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IndustryinFocuUnconventionalOil&Ga

October201

ShaleGasandHydraulic

Fracturingin

the

US:

OpportunityorUnderestimatedRisk?

ByDanaSasarean,SamuelBlock,andLindaElingLee


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October201

Summary

Shalegaspresentsahugenewpotential investmentopportunityandcouldpossiblytransformtheUSenergymarket.However,financialreturnsfromshalegasfacepressureduetoemerging

environmental liabilities, community opposition that limits access to resources, recoverable

reservesuncertainties,andnaturalgaspricevolatility.

Significant rampup inproductionwill likelyunveil twomajordriversof increasedoperationalcostand liabilities: lackofwater availabilityand contamination fromhigh volumeofwaste

water.Differentenvironmentalandsocialprofilesof thevariousbasinsmeans thatdrilling in

somebasinsentailspotentiallyhigheroperationalcostsandliabilities.

Someofthe largestshalegasproducers,suchasExxonandAnadarko,donotfacethehighestvaluationriskfromtheirshale involvementduetodiversificationofoilandgasresources.The

more pure play companies such as Chesapeake Energy, Encana, Ultra Petroleum, Range

Resources,andCabotOilandGasfacehigherrisks.

BasedonMSCIESGResearchsassessmentofcompaniesperformanceonenvironmentalissues,webelievethatcompanieswithpoorhistoricalperformancesuchasCabotOilandGas,BP,and

Chesapeake Energy are more likely to face community opposition and permitting issues,

possiblyhinderinglongtermgrowthpotentials.


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October201

Introduction

Shale gas, hailed by some as a game changer and even a silent revolution in theUS, is drastically

alteringthedomesticenergylandscapewithinternationalmarketimplications.Thesubstantialreserves

baseand

steep

domestic

production

increase

are

already

changing

the

international

natural

gas

market,

freeingup liquefiednaturalgas (LNG)capacityand loweringcontractprices inregionssuchasEurope

andRussia.Whilenaturalgasisalreadythebackboneofawiderangeofindustries,frompetrochemicals

andplastics to fertilizers, theprospects forgreateruse inpowergenerationand transportationmay

ensureitslongtermexpansion.Theproliferationofactivityintonewshaleplayshasincreasedshalegas

productionintheUSfrom0.39trillioncubicfeet(tcf)in2000to4.87tcfin2010,or23%ofUSdrygas

production. EstimatesofprovedUS shale gas reservesby theUS Energy InformationAdministration

(EIA)haveshotup from34 tcf in2008 to84 tcf in2011witha totalof862 tcfprovedandunproved

resources.Productionisforecasttoreach12.6tcfby20201.

For investors, however, the potential economic returns from shale gas production are still highly

uncertain.Inadditiontocompetingclaimsabouttheactualsizeandvalueoftherecoverablereserves,

communityresistance,negativemediaattentiontopotentialenvironmentalhazards,grassrootsactivist

opposition,andincreasedregulatoryscrutinyhavecalledintoquestionthecompaniesabilitytooperate

inanenvironmentallysafemannerandstillmeethighexpectationsof financialreturns.Nevertheless,

givencontinuedhighpricesforoil,andtheprospectofcheapnaturalgasintheshorttomediumterm,

webelievethattheoilandgassectorwillcontinuetopursueshalegasasamajorpartoftheirgrowth

strategyinunconventionalenergyextraction.Butwequestionthelongtermvaluationofcompanies

thatareunpreparedtohandlethecomplexinterplayofenvironmentalandsocialrisksinthisspace.

Whilemostoilandgasplayersarepresent inmultiple shalebasins, thedifferentenvironmentaland

social profiles of the various basins means that drilling in some basins entails potentially higher

operationalcostsandfutureliabilities.(Forasummaryofthekeyprocessesinshalegasrecovery,pleaseseeAppendixI:WhatisShaleGasandHydraulicFracturing?). Specifically,wherecompaniesaredrilling

determines the exposure to some of the most high profile and controversial elements of hydraulic

fracturing,includingtheissuesofwaterstress,wastewatermanagement,andcommunityoppositionto

landusechanges.

RelianceonShaleGasReserves

AmongcompaniesintheMSCIWorldIndex,weestimatethat54playersarecurrentlyinvolvedinshale

gasexplorationandproductionglobally.

