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The EPA Proposes New Drilling Regulations

by | published August 1st, 2011

Market averages are playing ping-pong this morning, as traders wait anxiously for Congress to pass the debt ceiling increase.

After all, why hurry, guys? You still have about 24 hours to prolong this sideshow!

It now appears there is adequate support to allow passage – perhaps because members see enough in the compromise to vote for it, or perhaps because enough arms have been twisted. Either way, energy prices are back up in early trading, a sign that commodities, at least, see passage.

High time we move on to other matters with less of a theatrical component…

And on the top of my list today is something that will have some immediate impact on how the industry drills for oil and gas.

Fracking Effects Have Drawn the Attention of Regulators

Last week, the Environmental Protection Agency (EPA) released a new series of proposals concerning the capture of more emissions that are currently moving into the atmosphere during drilling.

These emissions increase pollution and run the likelihood of creating a greater danger for the incidence of cancer.

The problem is hardly a new one.

Environmentalists have long argued that increasing the volume of drilling in a given location disproportionately raises the emission levels. The pollution effects tend to increase beyond a simple arithmetical aggregate of individual well results.

There is, in other words, a “triggering” effect on environmental dangers.

This is of concern in both oil and gas production, but the particular concern these days results from the development of shale gas sites. There, the combination of hydrofracking and horizontal drilling has resulted in a greater concentration of drilling locations per pad, while frac fluid introduces a wide variety of chemicals into the process.

That has drawn the interest of the EPA.

For the first time, last Thursday (July 28), the agency actually proposed regulations. (The issuance just beat a court-mandated deadline.)

The new regulations target air emissions resulting from fracking, including standards for volatile organic compounds, sulfur dioxide, and air toxins related to oil and natural gas production or transmission.

The objective is to reduce volatile organic compounds released from fracked wells by 95%, with overall harmful emissions from the oil and gas industry by a combined total of 25%. By volume, annual reduction targets are set at 3.4 million tons of methane, 540,000 tons of volatile organic compounds, and 38,000 tons of other toxins.

In its statement on releasing the proposals, the EPA noted that several states have similar standar

ds in their regulations of the industry.

The EPA further proposes that the costs of the new regulations be recovered by companies that use existing technologies to capture – and then sell – the natural gas that is now escaping in the drilling process. It puts that savings to the companies at no less than $30 million a year.

Two Interesting Developments

Most major companies that have reacted since the announcement are taking the new regulations in stride.

Several have noted that they already comply with the standards – especially companies in those states where they are currently incorporated into state regulatory approaches.

The problems will emerge for very small drilling operations whose profitability is already narrow, given the declining price of natural gas.

Larger operations have the advantage of hedging prices by trading gas futures and options. Smaller companies have less leverage in so doing, usually because they cannot benefit from offsetting significant volumes produced from geographically distinct basins.

I expect these new EPA regulations – while not the sole cause – will be a contributing element in stimulating the already-heated mergers and acquisitions market in natural gas. The necessary consolidation of operations has accelerated this M&A action, with smaller companies having choice acreage at the top of the acquisition list even before the EPA move.

The big boys will be getting bigger. And farm-in opportunities at existing operations now run by smaller companies are likely to further support the consolidation of asset control.

All of this is one more aspect to watch in selecting the best moves to make in a sector that's rapidly shaking out anyway, as we reach an end to an oppressive heat wave and the prospect of even greater amounts of extractable gas volume moving forward.

[Editor's Note: Click here to see what Kent's recommending now in his Energy Advantage.]

The second interesting development, for us as investors, involves the technological advances required by regulations like these.

The EPA is correct in saying that currently available approaches are enough to meet the standards. Yet there is still no clear idea of whether the regulations will prove sufficient as the well volume increases.

And as requirements to control air emissions increase, not even the estimated $30 million a year from capturing gas will be insufficient to offset the costs for new equipment.

That means an entire age of opportunity is about to emerge for what American entrepreneurs are particularly good at – designing remedies for problems once they are focused upon, while increasing efficiency and profitability in the process.

Could mean some incredible new profit opportunities for us, too.

Sincerely,

Kent

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