Here’s a reprint of the article in “Listed Magazine” for which I was recently interviewed by Susan Mohammad.
Few technologies have transformed an industry or become an economic game changer the way advancements in the hydraulic fracturing process, or “fracking” has.
In under a decade, fracking has made vast reserves of natural gas and oil previously uneconomical to access viable—turning the calculus of what’s possible for the industry entirely on its head. The impact has been most dramatic south of the border, where the U.S.—which for decades has fretted about being held hostage to OPEC and foreign energy—is projected to become the world’s biggest oil producer around 2020 and to achieve energy self-sufficiency by 2030. An immediate economic upside: more jobs. North Dakota, for example, has the country’s lowest state unemployment rate, due in large part to fracking-aided shale “tight” oil production in its underlying Bakken formation. To the east, future development of the Marcellus Shale Region—which holds a ridiculously huge 410 trillion cubic feet of gas (more than half the country’s total)—could give Pennsylvania a US$42.4 billion boost annually by 2035 (up from $7.1 billion in 2010), according to financial analytics firm IHS Global Insight.
In Canada, the advent of fracking—which involves high-pressure injecting of water and other chemicals deep into rock, breaking it open to permit feasible extraction of embedded gas and oil—has increased estimated potential gas reserves by a factor of three, four or more. In B.C., 7,300 wells have been fracked since 2005. However, it’s not all great news. Instead of pushing up production, the fracking-induced abundance contributed to a glut that sank prices. Demand from the U.S. has also declined, not surprisingly, resulting in a 16% decline in gas exports to the U.S. over the past five years, according to the National Energy Board. Unconventional gas production continues to increase as a percentage of the total, but overall production is pretty flat. Production of tight oil, on the other hand, is surging—but the totals are small. According to a National Energy Board briefing note, between 2006 and 2011, tight oil production grew to more than 170,000 barrels a day from less than 10,000.
But as miraculous as fracking technology is for the industry at large and for the economies of energy-rich regions, today it’s also seen as a risky salvation. Supply gluts and depressed prices are an immediate, bottom-line consequence. But among the broader public and other stakeholders, concerns over potential ground water contamination from methane and/or the myriad chemical ingredients in fracking solutions top the list. Gross water consumption is also a problem. Every single well that’s fracked uses millions of litres of water in the process; a 2011 U.S. Environmental Protection Agency report estimated that between 70 and 140 billion gallons of water are now used annually to fracture wells in that country. Fracking has also been known to cause earthquakes, air and water pollution, and contribute significantly to greenhouse gas emissions.
Even the word fracking itself is divisive. It contains enough power to assemble activists fearing environmental catastrophe, and to spur a wild-west development mentality as jurisdictions scramble to make approvals and get projects running before increased regulations and public opposition makes it more difficult, more expensive or impossible. It’s hard not to think of the scale and reach of similar opposition to the oilsands and the Keystone XL pipeline, and wonder if fracking is next to be tested in the same way?
It’s not that things aren’t already on the boil. Fracking disputes have piled up a lengthy history in the courts. And a number of states and provinces have introduced moratoriums or put restrictions on its use pending further research into all the potential health and environmental consequences. In January, Quebec’s Parti Québecois government was the latest. It said it was banning all fracking pending a review and introduc- tion of new governing legislation (this followed a partial moratorium installed by the previous Liberal government in 2011). At the other end of the spectrum, other states have lifted earlier restrictions and some haven’t and won’t go near them at all.
In terms of future regulation and legislation, both Washington and Ottawa are expected to announce the results of extensive reviews and new guidelines in 2014. No doubt, many companies involved at all stages of the energy production process will be watching and waiting (and trying to lobby) to see what those rules convey. Higher costs, market restrictions, increased exposure to potential liability—any and all of these can have serious consequences for share prices and valuations.
“Access is the biggest hurdle oil and gas companies must face in retrieving shale products,” says Milla Craig, owner of Millani Perspectives, a Montreal-based sustainable development consultancy. “You may have the best resource out there but if you can’t get access to it because the public doesn’t want you there, or because the public has influenced governments and regulators to impose barriers to access it, then that’s a major risk for an investor.”
At the same time, it’s often social media, documentaries and movie reenactments that get the people riled up. In that context, what does it say about fracking’s potential to grow as an issue that it’s spawned at least one celebrated indie doc, “Gasland,” and then just made it to Hollywood in the Matt Damon film, “Promised Land?”