Whilemajorshale reservesare located inmanycountriesasestimatedby theUSEIA (suchasChina,

Argentina,Mexico,andCanada)wefocusontheUS,whichaccountsfor13%ofresources(technically

recoverable,unproven reserves) andwhere explorationandproduction is currentlymost aggressive.

(For a breakdown of the countries with major shale gas reserves, please see Appendix II: Global

1AccordingtoSBIEnergyestimateshttp://www.sbireports.com/about/release.asp?id=2354


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October201

DistributionofUnprovenShaleGasReserves).Wehaveanalyzedthetop25companiesintheUS,asthis

marketiscurrentlyseeingthequickestinvestmentgrowth.Allofthesecompaniesfacedevaluationrisks

ifenvironmentalorsafety failurescauseadditionaloperationalcosts,reputationaldamage,or limited

accesstoresources.Whilethegreatertheproductionofshalegasthegreatertheriskexposuretothe

environmentalandsocialrisks, thecompanieswiththelargestshalegasproductionarenotnecessarily

mostexposedtovaluationrisk.Thelessdiversifiedcompanieswhoseoilandgasresourcebaseishighly

dependent on hydraulic fracturing such as Chesapeake Energy, Encana, Ultra Petroleum, Range

Resources,andSouthwesternEnergy (figure2), face thehighestriskexposure.Nonetheless,wenote

thatmultinational integratedoilcompaniesExxonMobil,BP,ConocoPhillips,Chevron,andShell,with

significant US natural gas reserves totaling about 57 tcf, largely made up of shale gas, are more

diversifiedandthuslessdependentonshalegas,butstillfacesomevaluationrisksandpotentiallosses

oninvestments.

FIGURE 1 Top25ShaleGasPlayersinUS**EstimatesofShaleGasReservesandProduction

Bcf=billioncubicfeet;mmcf/d=millioncubicfeetperday

*DailyShaleGasProductionvaluesrepresentstatisticsinfirsthalf2011,source:NaturalGasSupplyAssociation(NGSA)

**WilliamsEnergy,ElPasoEnergy,andMarathonarealsomajorplayersinUSshalegasbutareexcludedfromthisanalysis

QuoteSymbol Company

Name

EstimatedUSNatural

Gas

Reserves(Bcf)

NaturalGasProduction

(mmcf/d)*

EstimatedShaleGasShareinOverallO&GProduction

XOM Exxon(XTO) 26,100 3,873 0to20%

CHKN ChesapeakeEnergyCorporati on 15,455 2,639 75to100%APCN AnadarkoPetroleumCorporati on 8,100 2,369 0to20%

DVNN DevonEnergyCorporati on 9,000 1,997 50to75%

BP_GB BritishPetroleum(BP) 13,700 1,869 0to20%

ECAN EnCanaCorporati on 7,500 1,833 75to100%COP ConocoPhi l l i ps 10,500 1,621 0to20%

SWNN SouthwesternEnergyCompany 4,345 1,312 75to100%CVX Chevron(Atl as) 2,500 1,284 0to20%

EOG

N EOG

Resources,

Inc. 6,861

1,124

50

to

75%RDSA_GB Royal DutchShell (Eas t) 4,502 953 0to20%

APAN ApacheCorporati on 4,340 869 0to20%

HKN PetrohawkEnergy(BHPBi l l i ton) 3,392 792 75to100%OXY Occi dental NotReported 748 0to20%

QEPN QEPResourcesInc. 2,612 641 50to75%

UPLN UltraPetroleumCorp. 4,200 614 75to100%NFXN NewfieldExplorationCompany 2,490 510 20to50%

EQTN EQTCorporati on 5,200 464 50to75%

COGN CabotOi l &Gas Corporati on 2,644 439 75to100%RRCN RangeResourcesCorporati on 4,442 346 75to100%PXDN PioneerNatural ResourcesCompany 2,594 331 75to100%XEC

N Cimarex

Energy

Company 1,254

326

20

to

50%TLMT TalismanEnergyInc 5,240 315 20to50%

PXPN Plains Exploration&ProductionCompany 1,157 285 20to50%

HES Hess Corporati on 568 103 0to20%


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October201

MajorEnvironmentalandSocialChallenges

Themostcontroversialaspectsofhydraulicfracturing(fracking)revolvearoundtheissueofwater.Large

quantitiesofwaterareneededforthefrackingjob,whichcanincreaseregionalwaterstressandcreates

challengeswith themanagementofpostfrackingwastewater. Thehigh riskofwater contamination

andregionalwaterstressduringfrackingandproductionarepromptingstrongcommunityoppositiontoshalegasdevelopments.Methane,whichmakesup7090%ofthenaturalgas,canleakandcontaminate

drinkingwatersupplies.Thereleaseoftheleakednaturalgasintheatmospherealsohasclimatechange

implicationssincemethaneisahighlypotentgreenhousegas.

