1

The 84th Legislative Session At A Glance

The 84th Regular Legislative Session At A Glance

2

Texas Oil & Gas Association Champions Industry Priorities The 84th Regular Legislative Session At A Glance

The 84th Legislature was destined to be marked by the budget and the debate over how much tax relief the legislature would provide Texans. The debate centered on how much, not if, lawmakers would cut taxes thanks to Texas oil and natural gas. The Texas coffers were in fine condition because in 2014 the Texas oil and natural gas industry paid a record $15.7 billion in state and local taxes and royalties, the highest such collection from the oil and gas industry in Texas history. One thing was clear this legislative session: safe and responsible oil and natural gas production is unmistakably helping the state meet the needs of Texans.

Even with this rosier budget environment, the State’s oil and natural gas industry faced serious challenges and legislative threats that would have harmed the industry’s ability to anchor the Texas economy. The Texas Oil & Gas Association (TXOGA) monitored approximately 1,206 of the 6,300 bills filed and successfully fended off scores of harmful bills that ranged from redundant regulation of hydraulic fracturing to ill-conceived proposals regarding water well permitting and various proposals on tax issues.

The work on this legislation began well before the Legislature convened. In the fall of 2014, TXOGA surveyed its members to identify the most important legislative items for the 84th Regular Legislative Session.

Below is a snapshot of significant legislation pertaining to each of the identified priorities.

Local Regulation Taxes/ Budget Environmental/ Economic HB 40, HB 2595, HB 2991, HB SB 1, HB 32, HB 1, HB 7, HB Development 2993 2826 SB 709, HB 1794

Transportation Water Exploration & Production SJR 5, HB 4025 HB 30, HB 200,HB 655, HB HB 1392, HB 1481, HB 1552, HB 2207, 3324, HB 3413 HB 2521, HB 3291

Pipelines Seismicity* Electricity SB 474, SB 1812, HB 2256 HB 2 HB 1535 *Seismicity was not an original priority but was added as a priority mid-session.

Several key victories included in this list are the tax legislation, SB 1, HB 32, HB 1, and HB 7, local regulation legislation HB 40, and many others. Three key bills, HB 2826, HB 4025 and HB 3291, were vetoed by Governor Abbott.

In addition to providing unrivaled advocacy for its members on these issues in the Texas Capitol, TXOGA began a new phase of grassroots engagement that helped shape the debate at the Capitol and in communities across the state. Along with continued collaboration with the Joint Association Education Initiative to engage local decision makers in the process at the Capitol, TXOGA began an online education and activation campaign that encouraged everyday citizens to get involved.

Despite multi-front challenges, TXOGA made tremendous headway in educating new and returning lawmakers about the good work of the oil and natural gas industry, its continued economic impact on the state, and the opportunities and revenues oil and natural gas operations deliver to communities statewide. 3

Local Regulation Local regulation issues were a top priority for TXOGA and its members this session. To address local regulation issues across the state, TXOGA provided crucial leadership to help pass legislation to clarify the role of cities and the state in the regulation of oil and natural gas production. TXOGA, member companies, and other trade associations worked together to explain the issue and make the case for more certainty and consistency in local regulations of oil and natural gas production.

Lawmakers passed HB 40, which preserved local authority to reasonably regulate surface activity related to oil and natural gas operations and confirmed the state’s role in regulating oil and natural gas production. This legislation removes a statewide patchwork of fracking bans, establishes a rational local regulatory framework, and provides certainty and consistency to encourage safe energy production.

 HB 40 by Representative Drew Darby and Senator Troy Fraser, Local Control HB 40 provides that oil and natural gas operations are subject to the exclusive jurisdiction of the state. It explicitly preempts the authority of municipalities and other political subdivisions from regulating an oil and natural gas operation. However, it provides an exception which allows municipalities (but not any other political subdivision) to enact, amend, or enforce an ordinance or other measure that: (1) regulates only aboveground activity related to an oil and natural gas operation that occurs at or above the surface of the ground, including a regulation governing fire and emergency response, traffic, lights, or noise, or imposing notice or reasonable setback requirements; (2) is commercially reasonable; (3) does not effectively prohibit an oil and natural gas operation; and (4) is not otherwise preempted by state or federal law.

