent preemptive federal legislation or regulation, states may govern the production of natural resources from a common pool, in order to curb waste and protect the correlative rights of owners, by prorating production among the various wells operating in a field[x].”

Further, Congress has the power to preempt state law under the Supremacy Clause of Article VI of the U.S. Constitution. In determining whether state natural gas regulations were preempted, courts have identified three “factors” which include “(1) whether the regulation comes within the limits of the comprehensive federal regulatory scheme; (2) whether the state regulation conflicts with the federal interest, expressed by both Acts, in protecting gas consumers by ensuring low gas prices; and (3) whether the regulation is directed at purchasers”[xi].  Moreover, states are prohibited from directly regulating the sale, transportation, and delivery of gas in wholesale quantities moving in interstate commerce[xii].

Municipal by-laws and ordinances undertaking to regulate lawful business enterprises like the oil and gas industry are subject to scrutiny by courts to determine whether the regulation is a lawful exercise of the police power.  Thus, the government has no authority to interfere arbitrarily in such business or to seize without just compensation any property lawfully used in the business.  Courts have also held that the storage of gasoline, oil, and other petroleum products is not a nuisance per se, and the use of real estate for such purposes cannot be enjoined unless the use violates some state regulation[xiii].

Where a state agency, that is charged with regulation of the gas and oil industry and is authorized to perform both legislative and judicial functions, seeks to apply a rule or to determine a question of fact, the agency has to act under the set out rules of procedure.  Such an agency has to make a decision only after complying with the notice and hearing requirements as well as upon competent and relevant evidence[xiv].

Judicial Review of State Agency Action

Courts generally will not disturb the agency’s rules or orders unless they are clearly illegal, unreasonable, or arbitrary. Judicial review of administrative agency action is based on an abuse of discretion standard and the court may grant injunctive relief if the agency has acted capriciously or unlawfully[xv].  Under the primary jurisdiction doctrine, an administrative tribunal has primacy over the courts[xvi].  According to the doctrine, “courts cannot or will not determine a controversy involving a question which is within the jurisdiction of an administrative tribunal prior to the decision of that question by the administrative tribunal, where the question demands the exercise of sound administrative discretion requiring the special knowledge, experience and services of the administrative tribunal to determine technical and intricate matters of fact . . . ”[xvii].

[i] Hunter v. Justice’s Court of Centinela Township, 36 Cal. 2d 315, 317-318 (Cal. 1950).

[ii] Railroad Com. of Texas v. Manziel, 361 S.W.2d 560, 572 (Tex. 1962).

[iii] Trail Enterprises, Inc. v. City of Houston, 957 S.W.2d 625 (Tex. App. Houston 14th Dist. 1997).

[iv] Northwest Cent. Pipeline Corp. v. State Corp. Comm’n, 489 U.S. 493, 508 (U.S. 1989).

[v] Seagull Energy E&P, Inc. v. R.R. Comm’n, 226 S.W.3d 383 (Tex. 2007).

[vi] Mobil Exploration & Producing U.S. v. State Corp. Comm’n, 258 Kan. 796 (Kan. 1995).

[vii] Northwest Cent. Pipeline Corp., 489 U.S. 493.

[viii] Railroad Com. of Texas v. Sample, 405 S.W.2d 338 (Tex. 1966).

[ix] 15 U.S.C.S. § 717(b).

[x] Northwest Cent. Pipeline Corp., 489 U.S. 493, 510.

[xi] Railroad Comm’n v. Lone Star Gas Co., 844 S.W.2d 679 (Tex. 1992).

[xii] Id.

[xiii] Eskridge v. Sandusky, 136 N.E.2d 465 (Ohio C.P. 1955).

[xiv] Uhden v. New Mexico Oil Conservation Comm’n, 112 N.M. 528 (N.M. 1991).

[xv] Castle Valley Special Service Dist. v. Utah Bd. of Oil, Gas and Min., 938 P.2d 248 (Utah 1996).

[xvi] Railroad Comm’n v. Arco Oil & Gas Co., 876 S.W.2d 473, 478 (Tex. App. Austin 1994).

[xvii] Id.

Inside Regulation of Oil and Gas