1 Competitive Advantage & Critical Risk for Fracking Companies

As California struggles with record-breaking drought, and as water stress increasingly affects broad swathes of the U.S., a new report out today shows that some hydraulic fracturing companies and regions are especially vulnerable to looming water supply constraints. Across key shale development regions of the U.S. and Canada, 55% percent of hydraulically fractured wells are in areas experiencing drought. As water availability continues to wane, this will pit fracking companies against other key water users, particularly farmers and communities.

Who's at risk?
Today's report, "Hydraulic Fracturing & Water Stress: Water Demand by the Numbers," is the first to provide data on oil and gas companies' water use and exposure to water-stressed regions. Ceres, the report author, found significant long-term sourcing risks for companies operating in sensitive areas. The greatest risk lies with some familiar names.

  • Among the operating companies, Chesapeake Energy (NYSE: CHK  ) uses far more water than any other fracking company, with EOG Resources (NYSE: EOG  ) , XTO Energy -- an ExxonMobil (NYSE: XOM  ) subsidiary -- and Anadarko Petroleum (NYSE: APC  )  respectively in second, third, and fourth places.
  • Halliburton (NYSE: HAL  ) handled the most frac water of all the service providers.
  • Anadarko is at greatest sourcing risk, as more than 70% of the wells it develops are in areas of high or extreme water stress, particularly the Eagle Ford play and the Denver-Julesburg Basin.

Now, it's not as if these companies aren't aware of the importance of water in their operations, and some do take measures to reduce water consumption. Chesapeake, for instance, reuses nearly 100% of the water it produces in the Marcellus shale, and Anadarko is increasingly buying effluent water from local municipalities. Halliburton has moved decisively into providing frac-water recycling services for its customers.

But these efforts don't add up to a sufficient response to such serious risk. Chesapeake acknowledges that even with 100% of water recycled, its efforts still only reduce water demand for subsequent Marcellus wells by between 10% and 30%. Anadarko may be giving with one hand while taking with the other: a report due out tomorrow will detail hundreds of Anadarko's pollution violations in Pennsylvania over the past five years, including a disproportionate number for water pollution.

Investor response
As with any operational risk, investors should pay attention to this issue, as Steven Heim of Boston Common Asset Management explained:

Water sourcing and management is becoming a key competitive advantage -- and a critical risk -- for oil and gas companies using hydraulic fracturing to unlock new reserves. Investors need the data to understand how companies are meeting these challenges on a regional or play-by-play basis in order to appropriately value companies and also engage with them to improve their practices.

Other investor groups have been pushing a similar message, noting that companies in the hydraulic fracturing space as a whole do a poor job of assessing and communicating their risks around water and other issues. Even the Securities and Exchange Commission is paying attention, sending 70 letters of inquiry seeking further information from companies about risks related to fracking.

Investors are not sitting idly by, waiting for companies to act. On Tuesday, a coalition of investors filed shareholder resolutions with five fracking companies, including EOG Resources and ExxonMobil.

Shareholders are asking EOG Resources and ExxonMobil's boards of directors to report annually on "the results of company policies and practices, above and beyond regulatory requirements, to minimize the adverse environmental and community impacts from the company's hydraulic fracturing operations associated with shale formations." (Emphasis mine.)

I emphasize the part about going beyond regulation because Chesapeake has said publicly that it thinks existing regulations are adequate, even though that is clearly not the case. Indeed, a coalition of companies just joined in the launch of the Center for Sustainable Shale Development, seeking to address some of the risks more comprehensively.

Gold standard
The Ceres report recommends that fracking companies take various measures to address growing water tensions, broadly organized around disclosure, operational improvements, and stakeholder engagement. Companies would do well to take note and get involved.

Water stress is growing far more quickly than most models ever predicted, and it would be a dismal scenario indeed if fracking companies had to compete directly with agricultural interests and municipal demand. Collaborative efforts like the Center for Sustainable Shale Development are a step in the right direction. Companies can and should get out ahead of this considerable risk if they hope to continue operating in the coming years, and investors should demand as much.

Despite the risks, there's still a boom going on
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