FIGURE 2 MajorRisksAssociatedwithHydraulicFracturing(fracking)Risk SpecifictoHydraulicFracturing

Operational Wastewaterorflowbackwaterpresentssignificantoperaonalchallenges

(wastewaterconsistsoffrackingfluids+substancespickedupundergroundsuch

ashydrocarbonsandheavymetals)

Morewellsneededforproduconthanequivalentoilproducon morechances

ofmishapsandhigherlanddisturbanceFrackingoccursatabout9,000poundspersquareinchpressureorgreater

Poorcasingprovidesapathforgasmigraonundergroundandthenaquifer

contamination

Tracesofradiaoninshalerockandfoundinwastewater(lowlevels)

MarcellusandlikelyUcabasinsarenotwellequippedforreinjectionof

wastewaterorwatertreatment(localwatertreatmentplantsnotequippedto

handlethesevolumesorsubstances)

Regulatory Increasingstateandfederalregulaonsarelikelyinthenexttwoyearsdueto

pendingstudybyUSEnvironmentalProtectionAgency(EPA)

Reputational Publicopposiontohydraulicfracturing(temporarymoratoriuminNYstate)due

tofearsofwatercontamination

Environmental Highlevelsofwastewaterandchemicalsraisesrisksofsurfacespills

Highlevelsofinefficienciesinproduconandtransport(methanelosses

estimatedtobeashighas8%ofpotentialproduction,industryadmitslossesof1

to3%)leadingtohighemissionsofpowerfulgreenhousegas

35,000gallonsoffrackingfluidaddives(oentoxic)injectedundergroundper

well

LandUseandAccessto

Resources

Averageof7milliongallonsofwaterneededperwellperdrillingjobpotenally

stressingwatersuppliesinaregion(drillingjoblastsaboutaweek,additional

frackingmaybeneededtorestimulateawell)

Largelanddisturbancesfromaccessroads,trucking,storageponds,andother

surfaceoperationssuchaspiping,storageandwellpadconstruction,resultingin

lossesofnaturalvalue(trees,vegetation,biodiversity)adverselyaffectingthe

ecosystemaswellasallowingforhighermigrationofemissions,contaminants,and

sediments


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October201

High

Low

WaterStress

FIGURE 3 MajorShaleBasinsandRecentDroughtConditions

Source:USDADroughtMonitor.Droughtmonitor.unl.edu/.ShalebasinoverlayfromMSCIESGResearch.

FIGURE 4 MajorShalePlaysandWaterStressShaleplays States Water

Stress MajorPlayers

EagleFord TX Exxon,Petrohawk,Chesapeake,Aurora,Pioneer

WestTexasPermian TX Cabot,Chesapeake,Devon,EOG,Pioneer

Woodford OK,TX Cabot,BP,Devon,EOG,Exxon

Barnett TX RangeResources,Exxon,Chesapeake,Devon,Encana,EOG,Pioneer

Haynesville/Bossier LA,TX Petrohawk,Exxon,Cabot,Chesapeake,Plains,Encana,EOG

Fayetteville AR Southwestern,Petrohawk,Chesapeake

Marcellus PA,NY,OH,WV Cabot,Chesapeake,Ultra,EQT,Talisman,Range,Anadarko,Shell,EOG,Exxon(XTO)


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October201

0

5000

10000

15000

20000

MillionGallons

CumulativeShaleGasEstimatesofWaterUseandWasteWaterGenerationwateruse

wastewater

USwateruse100,000persons

(assumed575 litersperday/person)

FIGURE 5 Estimatedyearlywateruseandwastewater

*20072010representestimatesbasedonactualshalegasproductionlevels.20112020areestimatesbasedonaprojected12.6tcfproduction

by 2020 (source: SBI Energy). We assumed a 10% annual production increase over the period. Water use estimates are based on a 1.3

gallon/millionBritishThermalUnits(MMBtu)waterneedsaverage3.Wastewatergenerationestimatesassumethat70%ofwaterusedreturns

asflowbackandignoresanyotheradditionalproducedwater,whichmaydrasticallyincreasetheestimatedlevels.

