Fracking’s Controversial Image Is Your Investment Risk

Motley Fool Advisors

RE: Range Resources  & Cabot Oil & Gas

From the THE MOTLEY FOOL, August 5, 2013

Is fracked natural gas sustainable? Do its public relation risks hinder sound, long-term investing? Companies such as Cabot Oil & Gas Corporation  and Range Resources Corp.  are raking in profits from plays in the Marcellus Shale, but before making a long-term investment, I suggest you consider possible changes in states’ public policies. The potential for boom and bust in fracked natural gas is similar to public policy’s effect on the coal industry.

Companies with large holdings that require fracking (slang for hydraulic fracturing, whereby injected fluid forces open cracks in rock formations), especially in the Marcellus Shale, are paying out for investors. In the last quarter, Cabot Oil & Gas Corporation reported revenue was $373.3 million, with GAAP reported sales that were 37% above the prior-year quarter at $272.1 million. Range Resources Corp., likewise, had revenue of $398.2 million, up 30% from the prior-year quarter’s $322.2 million. Cabot Oil & Gas Corporation and Range Resources Corp. are the top two operators in Pennsylvania, one of the states most open to fracking, where 74 companies operate gas wells. For all intents and purposes, the fracking industry seems like it’s at the precipice of a continuing gold rush.

Range Resources Corp. is credited with starting the Marcellus Shale boom, and in 2011 sold all its North Texas Barnett Shale holdings to ramp up Marcellus production. The company’s strategy magnifies the importance of public policy for its future, now that it’s staked its future on the play. Its well count in the Marcellus is over 500 now, and the company expects production growth averaging 20% to 25% each year for the near future. Analysts believe that Range could reach 1.6 billion cubic feet of gas in about three years, and doubling that over time, 3 billion in six years, to surpass the U.S. record for a single year’s output. Be wary of those figures, as they’re based on assumptions about present production.

Cabot Oil & Gas Corporation too is heavily involved in the Marcellus; the company operates 226 wells in the formation and is starting a sixth rig in 2014. Cabot Oil & Gas Corporation CEO and President Dan O. Dinges expects capital spending to approximate cash flow this year. Cash flow at Range Resources Corp., meanwhile, is expected to outpace capital spending.

Both companies have seen huge jumps in earnings: in the third quarter, Range Resources Corp. saw revenue increase by 50% to $673.4 million, while Cabot Oil & Gas Corporation  reported a 40% increase in net income, up to $89.1 million from $35.9 million.

But let’s hit the brakes for a second and consider the public relations crisis in the industry right now, and its effect on public opinion and policy.

Industry image problems

Coal saw its boom, and then as those supplies waned, companies invented Mountaintop Removal, a destructive practice meant to mine thin seams of coal. With fracking, we have a practice that’s as lambasted, but much more widespread, so any negative PR also covers more ground. MTR was regional, fracking is national. The public relations problems surrounding fracking originate in both secrecy and in tactics used to save money at the expense of image. Let’s talk tactics first. The gas rights grab means less-reputable gas landmen may lie to save money. Recent news headlines include one about an Ohio Amish family, who sold their gas rights and received much lower prices per acre than neighbors. They can’t sue due to religious beliefs, a fact lawyers in the case say is relied on by some companies. The same article mentions an Amish lawsuit involving leasing rights, against Columbia Gas Transmission.

Why should we worry about the isolated cases in this article? With time, they build up and create a synergy corruption effect. Suddenly, Chesapeake, Cabot and Columbia all mire into one big tangled ball in the public’s minds. As for secrecy, gas companies have been remiss in publicly stating the chemical makeup of fracking fluid. Kansas has forwarded legislation to force a limited disclosure of those chemicals. Pennsylvania and 10 other states require that companies list their fracking liquid ingredients on FracFocus, but a Harvard study just found serious flaws in that database. Some other folks have been pretty upset about fracking too, for a while now.

Did you really think I would leave out Josh Fox and Gasland, and now Gasland 2? I’ve watched both movies, and like many others, I have concerns about polluting the water supply. Gasland 2 has shown on HBO, and they have about 114 million subscribers worldwide. That’s viewing potential. Add the watch parties held nationwide and that’s more potential for message distribution. At the Pittsburgh premiere alone, 1,700 people showed up. Whatever your view on the movies, the message has reached a general viewing audience.

Public policy problems

The reaction to fracking has varied drastically among states. In New York, a moratorium on fracking that started in 2008 is still in effect, with no foreseeable change. North Carolina just extended its own moratorium on onshore fracking, as many other states continue allowing the practice with no restrictions other than counting violations. The biggest unknown for fracking is the federal Environmental Protection Agency study that concludes in 2014. The EPA is studying potential impacts on human health, drinking water, and what happens to chemicals used in fracking, including processing and disposal. The preliminary report issued in 2012 is available here, but lacks any preliminary results. New EPA head Gina McCarthy has said states should regulate fracking practices, but we can assume the EPA study results will impact or change some states’ policies. Early findings suggest that some well water in Dimock, Pa., is unsafe for drinking, as a direct result of fracking, according to an internal EPA staff report just obtained by the media. The report directly conflicts with statements made by Cabot Oil & Gas.

Investing that considers risk

Natural gas prices are trending downward, for reasons of weather and market saturation, but the industry is still a smart investment. I suggest completing a thorough study of company reputation before making a long-term investment. First, where are the company’s holdings, not just the formation, but also the state? What track record does the company have with both environmental violations and with landowners leasing to it? And don’t forget to consider liquidity versus assets. For instance, Chesapeake Energy Corporation  just sold $1 billion worth of interests in gas lands to improve company liquidity and is veering toward more oil production. Chesapeake Energy has sold off a total $3.6 billion of interests, with plans for more asset sales totaling $2 billion to $4 billion. The company has already sold some of its Marcellus Shale holdings and, surprisingly, some oil holdings, while capital expenditures are down 43% this year. The company is focusing on those properties that provide the highest ROI, and emerging policies and gas prices could dictate if its next asset divestiture is in oil or gas lands.

Gretchen Stone has no position in any stocks mentioned. Gretchen is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited. The article Fracking’s Controversial Image Is Your Risk originally appeared on Fool.com as written by Gretchen Stone.