In addition, lawmakers missed an opportunity to further protect the rights of private property owners by failing to pass HB 2595 by Representative Jim Keffer. TXOGA worked with landowner groups on this legislation which preserves the use of referendum and initiative to decide non-land use and wet/dry issues thus removing the usage of a referendum to limit the rights of property owners. Lawmakers also failed to pass HB 2991 and HB 2993 by Representative Chris Paddie, both of which related to a municipality’s ability to regulate the location of and setback requirements for mineral exploration and development activities. Although we are disappointed this package of bills did not become law, HB 40 provided the necessary relief for the industry.

Taxes/ Budget Thanks in large part to the oil and natural gas industry, the legislature had sufficient revenue to consider expansive tax relief. The debate was not over if lawmakers would cut taxes, it focused instead on how much and in what manner tax relief would materialize. TXOGA worked tirelessly to ensure that the tax burden was not shifted to those that currently pay the largest share – businesses. Instead, TXOGA championed tax relief that would benefit all and included a broad-based reduction in the business franchise tax.

Lawmakers passed HB 32 and SB 1, which deliver broad tax relief for businesses and homeowners. Two of the provisions that business taxpayers found most problematic – the automatic annual escalator in the homestead exemption and the removal of half of the companies subject to the franchise tax via a small business exemption – were removed, a significant improvement over where the tax package started. HB 7 and HB 1 were also passed, which addressed funding for the Texas Railroad Commission.

4

 HB 32 by Representative Dennis Bonnen and Senator Jane Nelson, Franchise Tax HB 32 permanently cuts the basic rates of the franchise tax by 25%. The rate for retail/wholesale is reduced to 0.375%, and the rate for other industries is reduced to 0.75%. It also permanently cuts the E- Z tax rate by 42% to 0.331% of Texas receipts, and expands eligibility for the E-Z rate to companies with revenues of not more than $20 million, up from the current $10 million. It does not change the current $1 million small business exemption.

The bill also requires the Comptroller to conduct a comprehensive study by September 30th, 2016, to identify the effects of economic growth on future state revenues. The report should identify revenue growth allocation options to promote efficiency and sustainability in meeting the revenue needs of this state, including revenues allocated to the property tax relief fund, upon repeal of the franchise tax. The estimated fiscal impact for the 2016-17 biennium is a reduction in revenue of $2.56 billion.

 SB 1 by Senator Jane Nelson and Representative Dennis Bonnen, Homestead Exemption SB 1 is contingent upon voter approval of SJR 1. It raises the school tax homestead exemption to $25,000 from the current $15,000 and lowers proportionately the tax freeze for over-65 homeowners. It also prohibits a school district, municipality, or county that had provided a local-option homestead exemption in 2014 from reducing or repealing it through 2019. The estimated fiscal impact is $1.24 billion for 2016-17. It will be labeled Proposition 1 in the November election.

 HB 7 by Representative Drew Darby and Senator Jane Nelson, RRC Funding HB 7 directs $13.4 million a biennium to the Oil & Gas Regulation and Cleanup Fund, which is the primary funding source for the Texas Railroad Commission to administer the Natural Resources Code and conduct well plugging operations.

 HB 1 by Representative John Otto and Senator Jane Nelson, RRC Funding HB 1 appropriates approximately $87 million in fiscal years 2016 and 2017 and 820 FTEs for the biennium to the Texas Railroad Commission. The funding includes the following exceptional items, with a focus on additional staff inspectors and IT program upgrades: (1) Provides $2.8 million in addition to the base budget; (2) Authorizes 20 additional FTEs and $2.2M to enhance safety inspections; (3) Includes $150,000 to replace microfiche readers for the Commission’s Central Record Department.