MethaneLeaks

Anadditionalconcernaboutshalegasextractionisthatitmayreleaselargeamountsofmethane,which

couldcontaminatedrinkingwateraswellascontribute toclimatechange.Naturalgasconsistsof70

90%ofmethane,anontoxic,highlyflammableandasphyxiantgaswithhighclimatechangepotency.

AcademicstudiesfromDukeUniversity4haveconfirmedsystematicevidenceofmethanecontamination

ofdrinkingwaterassociatedwithfrackinginPennsylvaniaandNewYork.Thehealthimpactofmethane

contaminatedwaterisunknown.Theoil&gasindustryarguesthatmethaneleaksareassociatedmore

generallywithnaturalgasdrilling,notwithhydraulicfracturingperse.

3WaterConsumptionofEnergyresourceExtraction,Processing,andConversion,ErikMielke,LauraDiazAnadon,andVenkatesh

Narayanamurti,Harward Kenedy School, Belfer Centre for Science and Interantional Affairs, Energy Technology Innovation

PolicyResearchGroup,October2010

4Methanecontaminationofdrinkingwateraccompanyinggaswelldrillingandhydraulicfracturing,StephenG.Osborn,Avner

Vengosh,NathanielR.Warner,RobertB.Jackson,centeronGlobalChange,NicholasSchooloftheEnvironment,andthe

BiologyDepartment,DukeUniversity,Durham,NC27708,January2011


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October201

Methane fugitive gases and leaks in the atmosphere, throughout the lifetime of a well, are also

significantlyincreasingtheshalegasoverallcarbonfootprint.AccordingtoCornellscientists5,methane

leakagefromfracturingisworsethanwithconventionaldrilling;asmuchas8%ofmethaneinshalegas

leaksintotheairduringthelifetimeofshalegasproduction.Thefactthatunburnedmethanereleased

in the atmosphere has 20 times the warming effect of carbon dioxide (pound for pound) calls into

questionwhetheranyfutureconstraintsaroundgreenhousegasemissionscouldimpactthe longterm

growthoftheshalegasindustry.Onaverage,naturalgasemits30%lesscarbonwhenburnedcompared

tooilsenergycontent,whichmakesnaturalgasasacleanerenergyalternative.However,therelatively

high rateofmethane lossduring fracking (through leakage) coulddilute thebenefitofnaturalgas in

mitigatingclimatechangecomparedtooilandcoal.

CommunityOppositionMarcellusinfocus

Environmentalandhealthconcernsarethekeyreasonsthatenvironmentalistsandlocallandownersor

communityresidentsareopposedtohydraulicfracturing.Theseconcernsinclude:

potentialundergroundwatercontaminationfromtoxicchemicalsinthefrackingfluidsandnaturalgasseepingfromfaultywells

increasingstrainonwaterresourcesduetolargewaterrequirementsfordrilling potential soil, surface, and underground water contamination from inadequate

managementoraccidentalspills

increased landdisturbancedue to roadconstruction,waterstorage (pondsandlagoons),andlargenumbersofwellsdrilled

trafficandnoise from increasedactivity: tracks,compressorsandotherenginesusedduringdrilling

potential increased radioactivity from radioactive substances brought to thesurfacebytheflowbackandproducedwater

Landdisturbanceandtheintensityoflanduseforshaleproductionarealsoquitehigh.Fourteenshale

gaswellsareneededtoproducethesameamountofnaturalgasasproducedinconventionaloilfields

onanequivalentenergybasis.Eachwellrequiresroughly4to5acresperpad, includingwastewater

storage,andothersupportingequipment.

Comparedtootherbasins,communityopposition issignificantlystrongerintheMarcellusshalebasin,

whichcoverslargeareasofvaryingpopulationdensities.WhilepublicopinioninPennsylvaniaisdivided

on shale gas drilling, intense community opposition in some townships has delayed production and

could ultimately impose higher operational costs through more stringent regulations on fracking

activities.

