Natural Gas: New Environmental Rules Could Cloud Prospects

Concerns about the impact of methods used to extract gas from shale deposits could lead to tough restrictions—and crimp output for some producers

By David Bogoslaw

After years of talk about improved energy security for the U.S.—and a smaller carbon footprint for U.S. industry—natural gas seized the spotlight on Dec. 14 after ExxonMobil (XOM) announced a deal to acquire XTO Energy (XTO), one of the largest independent natural gas producers. The all-stock deal is worth $31 billion, plus the assumption of $10 billion in debt.

But could environmental concerns about the methods used to extract gas from its hiding place in the depths of shale deposits spoil the party?

There's been concern about a prolonged slump in natural gas prices below $4 per 1,000 cu. ft. (Mcf), due mostly to a supply glut from a production surge in unconventional gas deposits and a drop in demand due to the recession. But prices have briefly edged above the $5 level three times in the past three months, giving hope that demand is improving with the return of economic growth. The spot price of natural gas at Henry Hub, La., peaked above $13 in mid-June 2008 as all energy prices were spiking.

Although natural gas is certainly one of the cleaner fuels, compared with coal or crude oil, there are other concerns when it comes to its environmental impact, both real and alleged. Most of those revolve around the use of water when drilling in unconventional gas reservoirs such as the Marcellus Shale that snakes through the Appalachian Mountains. There have been serious cases of water contamination near drilling sites in seven states, but so far there's no conclusive proof the cause is the fluids used in hydraulic fracturing, the drilling process used to release gas trapped in compressed rock formations such as the Marcellus Shale.

Resistance to Fracturing

While 99% of the fluids' content is water and sand, the remainder is composed of up to 300 assorted chemicals that make drilling easier, either by reducing friction as the drill bit bores into rock or by keeping the spaces in the rock created by small explosions open after drilling. Oilfield service providers such as Halliburton (HAL), Schlumberger (SLB), and BJ Services (BJS), which control most of the $16 billion hydraulic fracturing market, aren't required to disclose the chemical content of the fluids they use. Environmental groups say some of the chemicals used in those fluids could be toxic in large enough concentrations.

Although a link between the fluids and contaminated water supplies has yet to be proved, in New York State there has been a moratorium on new gas drilling permits since July 2008. A coalition of upstate conservation groups, including the local chapter of the Sierra Club, requested the drilling ban at least until a comprehensive environmental impact statement from the state Environmental Conservation Dept. has been completed and reviewed publicly.

Some analysts and industry insiders think the resistance to hydraulic fracturing stems more from a not-in-my-backyard mindset among local residents and politicians than from any hard evidence linking water contamination to drilling fluids. Development of the Marcellus Shale has moved into parts of Pennsylvania and New York State that historically haven't experienced much drilling, says Scott Stevens, president of Upstream Energy Advisors, an oil and gas consulting firm, and a specialist in unconventional oil and gas resources.

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