 HB 2826 by Representative Jim Murphy, Chapter 313. VETOED. HB 2826 addresses Chapter 313 projects that span the boundaries of up to three contiguous school districts. It also requires that the Comptroller verify a random sample of at least a third of the data submitted by Chapter 313 projects used in the Comptroller’s report to the Legislature and verify the data using information from the Workforce Commission, CADs or other reliable sources. Personal identifying information is not subject to disclosure.

Environmental/ Economic Development TXOGA continued its work to make Texas more competitive by bringing certainty over the regulatory and permitting process. We supported many different bills across multiple issue areas that would create efficiency and help Texas to continue to attract and retain more business investment. Examples of this type of legislation include:

5

 SB 709 by Senator Troy Fraser, Contested Case Hearing Reform SB 709 shifts the burden of producing evidence from the applicant to protesting parties in contested case hearings (CCH) regarding applications with the Texas Commission on Environmental Quality (TCEQ) for air quality; water quality; municipal, industrial and hazardous waste; and underground injection control permits. It also limits the issues that may be referred to the State Office of Administrative Hearings (SOAH) to the factual disputes actually raised by the "affected person." SB 709 limits the time for a CCH to no longer than 180 days from the date of the preliminary hearing and requires TCEQ to provide notice of its rules related to administrative hearings to be posted on the internet. It also requires TCEQ to provide notice to the State Senator and State Representative of the area when a facility within that member's jurisdiction is issued a draft permit.

 HB 1794 by Representative Charlie Geren and Senator Kelly Hancock, Good Faith Remediation Until the passage of this bill, the law allowed local governments to bring lawsuits for penalties and injunctive relief for alleged violations of state environmental laws and to share equally in any awards even after remediation of the subject property. This bill provides that, in these lawsuits, the first $4.3 million of an amount recovered shall be divided equally between the state and the local government that brought the lawsuit and that any amount in excess of $4.3 million will be awarded to the state.

It also requires such a suit to be brought no later than the fifth anniversary or earlier of the date the person who committed the violation: (1) notifies the Texas Commission on Environmental Quality in writing of the violation; or (2) receives a notice of enforcement from TCEQ with respect to the alleged violation.

The bill applies prospectively.

Transportation TXOGA has been actively involved in transportation issues that relate to oil and natural gas production and strongly supports the funding of the State Highway Fund (SHF). Transportation infrastructure is vital to the success of our state and industry.

 SJR 5 by Senator Robert Nichols and Representative Joe Pickett, Transportation Funding SJR 5 proposes a constitutional amendment dedicating certain revenue derived from the tax imposed on the sale of motor vehicles to the State Transportation Fund (STF). It proposes a constitutional amendment to require that beginning in fiscal 2018, $2.5 billion annually be transferred from sales tax collections to the SHF that would otherwise be to general revenue (GR) during a fiscal year in which sales tax revenue exceeds $28 billion. It will be labeled as Proposition 7 in the November election.

In addition to the sales tax transfer, beginning in fiscal 2020, the Comptroller shall transfer 35% of motor vehicle sales tax collected in excess of $5 billion annually to the SHF. These two transfers may be reduced by as much as 50% by adoption of a resolution approved by a record vote of two-thirds of the members of each chamber of the Legislature. No revenue impacts from the bill are expected in 2016-17.

6

 HB 4025 by Representative Jim Keffer and Senator Carlos Uresti, Transportation Reinvestment Zones. VETOED. HB 4025 amends current law relating to funding to counties for transportation infrastructure projects located in areas of the state affected by increased oil and natural gas production, including money from county energy transportation reinvestment zones. The bill requires that weight tolerance permits must be related to oil and natural gas activities when being used to factor grant rewards. Requires that horizontal wells be weighted much higher than vertical wells. This is due to the fact that horizontal wells can require more than five times the number of trucks in the drilling process. It requires that the volume criteria gauge the number of oil and natural gas sites. It also allows the Texas Department of Transportation to spend more on the administration of the program, widen the area in which projects may be completed to encompass the county, and restricts the amount that counties may spend on administration to $100,000.