Make no mistake, fracking still isn’t driving a lot of institutional activism. In 2012, in the U.S., 10 shareholder resolutions were put to companies on fracking.“I think it’s a percolating issue,” says Glenn Keeling, director of Phoenix CST Advisors in Toronto, a leading proxy adviser.
For the most part, Keeling says, fracking still fits under a bigger subset of potential exposures and environmental risks. But that doesn’t mean it isn’t noticed. As Craig notes, as soon as analysts went back to the drawing board to look for other ways to identify risk after the 2008 financial crisis, weighing environmental, social and governance (ESG) factors for company valuation purposes and to identify potential investment risk became mainstream. “Two or three years ago Bloomberg started to embrace ESG data by adding it to their terminals,”she says. “They rolled the dice on it and now it’s their biggest growth sector.”
Craig also makes the important point that shareholder activism is a bit like an iceberg. There’s the noisy, public stuff above the surface that you hear about. But down below, or behind the scenes, managers of very substantial “ethical” funds and other large pension fund managers are putting quiet pressure on companies to integrate better ESG practices. There’s no doubt fracking comes up. “They will go directly to management teams. Their goal is ultimately to get the best performance for you and I as pensioners and they don’t need to make those activities public,” says Craig.
When it comes to finding ways forward that work for industry, affected communities and the environment alike, there are nearly as many questions and debates in academic, political and activist circles as there are potential fracking sites (and little consensus in sight). In the U.S. for example, some wonder who should regulate the chemically laden fracking wastewater? Should it be the Environmental Protection Agency or state-run transportation departments since the water is transported both within and across state lines?
In Pennsylvania, the Department of Environmental Protection recently announced a plan for a year-long study of radioactive waste from fracking. In New York State, where activist activity on both sides of the debate is growing, a moratorium on shale gas exploration expires at the end of February. During a recent protest in the city of Albany, legendary folk singer Pete Seeger showed up to lead the crowd in a rendition of “This Land is Your Land.” As the moratorium expiration drew near, environmental groups also hinted at the possibility of launching lawsuits if exploration is approved. Challenges in court could prevent companies from operating for years.
In Quebec, American firm Lone Pine Resources Inc. (TSX:LPR), which is incorporated in Delaware but headquartered in Calgary, filed notice last November that it intended to sue the federal government for more than $250 million over the previous provincial Liberal govern- ment’s moratorium. The company has said the move to halt natural gas exploration permits beneath the St. Lawrence River was illegal under provisions of NAFTA.
“It seems that we’ve either gone from a regulated-but-full-speed-ahead approach or the other end of the spectrum, which is it’s not going to happen at all,” says Matt Horne, director of the climate change program at the Pembina Institute in Calgary.
Horne says the level of alarm and activity against shale exploration varies from region to region, depending on a few factors including differences in geology. For example, where water basins are closer to the surface (as they are in Quebec or Eastern Canada when compared to aquifer depths in B.C.) concerns over contamination risks seem elevated. The presence of a few bad actors and incidents, which there has been in Pennsylvania, also “raises a bunch of alarm bells on the environmental implications,” says Horne.
The industry isn’t standing still. It’s primary association, the Canadian Association of Petroleum Producers (CAPP), publishes best-practice fracking guidelines that it expects all of its members to follow. Pembina’s Horne says it would be better if those guidelines were enforceable.
Horne also says companies should be more transparent about reporting which chemicals they use in fracking fluid (some companies have argued that this information is proprietary) regardless of whether they are operating in a jurisdiction that mandates they do so or not. FracFocus.org and FracFocus.ca are examples of U.S. and Canadian chemical disclosure sites where companies can do just that. In B.C., the British Columbia Oil and Gas Commission has forced companies to disclose the chemicals used in fracking fluid 30 days after the completion of a job. The information is then made public on FracFocus.ca (where over 450 companies are listed as participants.)
Due to environmental risk factors, Horne expects regulations to tighten in many jurisdictions, which will translate into higher operating costs for an industry already worried about a sharp decrease in exports.
Another voice joined the alarmist chorus in early February, when federal Environment Commissioner Scott Vaughan singled out risks from chemicals used in fracking in his last report as auditor of Canadian environmental regulations.Vaughan said he was worried about gaps in the government’s knowledge about all the chemicals used in the process— not only because they might be hazardous and dangerous, but because the government says as long as its information is spotty, “it cannot determine whether risk assessments and control measures are warranted.”