Natural Gas: New Environmental Rules Could Cloud Prospects

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Regulation of hydraulic fracturing has been assigned to the states since the definition of "underground injection control" (UIC) in the Safe Drinking Water Act of 1974 was revised under the Energy Policy Act of 2005 to exclude hydraulic fracturing. A congressional bill introduced on June 9, 2009, seeks to eliminate the exclusion under the SDWA. That would require fracturing companies to disclose the chemical content of fracturing fluids, which now are kept secret to protect proprietary formulas.

If hydraulic fracturing does end up being subject to tougher regulations, any additional costs related to compliance won't necessarily be onerous for producers, says Handler at Credit Suisse. If regulation is limited to procedures around well sites, the impact may be relatively small, while moving up toward full UIC compliance would add potential expense, he wrote in an e-mail to Bloomberg BusinessWeek. The larger integrated companies like ExxonMobil that are looking to acquire unconventional gas resources are generally thought to have more comprehensive safety procedures in place anyway, compared with smaller companies, he says. The cost of restricting the chemicals that can be used, measured either in cost per well or possibly lower gas production, is harder to quantify, he added.

Socially Responsible Perspective

Socially responsible investors, who try to minimize, if not eliminate, their exposure to companies and sectors with questionable environmental, labor, or corporate governance practices, also are keeping careful watch on developments in the natural gas industry.

Reynders, McVeigh Capital Management, though positive about natural gas moving into the energy spotlight, hasn't been keen to invest in companies that use fracturing because of concerns about waste products generated by the technology and sensitivity about water issues, says Chat Reynders, a principal at the Boston-based firm.

That's why he prefers EnCana (ECA) over XTO and was thrilled when the Canadian producer spun off its oil sands production unit Cenovus Energy (CVE), which was getting too aggressive in energy-intensive oil sands for his taste, at the end of November. "We liked that EnCana became more of a pure-play natural gas producer" and used the proceeds from selling the firm's Cenovus holdings to increase its exposure to EnCana and invest in Calgon Carbon (CCC), a water purification company.

"We didn't invest in XTO because of how 'frac-ing' intensive it was," he says. "[EnCana has] enormous reserves not based on frac-ing. For us, that's the kind of natural gas company we want to invest in."

Reynders sees the Exxon-XTO deal as the beginning of a trend in which more major integrated energy producers will acquire independent E&P companies in order to exploit their valuable shale deposits.

Technological Promise

He expects responsible natural gas producers over time to increase their monitoring and use of technologies designed to protect the environment surrounding drilling sites, including water treatment processes. But he sees smaller, independent producers, which often are more vested in the local communities where they operate, as more likely to do so than the larger integrated players whose focus as they acquire these resources will be on exploiting them.

But gas consultants Stevens and Fagerstone believe the major producers are more sensitive to damage to their public images and brand names if an environmental glitch occurs. The majors also can better afford to spend more money on such technologies, says Stevens.

Just as advances in technology have enabled natural gas production to jump to more than 8 billion cu. ft. per day, from 2 billion, in the past five years, further technological breakthroughs may yet reduce the chances of environmental damage from drilling.

Instead of trucking wastewater away to disposal wells buried thousands of feet underground, some unconventional gas producers are starting to use water treatment procedures such as reverse osmosis and electrodialysis to remove contaminants from the one-third of the water that typically returns to the wellhead after drilling. Treated water can either be reused in fracturing other wells or even for non-industrial consumption, says Stevens.

EOG Resources (EOG) is currently filtering water that returns to the surface in its Marcellus Shale wells and has been able to reuse virtually all of the water for industrial purposes, according to a company spokeswoman.

"None of these [methods] are going to stop development," says Stevens. "[Natural gas] is still going to be a very attractive investment" for its low costs and proximity to end-use markets.

Bogoslaw is a reporter for BusinessWeek's Investing channel.

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