Water TXOGA tracked many water bills this session, including several that intended to clarify regulation and the permitting process to ensure that Texas water remains the protected resource it is. Early in the 84th Session, it seemed that it would be another big water session with the continued drought and key legislators focused on the issue. More than 150 bills were filed and many long hearings were held on contentious groundwater and surface water legislation. While very few of the controversial issues were resolved, ultimately 43 water bills passed including several related to the mapping, development and regulation of brackish groundwater. This was one of the most contemplated water issues of the session and one that was quite important to the oil and natural gas industry that has made substantial investments in the utilization of brackish water.

While groundwater was the key water focus of the Session, a number of surface water bills were quite contentious with TXOGA actively opposing several bills that could have impacted water supply for some downstream operations. HB 3324 by Representative Lyle Larson proposed revising the standards for securing an interbasin transfer and HB 3413 by Representative James Frank provided a general permit to convey water using bed and banks of a natural stream. Both bills failed to pass.

 HB 30 by Representative Lyle Larson, Brackish Groundwater Bill HB 30 was the primary bill relating to brackish groundwater and TXOGA worked successfully with Representative Larson to ensure that no regulatory barriers were created to hamper the industry’s usage of brackish water or our ability to continue developing oil and natural gas. As passed, HB 30 coupled with $2 million in appropriations will expedite the mapping of highly productive brackish aquifer formations by the Texas Water Development Board and provide a scientific basis for future deliberations regarding the management of brackish groundwater.

 HB 655 by Representative Lyle Larson, Aquifer Storage Another key groundwater bill authored by Representative Lyle Larson was HB 655 encouraging the development of aquifer storage and recovery projects providing for more effective and efficient storage of water in the future.

 HB 200 by Representative Jim Keffer and Senator Charles Perry, Groundwater Future Conditions TXOGA also supported HB 200 by Representative Keffer, an important groundwater bill regulating the desired future conditions process. Desired future conditions are set by groundwater conservation 7

districts within a groundwater management area every five years and the basis for determining production rates. HB 200 creates a meaningful appeals process for challenging desired future conditions.

Exploration & Production TXOGA fought to create more opportunity for economic growth in the oil and natural gas industry under E&P related bills. Lawmakers missed several opportunities to increase oil and natural gas production in Texas. One example of a missed opportunity was HB 1392 by Representative Cecil Bell, which would have allowed the recovery of stranded oil or natural gas from depleting Cenozoic Era reservoirs. Lawmakers missed another important opportunity by failing to pass HB 1552 by Representative Tom Craddick. This legislation would have allowed a producer to operate a well that traverses multiple tracts in order to prevent waste, to promote conservation, and to protect correlative rights. While this legislation failed to pass this session, lawmakers were made aware of how important this issue is to continued production and they vowed to continue dialog throughout the interim. Despite these missed opportunities, several important bills did pass that protect the industry and improve foreclosure procedures.

 HB 1481 by Representative Jim Murphy, Drones HB 1481 prohibits the operation of an unmanned aircraft over a critical infrastructure facility and provides that a person commits a misdemeanor offense if the person intentionally or knowingly: (1) operates an unmanned aircraft over a critical infrastructure facility and the unmanned aircraft is not higher than 400 feet above ground level; (2) allows an unmanned aircraft to make contact with a critical infrastructure facility, including any person or object on the premises of or within the facility; or (3) allows an unmanned aircraft to come within a distance of a critical infrastructure facility that is close enough to interfere with the operations of or cause a disturbance to the facility.

 HB 2207 by Representative Jim Keffer, Foreclosure HB 2207 provides that an oil or natural gas lease covering real property subject to a security instrument that has been foreclosed remains in effect after the foreclosure sale if the oil or natural gas lease has not terminated or expired on its own terms and was executed and recorded in the real property records of the county before the foreclosure sale.

