Fracking: Economic Opportunity Or Environmental Time Bomb?

Includes: BP, RIG
by: IG's Dealing Floor

By Tom Fawcett, who works on IG's shares dealing floor in London.

The controversial debate over fracking pits the government and big business against environmentalists and local interest groups and has dominated recent news headlines. Hydraulic fracturing or fracking is the process of pumping a high pressure mixture of water, sand and chemicals into rock, to extract natural gas not exploitable by conventional drilling techniques. Its supporters claim it will provide the UK with an abundant source of cheap, clean energy and bring long-term energy security as well as a much needed boost to the Treasury and the wider economy. Its critics say it is unsafe and that the government is prioritising profits over the environment, when it should be honouring our commitment to fossil fuels.

The US is undoubtedly the world leader in fracking and those in favour point to the benefits they have enjoyed as a result. The increase in domestic production has significantly reduced their reliance on imports, whereas the UK is still heavily reliant on gas from Russia and the Middle East. The increase in US supply has driven natural gas futures 40% lower and falls in wholesale prices have filtered down to consumers. Compare this to the UK where household budgets have been squeezed by rising utility bills and frozen public sector pay.

As of 2010, 60% of new oil and gas wells were being fracked (Source: "Hydraulic fracturing. History of an enduring technology" - Journal of Petroleum Technology), as one the major global players (the oil and gas industry accounts for 16.5% of the FTSE 100), can the UK afford to be left behind? With the FTSE 350 Oil & Gas Producers sector trading at 7560 and therefore flat in 2013- compared with the overall performance of the index which has risen by 10%- is fracking the shot in the arm the industry needs?

Fracking uses a harmful array of chemicals, including lead, uranium, mercury and hydrochloric acid. Typically less than half of these are recovered, leaving the rest to seep into local water and air supplies. Opponents are worried that this could lead to contamination and there have already been cases of this in the US. As the UK has one of the highest population densities in the world, drill sites will be in closer proximity to population hubs (Cuadrilla's controversial Balcombe site is less than 35 miles from London) making the risk of contamination far more acute. Fracking has also been linked with seismic disturbances, in 2011 Caudrilla were forced to suspend drilling near Blackpool after a series of earthquakes, and although fracking is not a new technology, still relatively little is known about the long term geological implications.

The lifting of the fracking ban and subsequent tax breaks announced in this April's budget, present a significant opportunity for the industry in the UK, and have lifted the prospects for firms like IGAS Energy Plc (IGAS.L). Last month Cannacord Genuity raised their price target for IGAS to 174p which is a 55% premium on August 21 close of 112.25p.

Be warned however, the BP Deepwater Horizon disaster in 2010 has taught us that complacency toward environmental and safety concerns can be costly. CEO Tony Haywood lost his job, the firm paid out billions in compensation, suffered reputational damage in the US and the share price is yet to recover. Three years on, BP Plc (BP) is at 432.55 and trading at a 33% discount compared to pre-catastrophe levels and owner/operator of the ill-fated rig, Swiss firm Transocean (RIG) is trading at a near 50% discount at 4278.

So, while the opportunities are clear to see, investors need to be wary of all the health, safety and environmental risks when considering companies in the energy sector.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by Tom Fawcett, who works on our shares dealing floor here at IG. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

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