With everyone's attention focused on the Gulf oil spill clean-up efforts, there is another environmental controversy brewing in the energy sector. While hydraulic fracturing and pressure pumping have been hailed for their ability to open up new reservoirs of oil and gas in the United States, there is growing concern about the environmental impact of these activities. Although I do not think these worries are ever going to shut down operations in areas like the Marcellus Shale, energy investors need to keep an eye on this issue.
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What the Frack?
In simple terms, hydraulic fracturing, or "fracking" (also often spelled 'fracing' in the industry), is a process by which drilling companies force fluids down a bore hole and use that pressure to crack the rock. Those cracks are then kept open with additional additives called proppants (sometimes sand, but increasingly purpose-built ceramic particles). Oil and gas that was previously trapped within the pores of that rock can then migrate out through those cracks and up the well.
It is this process (along with other innovations like horizontal drilling) that has opened up many new areas of so-called shale gas to energy companies. Well-known energy-producing areas like the Haynesville Shale in Texas and Louisiana, the Barnett Shale in Texas, the Montney in Canada, and the Marcellus Shale in the East/Northeast U.S. are all examples of major resource-rich production areas that have come into play because of these advanced production techniques. (For more insight on oil recovery, see the Oil And Gas Industry Primer.)
The Fly in the Ointment
Unfortunately, there are no free lunches and fracking is no exception. First you have the obvious issues. The rapid pace of drilling has led to traffic snarls in small communities with trucks from service companies like Halliburton (NYSE:HAL) and Baker Hughes (NYSE:BHI) running all over the place, to say nothing of the noise, dust, and demands on local water supplies that drilling and fracking produce.
There are even worse concerns, though. Largely in response to community-level activism, the EPA is taking a closer look at the environmental impact of fracking. In particular, there are concerns that fracking may lead to groundwater contamination from chemicals like benzene and toluene, whether through leakage of drilling fluids into the rocks and eventually into drinking water aquifers or mobilization of harmful chemicals that already exist in the rock and are "liberated" by the fracking. (For related reading, see New EPA Rules Could Stir The Air.)
That is serious enough in itself. On top of that, though, there are concerns about companies spilling chemicals or storing them onsite in open pits. Moreover, well blowouts can likewise contaminate an area with chemicals and hydrocarbons.
Industry Takes the Heat
Unfortunately, the industry has not helped its own cause lately. The Denver Post recently reported that more than 1,000 spills over the last two and a half years in Colorado have totaled more than five million gallons of drilling fluids and oil, with the largest number of spills attributed to Anadarko (NYSE:APC) and Noble Energy (NYSE:NBL). In the Marcellus, both Cabot Oil and Gas (NYSE:COG) and EOG (NYSE:EOG) have incurred the wrath of Pennsylvania officials for contamination problems.
Big Stakes
One way or another, the energy industry has to find a resolution to this issue. About 90% of active natural gas wells in the U.S. use fracturing fluids, but legislation passed in 2005 puts those fluids outside the rules of the Safe Drinking Water Act. I would say it is fair to assume that that rule is going to be overturned, or at least significantly tweaked.
For companies like EOG, Cabot, Chesapeake (NYSE:CHK), Ultra Petroleum (NYSE:UPL) and ExxonMobil (NYSE:XOM) (in part through its acquisition of XTO Energy), the stakes are enormous. Fracking is essential to getting more gas out of the ground, and gas looks increasingly essential to our energy future. The key, then, is to figure out how to operate more safely and show more respect for the concerns of local residents who worry about their water supply and long-term health. (For related reading, see Go Green With Socially Responsible Investing.)
The Bottom Line
Concerned citizens need to accept that drilling is not going to go away, but they are not going to be ignored or pushed aside either. If these companies are smart, they will move on their own to find safer ways to operate and be more responsive to accidents. For investors, a lot hangs in the balance; they need these companies to continue boosting their production, but as a quick look at BP's share price makes it clear that the cost of a major mistake is more than most companies can bear.
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