An interest of the mortgagor, including a right to receive royalties or other payments, passes to the purchaser of the foreclosed property to the extent that the security instrument under which the real property was foreclosed had priority over the interest in the oil or gas lease of the mortgagor or the mortgagor's assigns.

However, it provides that if real property that includes the mineral interest in hydrocarbons together with the surface overlying such mineral interest is subject to both an oil or natural gas lease and a security instrument and the security interest is foreclosed, the foreclosure sale terminates and extinguishes any right granted under the oil or gas lease for the lessee to use the surface of the real property to the extent that the security instrument under which the real property was foreclosed had priority over the rights of the lessee under the oil or natural gas lease. It also provides that an agreement, including a subordination agreement, between a lessee of an oil or natural gas lease and a mortgagee of real property or the lessee of an oil or natural gas lease and the purchaser of foreclosed real property controls over any conflicting provision of this section. It prohibits an agreement between a mortgagor and mortgagee from modifying the application of this section unless 8

the affected lessee agrees to the modification. Finally, the bill states these provisions do not apply to a security instrument that does not attach to a mineral interests in hydrocarbons in the mortgaged real property.

 HB 2521 by Representative Garnet Coleman and Senator Carlos Uresti, Oil and Gas Revenue for County Road Maintenance HB 2521 requires that any payment received from the leasing of oil and natural gas under lands owned by the state that were or may be acquired by a county to construct a county road shall be deposited to the credit of the county road oil and gas fund as created by this Act. It also provides that a lease of oil and gas under land that is entered into on or after September 1, 2017, must require any payment under the lease to be made directly to the county in which the land is located, as determined by the commissioner and described in the lease, for deposit to the credit of the county road and bridge fund of the county.

HB 2521 does not create a cause of action for a county to pursue remedies under a lease described above and a county is not considered to be a party to such a lease for the purpose of asserting a right granted by the lease.

 HB 3291 by Representative Richard Raymond and Senator Judith Zaffirini, Oilfield Theft. VETOED. HB 3291 provides that a person who is not a pipeline operator or gatherer authorized to operate by the Railroad Commission of Texas (RRC) commits a second degree felony offense if the person recklessly possesses, transports, removes, delivers, accepts, purchases, sells, or physically moves oil, natural gas, or condensate as a part of a transaction for which the RRC requires a permit or railroad commission approval or authorization unless the RRC has: (1) issued a permit, approval, or authorization for the transaction; or (2) received a request for a permit, approval, or authorization for the transaction and the request is pending before the railroad commission.

Pipelines TXOGA has long been a pro-midstream advocate at the Legislature, representing a vast majority of the State’s pipeline mileage and natural gas processing capacity. The 2015 session brought opportunities for the industry to promote continued regulatory certainty and legal stability for pipeline-related issues. An issue this session that did not prevail was SB 474 by Senator Lois Kolkhorst, a measure that would have increased costs and delayed in-service completion dates. In addition, lawmakers failed to pass HB 2256 by Representative Keffer, which aimed to transfer ratemaking functions from the RRC to the State Office of Administrative Hearings, a move previously approved but due to increased cost to the ratepayer and inefficiencies at the State Office of Administrative Hearings, the Legislature changed it back.

 SB 1812 by Senator Lois Kolkhorst and Representative Charlie Geren, Reporting of Eminent Domain SB 1812 amends the Government Code to require the Comptroller of Public Accounts (Comptroller), not later than September 1, 2016, to create and make accessible on a website maintained by the Comptroller a database with information regarding public and private entities, including common carriers, authorized by the state by a general or special law to exercise the power of eminent domain.

It requires a public or private entity, including common carriers, authorized by the state by a general or special law to exercise the power of eminent domain, not later than February 1 of each year, to submit to the comptroller a report containing certain records and other information specified by the bill's 9

provisions for the purpose of providing the Comptroller with information to maintain the eminent domain database. It requires the entity to submit the report in a form and in the manner prescribed by the Comptroller.

