The news today is that the EPA is reaffirming its conclusion that Encana (NYSE:ECA) wells near Pavillion, Wyoming have tainted water with fracking subproducts. This is the first time that water contamination is officially linked with hydraulic fracturing.
It's highly likely that such linking will lead to more EPA regulations on fracking, more complaints regarding fracking and ultimately large class-action lawsuits against the companies doing the fracking, such as Encana itself but also Chesapeake Energy Corporation (NYSE:CHK) and many others.
What consequences can these developments lead to, then?
If the EPA decides to more tightly regulate fracking, it's highly likely that complying with such regulations will lead to more expensive drilling. For the same natural gas (NYSEARCA:UNG) prices, such would necessarily lead to lower profitability for the sector.
A Class-Action nightmare
Sensing blood, the lawyers might go after every deep-pocketed natural gas fracking company out there. This would then turn into higher legal costs in the most optimistic outcome, and highly damaging awards in the worst case. There are instances, such as with asbestos, where this bankrupted an entire industry. Since the fracking angle deals with poisoning water, it's not impossible for the same to happen here, even if the political angle of assuring energy independence should provide a significant counter-weight.
Higher natural gas prices
Anything which might lead to less drilling and less usage of fracking will naturally lead to less natural gas production and higher natural gas prices, since exploring shale deposits already accounts for more than a third of all the natural gas produced in the U.S.
The shale gas boom has created a very large number of jobs. Estimates point to 600k jobs during 2010, growing to as much as 1.6 million by 2035. Were this industry to become intrinsically a lot less profitable due to regulation and lawsuits and these jobs would go away or never materialize.
It's widely believed that the EPA's aggressiveness is a function of Obama's Presidency. Were Obama to lose the Presidency in this year's elections, the resulting EPA might well be more lenient regarding fracking. And this point, however, Obama still shows up ahead in the polls.
It should be noticed that there are somewhat widespread complaints regarding water contamination, so this issue might well not go away no matter what happens politically.
Either way, this situation presents a risk which is very hard to quantify.
Today's news from the EPA cannot easily be dismissed. Although it's very early in this particular game, a dynamic can emerge which can lead to tremendously negative outcomes for the players in this sector.
This situation bears close monitoring, or the avoidance of companies using fracking, altogether.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.