To put it mildly, Colorado’s oil and natural gas industry has undergone enormous changes over the past few years.
The state — long known as a powerhouse energy producer — has faced daunting political and regulatory challenges along with a flurry of M&A activity that’s brought about sector consolidation. Today’s landscape is very different, reflecting the industry’s focus on adapting and moving forward.
These state-specific challenges have been compounded by the pandemic’s impact on global energy demand. Institutional capital is demanding that upstream companies shift their focus from growth to prioritizing sustainability and free cash flow generation for shareholders. The significant uptick in ESG reporting and related sustainability commitments reflects this emerging investor sentiment.
Energy producers operating across the Centennial State are adapting to meet these new challenges by embracing and pioneering sustainability-focused opportunities. They are investing in technology that manages emissions (especially related to methane) and water usage, partnering with utilities to purchase more renewable energy to power their operations, actively engaging with their most critical stakeholders, including the communities in which they operate, and enhancing their governance and risk mitigation structures.
Colorado’s rigorous regulatory structure, along with the need for extensive outreach to communities near operating locations, has helped energy companies in the state stay ahead of the curve in this new ESG focused investor reality.
Despite Shifting Political Winds, Support for Energy Industry Remains Strong
For years, Colorado was a true political swing state with state and federal offices moving back and forth between Republicans and Democrats.
That purple tint seems to have faded, however, and Colorado is becoming a Democratic stronghold. The state has gone blue in recent presidential cycles; both U.S. Senators are Democrats, the state legislature is under Democratic control, and Gov. Jared Polis cruised to victory in 2018.
In recent years, a wave of ballot measures, laws and regulations around the industry have come forward. Despite this shift, the state, maintaining its strong western, independent profile, continues to support the oil and natural gas industry.
The same year that Polis was elected, a ballot measure sponsored by activists that would have effectively banned production in the vast majority of the state was defeated by a double-digit margin. And after Polis entered office, he did not seek to ban fracking as Gov. Andrew Cuomo has done in New York and Gov. Gavin Newsom seeks to do in California.
Instead, Polis, working with the state legislature’s Democratic leaders, focused on passing SB-181 — a regulatory overhaul of the industry that was signed into law in 2019.
The rulemaking process that came out of the law has involved everything from the creation of a full-time professional regulatory body and new rules governing the “flowline” pipes running underground to increased monitoring of wells, and an end to routine flaring and venting, among a host of other changes.
Most notably, that rulemaking process also created an expanded setback zone, requiring 2,000 feet of distance between natural gas and oil operations and homes, schools and other structures. This new setback will no doubt put certain resources in Colorado out of reach for future exploration, but a 500-foot “off-ramp” presents development opportunities for the industry that will require increased flexibility and greater partnerships with local communities.
Along with SB-181, another major law came out of 2019. SB-1261 prompted the creation of the Greenhouse Gas Pollution Reduction Roadmap that lays out a 30-year plan to drastically reduce the state’s emissions footprint and which involves nearly every sector of the economy, including transportation, agriculture, power utilities, and residential and commercial buildings.
In a compromise reached among liberals in the state legislature and Gov. Polis, additional legislation supporting the Roadmap will require the natural gas and oil industry to reduce its emissions by 60% by 2030, meaning that operators in the state will once again need to update their production processes.
With these pledges on the books, it’s really no surprise that many consider Colorado to have rules that are “seen as some of the strictest in the country.”
Consolidation Among Major Players
These past two years, full of new laws and regulations, along with the COVID-19 pandemic, have prompted another major change in Colorado’s industry: A series of mergers and acquisitions that’s resulted in consolidation, which is a top priority for investors focused on capital efficiencies and scale.
Consolidation has happened among smaller companies as well. In 2019, PDC Energy acquired SRC. This year, Bonanza Creek and High Point completed a merger before Bonanza Creek, then merged with Extraction. That new company, Civitas Resources, then acquired Crestone Peak in early June.
A Smart Turn Towards ESG-Focused Operations
These political and regulatory challenges, combined with the surge in M&A activity, align with growing ESG expectations, particularly the focus on climate change. No longer can companies focus solely on expansion-based structures; rather, to remain competitive and to access capital, they must integrate ESG factors into their overall business strategy.
These ESG practices show that companies are working to provide much-needed energy with a lower carbon footprint and ensuring their operations protect the communities in which they operate. The general investment philosophy is that companies proactively implementing ESG practices can expand their investor base, maximize the efficiency and value of their assets and infrastructure over the long run, lower their emissions profile and costs, advance their permitting, and even create differentiated products and services.
Occidental is a strong example of how the industry can operate between these two mandates. In addition to being one of the world’s largest energy producers, the company is also on the cutting edge of commercializing carbon capture and storage and direct air capture technology, which can pull carbon dioxide directly from the atmosphere and permanently bury it deep underground. Last year, the company partnered with LafargeHolcim and others to study capturing carbon at the Portland cement plant in Florence. Occidental has also endorsed the World Bank’s Zero Routine Flaring program.
Cutting-edge air monitoring projects are also coming to market. Project Canary, a Denver-based start-up, partners with energy companies in Colorado and nationally to provide continuous air monitoring for methane emissions at production sites as well as across the midstream and utility value chain. The technology enables operators to instantly mitigate and repair leaks and reduce emissions.
Project Canary’s proprietary Trustwell certification system tracks a robust set of data points aimed at improving the overall sustainability of their operational performance. Taken together, these technologies and real-time data enable energy producers to sell “Responsibly Sourced Gas” at a premium to end-use customers with emissions reduction targets, such as utilities.
Civitas is a prime example of a producer that is shifting its business model to emphasize its ESG performance. The company announced its intention to be Colorado’s first net-zero natural gas and oil producer as part of a broader effort to align its business model completely with shareholders and other key stakeholders such as the communities where operations are located. A key focus of the company will be deriving maximum value from current acreage, reinvesting at a rate consistent with overall demand for oil and gas, and returning capital to shareholders. Civitas will also support the production of community solar facilities and finance a community fund to address community interests.
These trends are not exclusive to the upstream and midstream sectors. Suncor Energy (U.S.A.) Inc., which operates Colorado’s only oil refinery, recently announced a new air monitoring program that will provide real-time data to the public in a partnership with Montrose Air Quality Services. The new program is part of an effort to respond to feedback from the community to have enhanced transparency around the refinery’s operations.
So Goes Colorado, So Goes the Rest of the Country?
Will recent events in Colorado be replicated in other energy-producing states around the country?
The industry should be prepared for it.
Climate change and ESG continue to dominate boardroom agendas as well as investor conferences, and now, these conversations have made their way to government. Oil and natural gas companies in states like Texas, New Mexico and Pennsylvania are likely to face increased pressure from government leaders and investors about how they run their business and mitigate every aspect of risk.
These companies can no longer count on the old business model that placed maximum energy production as the top priority but must focus more on producing their current assets in the most sustainable way as demand for lower-carbon energy soars.
This doesn’t mean that unprofitable times are ahead.
Despite this new landscape, innovation and a willingness to adapt in Colorado show that the industry can still manage profitable and successful operations in the state while serving as a model for the nation.
In fact, it’s put many of these companies on the cutting edge of producing energy cleaner and more responsibly — a strategy and approach that’s sure to pay increased dividends in the future as the pressure from governments, investors and communities continue to grow.
About the Authors: William Allison and John Glennon advise energy companies as part of the FTI Consulting’s Strategic Communications practice and are based in Denver.