New Fracking ETF Looks Past the Backlash

Despite a gathering storm of environmental concerns over the use of extreme hydraulic drilling techniques, or ‘fracking’, Van Eck Global recently launched the first U.S.-listed exchange-traded frack fund. FRAK offers “pure-play exposure” to companies such as Chesapeake Energy Corp., Devon Energy Corp., Eog Resources, Noble Energy, and Occidental Petroleum Corp., all of which use these unconventional methods to tap methane, oil and natural gas. The fund essentially is a bet that the nation’s energy needs will trump concerns over the environmental impact of fracking, or at least that such concerns will be relatively easy to manage.

Hydraulic drilling bores at a diagonal angle to hit the horizontal reservoirs — as opposed to sending a drill straight down — which greatly increases the chances of hitting the targeted deposits, say proponents. But the process also entails drilling through miles of rock and fracturing the shale with a voluminous cocktail of locally drawn water, sand and chemicals, some toxic, injected under extreme pressure to release the gases. And that has contaminated local drinking water and air and allegedly produced other public hazards, including earthquakes.  

Van Eck’s Market Vectors Unconventional Oil & Gas ETF (FRAK) takes these concerns more or less in stride. Fracking is considered “a quantum leap” from historic methods of gas and oil drilling that makes extraction from hard to reach deposits much more feasible, says Shawn Reynolds, a senior energy analyst for Van Eck. “It allows you to access resources from areas that haven’t been profitable in volumes that made sense economically,” Reynolds explains.

Yet a political backlash is clearly brewing. In 2005 the Bush administration created what critics call the Halliburton loophole, a last minute exemption inserted into an energy bill at the request of then-vice president and former Halliburton CEO Dick Cheney. This stripped the EPA’s authority over injection wells used in hydraulic fracturing, a process invented by Halliburton in the 1940s.

But after reports of air and water contamination near fracking operations, the EPA last year verified that fracking chemicals, including benzine, had appeared in a Wyoming aquifer, that methane gas was found in Pennsylvania drinking water and that fracking chemicals were detected in air quality tests in Texas.

“Until these loopholes are filled the natural gas industry will continue to put our environment and health at risk,” says Deb Nardone, director of the Sierra Club’s Natural Gas Reform Campaign. Sure enough, the air and water contamination findings have spawned state and federal legislation aimed at curtailing the use of fracking.

A bill introduced in the U.S. House of Representatives by New York State Representative Maurice Hinchey, a Democrat, seeks to close the Halliburton loophole. Another House bill, the Fracturing Responsibility and Awareness of Chemicals Act of 2011 introduced by Colorado Democrat Diana DeGette, would repeal a similar exemption for fracking from the Safe Drinking Water Act. Both bills would require disclosure of chemicals used in the process, some of which are considered trade secrets.

Meanwhile, high-volume hydraulic fracturing has been banned in New York state pending the results of an environmental impact review by authorities there. While the review is likely to be completed later this year, high-volume hydraulic fracturing will not be allowed in the New York City and Syracuse watersheds regardless of its findings, Emily DeSantis, a spokesman for the New York State Department of Environmental Conservation, tells Institutional Investor. New Jersey has also imposed such a moratorium. And the Delaware River Basin Commission, which controls water supplies to Delaware, New Jersey, New York and Pennsylvania, has postponed a vote that would have ended its moratorium on such drilling, originally scheduled for November 21, 2011. The commission said it is concerned that the recent discovery of the Marcellus Shale formation, which runs through those states as well as Ohio and West Virginia and lies under 36 percent of the basin and is believed to hold 4,359 trillion cubic feet of natural gas trapped in its formation, “may have a substantial effect on the water resources of the basin” by reducing the flow in streams, aquifers, or both that are used to supply the huge amounts of fresh water needed for fracking.

Not everyone accepts a causal link between fracking and air and water contamination. A report published last month by the Energy Institute at The University of Texas at Austin declared that fracking “has no direct connection to reports of groundwater contamination,” and noted that many problems ascribed to hydraulic fracturing are no different from those of other types of oil and gas drilling operations. The report went on to note that these problems reflect easily remediable troubles involving inadequate casing, bad cement or other surface procedures. “Surface spills of fracturing fluids pose greater risks to groundwater sources than from hydraulic fracturing itself,” the report concluded.

Meanwhile, some states welcome fracking for its economic benefits. North Dakota, for one, credits the drilling with the best employment numbers the state’s seen in years and has threatened to sue the EPA if it bans the practice.

Reynolds asserts that “the geological risk [from fracking] is nil,” and that other problems such as surface fluid spills and improperly disposing of waste “can be easily regulated.” Some sites are drilling disposing wells to handle waste.

For that reason and because the stakes are so huge, Reynolds doubts that the backlash will lead to a permanent ban on the practice.

“If fracking is banned on a national scale, it would halt all drilling ­— conventional as well — because they frack as well,” he notes. New York’s DeSantis notes that fracturing that uses less than 80,000 gallons of water is allowed while the state’s environmental review is underway.

Nardone of the Sierra Club contends the potential consequences of fracking merit more than a brief moratorium. “The problem is not only above ground but also below,” she asserts, noting that disposal wells “add to the many problems of fracking.” She contends that in disposing of its toxic wastewater by injecting it deep into the ground via injection wells, the industry is producing environmental consequences far beyond water contamination, and that regulators as well as the industry are ignoring these facts. “Not only is the toxicity of this flowback water and amount they inject into the ground kept secret from the public,” Nardone asserts, “it also is linked to causing earthquakes in parts of the country not known to have earthquakes in the past, like Youngstown, Ohio.”

Nardone isn’t alone in disputing the idea that fracking can be easily regulated. Paul Bugala, an extractive industries analyst and senior sustainability analyst for Bethesda, Maryland–based Calvert Investments, agrees with Nardone that the emphasis should be “on what comes up rather than what goes down.” Wastewater and flowback, caused by injected water coming back up, are “contaminated with salt, brine and lot of minerals, including radioactive elements,” Bugala says. Water already underground can seep back up over a long period of time, he points out, carrying greenhouse emissions from wells not capped. “How the sites are treated is important,” he says.

Nonetheless, Reynolds predicts that fracking will be viable once regulations have been modernized in ways that don’t curb its profitability. He notes that unconventional technology makes possible “drilling in tens of thousands of places.” But he contends, “The regulatory requirements for drilling of this magnitude are not in place yet.”

One issue Reynolds and Bugala agree on is the stakes involved. “We’re entering the end of an era of easy to access resources,” says Bugala, only he thinks investments in both natural gas and alternative energy offer the potential for “significant volatility” as well as growth.

Bugala, whose own firm offers two environmental funds, Calvert Global Water and Calvert Alternative Energy, says investors have to worry about everything from carbon pricing and project delays to an inability to attract trained labor. “They need to ask which companies are going to be the most innovative,” he adds.