5Methaneandthegreenhousegasfootprintofnaturalgasfromshaleformations,RobertW.Howarth,reneeSantoro,Anthony

Ingraffea,DepartmentofEcologyandEvolutionaryBiology,CornellUniversity,March2011


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October201

FIGURE 6 TheMarcellusShaleandMajorWaterBasinsMap

Source:WaterResourcesandUseforHydraulicFracturingintheMarcellusShaleRegion. J.DanielArthur,P.E.,SPEC;MikeUretsky,PhD.;

PrestonWilsonALLConsulting,LLC

In thestateofNewYork,whichhasjurisdictionoverasmallportionof theMarcellusShale, the local

governmentimposedatemporarymoratoriumonnewdrillingpermitsinDecember2010.Asoftheend

ofJune2011,thestateadministrationindicatedthatithasbeencontemplatingpoliciesthatwouldonly

allowfrackingonprivatelands,andexcludeareasthatcontainaquifersusedforcitydrinkingwater(theNew York City and Syracuse watersheds) as well as parks and wildlife reserves; the issue has been

undergoingapubliccommentperiodandnewrulingisexpectedimminently.

ThecommunityoppositioninpartsoftheMarcellusshalebasin,whilemotivatedbyenvironmentaland

healthconcerns, isalso largelyabyproductofprevailingsocialsentimentandpoliticalopinion in that

region.Notunexpectedly,theexpansionofoil&gasactivities intoareaspreviouslyuntouchedbythe

industry will continue to face fierce opposition from the community, unless companies adequately

manageenvironmentalimpactandcommunityhealthconcernsthroughcommunicationandadoptionof


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October201

bestenvironmentalpractices.Thepopulationdependenton thewater resources in theNortheast is

quite high (see figure 7), which means that any potential issues with water contamination would

arguablyhavealarger impact inpartsoftheMarcellusshalebasinascontaminationofdrinkingwater

therecouldultimatelyimpactmorepeople.6

FIGURE 7 OverlayofUSPopulationandShaleBasins

Source:USNationalAtlas.http://nationalatlas.gov/.ShalebasinoverlayfromMSCIESGResearch.

CompanieswithsignificantinterestsintheMarcellusbasin,asopposedtoallothershaleplays,facethehighest community opposition and regulatory risks. Despite the heightened risks from wastewater

managementand intensecommunityopposition,15outofthe25majorshalegasplayersareactively

pursuingproductionopportunitiesintheMarcellusbasin(seefigure8).

Companies capabilities in stakeholder engagement can help reassure communities, facilitate the

permitting process, and ultimately head off costly litigation. In evaluating companies relative

capabilities,MSCIESGResearchtakesinaccountofcompaniesprogramstargetingrelationshipbuilding

withNGOsandparticularly landowners;strategies tobuild localeconomiesthroughsupport for local

businesses and suppliers, employment, training andprofessionaldevelopment; and support for local

communityservicessuchaseducationandhealth.WenotethatUltra,CabotOil&Gas,andEOGlack

strong records or clear programs to manage community impact. Lack of community engagement

strategyatEOG,forexample,hasexposedthecompanytoongoingcommunityresistance,impedingitsabilitytocarryoutplannedhydraulicfracturingjobsinnewcommunities. Thecompanynamecontinues

to appear in the news in negative association to hydraulic fracturing after a shale well blowout

promptedregulatorstoissueaworkstoporderin2010.

6WenotethattheBarnettshalebasinintheDallasFortWortharea,wheremorethantwomillionpeoplereside,isalsohighlypopulated.Arguably,spillsandwater

contamination inthisbasinwouldalsoaffectalargenumberofpeople.


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October201

Strong Weak

CommunityEngagementPrograms

FIGURE 8 MarcellusOperationsandCommunityPrograms

50%ormore

10to50%

Under10%

Loworunderdevelopment

Nopresence

ShaleOperationsinMarcellus

CompanyNameShale

DependencyonMarcellus

ActiveWellsinFirstHalf2011inPA

MSCIEvaluationofCommunityPrograms

ChesapeakeEnergyCorporation 1326

TalismanEnergyInc 673

RangeResourcesCorporation 609

AnadarkoPetroleumCorporation 421

EQTCorporation 367

CabotOil &GasCorporation 254

EOGResources,Inc. 242

UltraPetroleumCorp. 226

Chevron(Atlas) 182

Exxon

(XTO)

106

EnCanaCorporation 14

Hess 8

SouthwesternEnergyCompany

Shell(East)

NewfieldExplorationCompany

DevonEnergyCorporation

BP

ConocoPhillips

ApacheCorporation

Petrohawk(BHPBilliton)

Occidental

QEPResourcesInc.

