The U.S. Government Accountability Office, or GAO, the agency that audits the federal government for Congress, just issued a major new report on the EPA's oversight of fracking. The report contains both good news and bad news for U.S.-centered oil and gas producers such as Chesapeake Energy (NYSE:CHK) and Devon Energy (NYSE:DVN).
The good news is that the danger of well-water contamination from fracking appears to be exaggerated and the EPA's current regulation of fracking wastewater appears to be working. Here's what the GAO report noted about Underground Injection Control (UIC), or class II, the EPA's fracking regulation program:
"Overall, EPA and state program officials reported that these safeguards are protective, resulting in few known incidents of contamination."
The GAO found that the EPA and 39 state governments to which it has delegated regulation of fracking are doing a good job of preventing contamination. It also found little documented evidence of well water contamination.
The GAO has determined that increased regulations and changes to the fracking process might not be necessary. That's really good news for Chesapeake, which has 5,500 potential drilling locations in the Utica Shale alone, according to my Seeking Alpha colleague Callum Turcan. One of the main objections to fracking has been fear of well water contamination and loss of property values on the part of rural landowners.
EPA Lacks Fracking Data
The bad news is the EPA has done a poor job of collecting data about fracking and assessing its other impacts. In particular, the agency has not gathered information about the potential earthquake dangers from fracking. This has occurred because information has been collected on a state-by-state basis.
The EPA is working on a national database of fracking information, but that database will not be ready for two to three years, according to the GAO.
The Good News for Oil and Gas Drillers
The good news for companies like Anadarko Petroleum (NYSE:APC), Chesapeake, Devon, etc., is that federal oversight of fracking is disorganized and major regulatory efforts seem to be years away. That means they'll probably have a lot of wells drilled by the time Uncle Sam gets around to increasing restrictions.
Since drillers have increased their speed of operation, Turcan noted that it now takes Chesapeake just 13 days to drill a well. In 2013 it took 18 days, a sure indication of greater efficiency and technical skill.
Profit Margins Falling
It also means that federal regulation will have little effect on their growing revenues or profit margin. Devon Energy's TTM revenues grew from $8.97 billion in March 2013 to $12.15 billion in March 2014. Chesapeake's revenue shot up from $13.32 billion in March 2013 to $19.13 billion in March 2014.
Chesapeake also reported an extremely healthy gross quarterly profit margin of 29.89% in March 2014, although it was down from 34% in March 2013. Devon reported a gross quarterly profit margin of 48.91% in March 2014, down from 54.95% in March 2013. Anadarko reported a gross quarterly profit margin of 70.58% in June 2014, down from 74.32% in June 2013. Apache (NYSE:APA), in contrast, reported a modest increase; its gross quarterly profit margin rose from 79.26% in June 2013 to 80.51% in June 2014.
As you can see, profit margins are falling at oil and gas drillers, making them vulnerable to outside forces such as government regulation. That's why the GAO report is both good and bad news for this industry. Government is interested in it but not necessarily willing to take action.
One final thought here: it looks like companies such as Chesapeake could be victims of their own success. They've gotten so good at increasing production that they may have created a glut of oil and natural gas in the U.S. market and driven down prices. I have to wonder how long that will continue and how exports will affect it.
Disclosure: The author is long CHK. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.