Energy Independence: Fracking’s Downside


Over the last few weeks in InvestorPlace’s series on America’s progress toward energy independence, we’ve tried to identify what it means to finally realize the dream of energy self-sufficiency and analyze the opportunities for investors in this emerging mega-trend. From giving new life to old producing regions like Alaska’s North Slope to potentially exporting our bounty through new LNG facilities, we’ve tried to focus on the numerous positives within this new paradigm.

And there are plenty of positives — like job growth and a boom for America’s manufacturing base. But there are some controversies as well. Much of our new-found energy abundance has been due to the widespread adoption of advanced techniques like horizontal/inclined drilling and hydraulic fracturing.

Opinion is bitterly divided over how to use these advanced methods and how much risk they pose to the environment. Fracking has become a dirty word to many individuals living in the shale basins across the country. Spooked by films like 2010’s GasLand — and its footage of polluted tap water that could be lit on fire — environmentalists have raised concerns about contamination of freshwater aquifers, pollution from truck traffic and increased greenhouse gas emissions stemming from the fracking boom.

While the concerns that fracking causes earthquakes are most likely overblown, at least a few of the other claims have some validity. The International Energy Agency (IEA), which coined the phrase “The Golden Age of Natural Gas,” recently put out a report saying “A tripling of natural-gas production from unconventional sources, such as shale formations, will only happen if environmental concerns are addressed.”

Ultimately, the IEA believes that if companies and regulators aren’t transparent, take the concerns of local communities seriously and monitor the environmental impacts of drilling, the shale boom won’t be successful.

Maybe the IEA is on to something. In our efforts to tap all things shale and the “dash for gas,” perhaps we’ve taken some of the environmental concerns too lightly.

Threatened Aquifers

At its core, fracking is a relatively simple process. First, a well is drilled down and then out horizontally through the hard shale rock. Water, chemicals and “proppants” (such as ceramics or grains of sand) are then pushed through the well at incredible pressures, causing the underlying shale to crack and fracture, releasing the gas trapped inside. The gas flows up the well and to the surface to be captured.

This is where environmentalist and public outcry begins, with the biggest focusing on the threat to freshwater aquifers. While most shale reserves are 6,000 to 10,000 feet deep — well below most water tables — the concern is that various fracking liquids can leach into public drinking water, spurring movements to ban the practice. The cement and steel casings that line wells as they pass through the water table can fail, and in dozens of cases, companies have paid large fines for water contamination that has occurred closer to the surface.

In 2010, the Pennsylvania Department of Environmental Protection ordered Cabot Oil & Gas (NYSE:COG) to shut down its project in Dimock, Pa., after an investigation revealed that storage pits for drilling fluids had leached and contaminated the groundwater. Other reports include the spillage of the fracking fluids or tainted water during transport to or from the drill sites as well as the disposal of improperly treated water into rivers.

Some states, like New York and New Jersey, have voted to ban fracking, and the U.S. Environmental Protection Agency released a 190-page report explaining how it plans to conduct a study on the impact of shale gas on drinking water. That report should be ready by 2014. More recently, a hearing conducted by the House Committee on Oversight and Government Reform debated if the federal government should regulate fracking because scientists claim that air and water pollution from production moves across state lines.

Globally, both France and Bulgaria have banned the practice, and activity is suspended in the U.K. until a series of environmental studies are concluded.

Solutions With Opportunities

Given that the shale gas boom is extremely important to the U.S. economy and the country’s future, it’s not going away any time soon. It’s become too integrated with electricity generation and energy demand both here and abroad. At the same time, the environmental impact also can’t be totally eliminated. But many of the problems can be addressed. The IEA report underscores the idea that “The destiny of the shale-gas industry will be decided not by the best practices but by the worst practices.”

Therein are the investing opportunities. For example, Halliburton (NYSE:HAL) has begun testing new fracking liquids made with ingredients developed by the food industry rather than the chemical industry. Likewise, biofuel firm Verenium (NASDAQ:VRNM) is developing a new enzyme that replaces hydrochloric acid normally used to eat away at the guar gum that the industry uses to pry the rocks open.

Still, at the heart of the debate is water because fracking requires millions of gallons of it, which must then be disposed of safely. Odds are, any future legislation — state or federal — would determine how water used in fracking is cleaned and returned to aquifers. The EPA is currently mulling rules about making “green completion” equipment mandatory. This technology captures methane and volatile organic compounds from the drilling water.

For investors, that could mean betting on water through the PowerShares Water Resources ETF (NYSE:PHO). The fund is the most heavily traded of water-focused ETFs and contains the most assets under management. It follows a basket of companies dedicated to generating clean potable water.

While PHO also provides some exposure to utilities, the bulk of its holdings are industrial firms focused on filtering and purifying water. Add this to the fact that demand worldwide, especially in emerging markets, for clean water is increasing and you have an interesting play on the environmental side of shale drilling.

Overall, shale gas extraction isn’t going away, but neither are some of its potential problems. For investors, the PowerShares Water Resources ETF could be a good way to profit from the needed cleanup.

As of this writing, Aaron Levitt didn’t own any securities mentioned here.

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