Given the near-religious fervor currently surrounding what many call the "shale gas revolution," you might think that natural gas is a precious commodity. It might then surprise you to learn that when natural gas is produced as a byproduct from oil wells, developers often burn it off in a practice called "flaring." Flaring is stupid from almost every perspective, and yet it persists at alarming levels. Investor pressure and potential environmental regulation are likely to force a reduction in flaring, which would have a real impact on companies operating in the oil and gas sector.

Gas: no longer just a crude joke
Flaring is problematic for two reasons. First, it emits damaging greenhouse gases to the atmosphere and compromises regional air quality. Second, it wastes a valuable resource at a time when the world has a seemingly insatiable appetite for energy. It's sort of like incinerating money, and investors should have a problem with that.

The scale of the waste is considerable. Based on EPA estimates, the industry lost more than $1 billion in profits in 2009 due to venting (release of natural gas without combustion), flaring, and accidental leaks called "fugitive emissions." The U.S. Government Accountability Office, with supporting data from EPA, estimates that roughly 40% of natural gas that's vented and flared on onshore federal leases could be captured economically with currently available control technologies.

There is currently a glut of flaring taking place in the Bakken formation, a prolific oil and natural gas liquids source underlying parts of North Dakota, Montana, and Saskatchewan. According to a December briefing from the North Dakota Industrial Commission: "[The] high liquids content makes gathering and processing of Bakken gas economic. Additions to gathering and processing capacity are helping but the percentage of gas flared did not change at 30%." To put this in context, Bakken flaring burns off enough energy each day to heat half a million homes.

Pressures on the sector
Why would this be? One reason is that producers want to keep wells active without extracting at a meaningful level because of currently low natural gas prices. Industry players say that a bigger reason is inadequate takeaway capacity, the infrastructure necessary to transport natural gas from where it's produced to where it's used. However, a July 2012 study from Bentek Energy for North Dakota policy makers found current takeaway capacity exceeds production. The study found the real reason for the Bakken's high flaring levels to be the insufficient gathering pipeline infrastructure and gas processing capacity required to process wellhead gas and prepare it for shipping.

Whatever the case may be, there is a void to fill. Even if takeaway capacity is currently sufficient, significant development in gathering and processing infrastructure will lead to greater outflows of natural gas, which sooner or later will exceed takeaway capacity. Thus, if there is to be a reduction in flaring, it will yield serious opportunities for midstream operators, and they know it.

Enbridge Energy Partners (EEP) expects to complete work on its Bakken Access Program early this year. The aim of the program is to expand the gathering capacity on its North Dakota system by 100,000 barrels per day . While the program is currently aimed at crude oil gathering, the company is well positioned through its expertise and presence to manage similar demand for natural gas infrastructure. Alliance Pipeline, of which Enbridge owns 50%, expects to complete its Tioga pipeline delivering natural gas from the Bakken Shale formation to the Chicago market by mid-2013 .

ONEOK Partners (OKS) completed its Garden Creek plant, a 100 million cubic feet per day natural gas processing facility serving Bakken producers in January 2012. ONEOK plans to invest approximately $1.5 billion-$1.8 billion for growth projects in the Bakken Shale between now and 2014 in its natural gas gathering and processing and natural gas liquids (NGL) businesses. 

Plains All American (PAA -1.35%) has been transporting NGLs by rail for around 25 years, and has a significant presence in the Bakken formation that it continues to expand both organically and through acquisitions. Plains is well-positioned to benefit from increasing natural gas production in the Bakken. My only concern is that rail transport presents a significantly greater risk of spills than moving NGLs by pipeline. A U.S. railway is about 34 times more likely to spill hazardous materials than a pipeline transporting the same volume an identical distance.

Interestingly, Energy Transfer Partners (ETP) may appear to be betting against this trend in its plans to convert its Trunkline system – which provides access to the Bakken play, among others – from natural gas to crude by April 2014. The move is a response to a bottleneck in crude takeaway capacity from the Bakken. In regulatory filings, ETP said the converted pipeline would still be able to carry natural gas, so perhaps this is the perfect hedge against whatever the future holds.

Burning question
But will there be a reduction in flaring? My guess is yes. The oil and gas sector is feeling the heat from two quarters: regulators and activist investors. The EPA has recently tightened regulations on a type of flaring that takes place during natural gas fracking. While this type of flaring only accounts for a small fraction of Bakken flaring, the issue is clearly on the regulatory radar. Meleah Geertsma, staff attorney at the Natural Resources Defense Council, told me that her group expects EPA to look into area-specific flaring issues in the future. Peter Zalzal, staff attorney at Environmental Defense Fund, says that his group is working with the EPA to close gaps in existing standards.

Meanwhile, a group of investors representing $500 billion in assets sent a letter in March 2012 to 21 of the industry's largest shale oil producers urging them to reduce or eliminate flaring. Such shareholder pressure is on the rise, and I believe it will become increasingly difficult for companies to ignore.