Recent moves by the EPA to increase scrutiny of hydraulic fracturing — known as “fracking” — do have potential to change the dynamics of the gas market. Fracking is the key to unlocking gas, gas liquids and oil from shale and involves shooting a mix of water (more than 95 percent), sand and what amounts to detergent at underground rocks to create fissures to unlock the energy.
An outright national ban on the process such as France enacted last year would shut in a third of U.S. gas supply, creating an instant shortage where a massive surplus now exists. That would leave the field to Canadian producers, who would immediately see a sharp rise in the price of their output.
That’s highly unlikely. What’s probable, though, is that states such as New York and Colorado will impose new environmental and safety regulations on companies using hydraulic fracturing. How much they inhibit drilling will depend on how far they go. To the extent these moves increase costs or slow production, Canadian producers will benefit.
Meanwhile, the EPA has announced a comprehensive study of drinking water and fracking, set to be completed in 2014, and will propose rules to force chemical makers to disclose products used in the process. Anything it does now regarding fracking could easily be reversed if Republicans gain control of the White House.
Moreover, President Obama has repeatedly endorsed greater use of natural gas as a way to speed energy independence and as a replacement for much dirtier coal in generating electricity. Both are currently impossible without the widespread use of hydraulic fracturing to produce oil and gas from shale.
Consequently, it’s unclear how far the EPA can or will go with its current scrutiny of fracking. It’s increasingly clear, however, that it will go after certain companies it deems in violation of health and safety regulations. This week, for example, the agency announced it will collect and sample water from wells in a Pennsylvania town near a gas-drilling site that used hydraulic fracturing. That follows the release of an EPA report blaming Encana for chemicals found in groundwater supplies in west-central Wyoming.
The key for Canadian producers is that whatever happens will push up costs for rivals operating in the US. And all else equal that would reduce output and supply, and eventually boost gas prices.
But again, the current environment for gas producers is one of massive supplies and very low prices, while the prices of oil and NGLs are strong. That’s the environment dividend-paying Canadian producers will be operating in for 2012. Though a spike in oil or a fracking ban in the U.S. would be a bullish surprise, these are the assumptions investors should make before investing in energy stocks this year.