It requires the Comptroller to provide written notice to an entity that does not timely submit a report as required and requires an entity that is provided such notice to report the required information not later than the 30th day after the date the notice is provided. The penalty for not complying by the 30th day- delinquent notice is a civil penalty of $1,000. The bill authorizes the Comptroller to adopt rules and establish policies and procedures to implement the bill's provisions.

Electricity TXOGA fought for legislation that would encourage economic growth by creating reliable and sustainable policies that benefit those that do business in Texas. We worked to reach a compromise on legislation related to the rates of and certificates of convenience and necessity for certain non-ERCOT electric utilities. As originally filed, the legislation posed the threat of uncertainty and increased electricity costs on the oil and natural gas industry.

 HB 1535 by Representative John Frullo, Non-ERCOT Negotiations yielded significant improvements to this bill, including: eliminating unfavorable provisions for a generation rider and twice-per-year transmission cost updates for non-ERCOT utilities, limiting the scope of the period for which a rate increase may “relate back,” making any relation-back of a rate change apply equally to rate decreases, and adding a periodic rate case requirement and ensuring rate reviews if the utility is over-earning. The compromise bill permits non-ERCOT utilities to update test year costs up to 30 days prior to the beginning of a rate case, but includes language requiring those adjustments to reflect both cost increases and decreases. It also allows rate increases to “relate back” to the 155th day of a rate case (a 30-day relate back period), but with language clarifying that this would apply equally to rate decreases. It further requires utilities to file a rate case if they are over-earning for two consecutive years or within 48 months of the final order of their last rate case. The bill also sets permissive 180-day and 365-day deadlines for generation and transmission CCN cases, respectively. These provisions expire on September 1, 2023 (the same as the current date for PUC sunset).

Seismicity Seismicity became a legislative issue as more seismic activity was reported in North Texas and Southern Methodist University researchers released a study on the topic. TXOGA takes seriously the issue of seismicity and supports science-based regulations related to seismicity issues. In October 2014, TXOGA and our members applauded the Texas Railroad Commission for proactively adopting new rules related to induced seismicity and disposal wells. These rules require applicants for new disposal wells to provide historical seismic data and clarify the Commission’s authority to modify or terminate a disposal well permit if scientific data indicates a disposal well is likely to be or determined to be contributing to seismic activity. This session lawmakers passed HB 2 which included funding for more research on the issues of seismicity in Texas.

 HB 2, Input from Representatives Myra Crownover and Drew Darby Representative Crownover initially requested $2.4 million for UT-Bureau of Economic Geology (UT-BEG) to purchase seismometers (22 both fixed and mobile/deployable) to obtain seismic data as necessary tools for both researchers and regulators. After input from Representative Darby, the item was moved to the supplemental budget (HB 2) so that the money was appropriated immediately and included an 10

extra $1 million per year to accommodate research and reporting requirements. An advisory committee appointed by the Governor will include members of academia, the RRC seismologist, and representatives from the oil and natural gas industry who will assist UT-BEG with access to additional fault information.

Vetoes of Note Governor Abbott completed his first veto period on Saturday, June 20th. In total, 42 bills were vetoed and budget items were line item vetoed. In addition to the three vetoed bills noted above, the following are of particular interest to the oil and gas industry.

HB 1633 Author: Romero, Jr. Sponsor: Uresti Last Action: 06/20/2015 E Vetoed by the Governor Caption: Relating to application and notification requirements for a permit to drill an oil or gas well in or near an easement held by the Texas Department of Transportation.

HB 2282 Author: Guillen Sponsor: Uresti Last Action: 06/20/2015 E Vetoed by the Governor Caption: Relating to the procedures for protests and appeals of certain ad valorem tax determinations.

HB 2647 Author: Ashby | Larson | Paddie | Clardy | Lucio III Sponsor: Estes Last Action: 06/20/2015 E Vetoed by the Governor Caption: Relating to a limitation on the authority to curtail groundwater production from wells used for power generation or mining.

If you have any questions or need any additional information please contact Mari Ruckel at [email protected].