Fracking in the news: should investors care?

May 27, 2016

Hydraulic fracturing - also known as fracking - has burst back into the UK media's attention with the approval for Third Energy, a UK oil and gas company, to frack in North Yorkshire. This is the first application to be approved in the UK since a ban was lifted in 2012 that had been put in place following earthquakes at Cuadrilla wells the year earlier.

The news increases the debate about the UK’s fracking industry and the role of the global oil and gas sector in a low carbon economy post-COP21. Third Energy’s shareholders are likely to be closely watching not just the short-term financial viability of the application, but also how the company manages environmental and social issues that could damage long-term returns.

So, what does fracking mean for investors?

A cocktail of risks

With the “shale revolution” in the US and Canada, investors questioned the risks associated with fracking practices and how companies were mitigating and disclosing these risks. Fracking has been less prominent in Europe, with countries such as France placing a moratorium on fracking, citing the high risk of negative environmental impacts.

As substantial quantities of water are required, access to water is a physical risk that can threaten production, especially in areas experiencing water stress. Poor management of the water including flow back water can pollute and contaminate drinking water, creating a health risk for local communities and a reputational risk for companies. How a company communicates with local communities on its activities is important in mitigating this risk.

Another concern is greenhouse gas emissions. In particular, methane as the primary component of natural gas, can be loss through leakage, venting and flaring. A recent EDF report found that US oil and gas companies are failing to adequately disclose meaningful information on emissions of methane, which being 84 times more potent than carbon dioxide is a significant contributor to climate change. Emitting methane into the atmosphere is also losing a potential revenue source from gas that could be used or sold elsewhere. In the US and Canada, new regulations on methane limits have been announced leaving investors questioning the exposure of companies and their ability to comply. An increasing number of investors are also cautious of the amount of carbon in their portfolio as the economies in which they operate transition to a low-carbon setup. 

A slump in oil prices and cuts to capex means that fracking has become financially unfeasible for many global companies, creating a risk of uncompleted shale wells, nick-named “fracklog”. Investors will need to challenge companies on their exposure to stranded shale assets. This differs between countries: in the UK for instance, the government is encouraging the shale industry to develop in order to secure the nation's energy requirements. 

The importance of disclosure and engagement

The Disclosing the Facts benchmark encourages companies to disclose their fracking practices so that investors have the data needed to understand a company’s exposure to ESG risks. Using a scorecard, the benchmark identifies specific aspects of fracking that pose a risk. By communicating how they are managing these risks, companies can alleviate investor concerns that may arise from media attention.

Some companies are finding that following environmental good practice is operationally more cost-effective than original practices. Therefore, disclosure of these methods puts investors engaging with companies in a good position to share this knowledge. Shareholder engagement enables investors to better assess and manage their exposure to the financial, operational and reputational impacts of the risks associated to fracking operations in their portfolios. Through engagement, investors can influence companies to increase their disclosure on fracking practices and also improve their performance.

This year, the PRI wrapped up a collaborative engagement on fracking and is currently conducting a benchmark study on the public disclosure of fracking practices by oil and gas companies. Investors engaged with a number of oil and gas companies globally to improve their disclosure and performance of fracking activities around four focus areas: governance, water use and quality, air emissions and community impact and consent. The results of the benchmark will be released later this year.