PioneerNaturalResourcesCompany

CimarexEnergyCompany

PlainsExploration&ProductionCompan


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October201

ProxiesforMeasuringRiskManagement

Inour2011Environmental,SocialandGovernance(ESG)ratingsresearch,wefoundthatthecompanies

with the highest concentration of assets in shale gas plays are also the ones with the poorest

disclosure of key metrics such as fresh water withdrawal, incidence of spills, waste generation andtreatment.Thesecompanies include:UltraPetroleum,ChesapeakeEnergy,Range,andCabotOiland

Gas.

While companies overall track records can be indicative of their ability to manage the social and

environmentalrisksaroundshalegasdrilling,wenotethatcurrentlymostplayersinthe industryhave

notdisclosedsufficientdatatoallowinvestorstomakeindepthanalysisonthespecificrisksinvolvedor

the companies risk management capability. Given the different levels and types of exposure to

environmentalrisksinthedifferentshalebasins,moredetaileddataonthelocationofcompaniesshale

reserves is necessary to gain a fuller picture of the operational and reputational risks facing each

company. Additionally, disclosure specifically around the use and treatment of water in shale gas

operations is imperative for investors tounderstand theextent towhichcompanieshavebuilt in the

costs of maintaining operational integrity and potential exposure to future liability associated withaccidentsandcontamination.

Investors are activelypursuing specificdisclosure of fracking operations. For instance, theNew York

State Common Retirement Fund has successfully included fracking shareholder proposals at 16

companies.Furthermore,theU.S.SecuritiesandExchangeCommissionhasaskedoilandgascompanies

fordetailed informationon fracking, including fracking fluid chemicals compositionandmanagement

initiativesfordealingwiththeenvironmentalimpact.LegislationatthestatelevelincludingDelaware,

New York, Pennsylvania, and Wyoming has been proposed or adopted regarding disclosure and

standardsofoperationsandenvironmentalmanagementpractices.

2011

Proxy

VotingOilandgas companieshavecomeunderpressure toprovidemore information regarding

their exposure to risks associated with shale gas drilling. During the 2011 proxy season,

Institutional Shareholder Services Inc. (a subsidiary of MSCI) reported that shareholder

resolutions related to theenvironmental risksofshalegasdrillinggarneredanaverageof

40.7% support, a rise of 10 percentage points from 2010. The table below shows the

resolutions filed in 2011 seeking greater transparency on the environmental impacts of

hydraulicfracturingandtheimplementationofpoliciestoreducehazardsfromtheprocess.

*Theproposalswerewithdrawnaftervariousagreementswiththeshareholders.

Companieswithfrackingrelatedproposals

filedin2011Voting

percentage

Energen 49.5%Carrizo Oil & Gas 43.7%

Ultra Petrleum 41.7%

Chevron (Atlas) 40.5%

Exxon (XTO) 28.2%

Cabot Oil & Gas Corporation withdrawn*

El Paso withdrawn*

Anadarko Petroleum Corporation withdrawn*

Southwestern Energy Company withdrawn*


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October201

Ourassessmentofacompanysabilitytomanageenvironmentalimpacttolandresourcesisbasedon

thefollowingfactors:

Performancetrackrecordonfrackingoperations Performanceonwateruseandspills(benchmarkedagainstpeersbasedonavailabledata)

Evidenceofoverall

policy

implementation:

environmental

and

social

impact

assessment

prior

to

operations, initiatives forminimizing environmental disturbance and impact, and community

andstakeholderengagement

ClearpoliciestoprotectbiodiversityandrespecttraditionallandusepracticesWehave identifiedCabotOil&GasandChesapeakeEnergyashavingthepoorestperformance track

record, due to significant fines and pending lawsuits stemming from contamination and community

impact from fracking. Other companies with evidence of spills and blowups from fracking, or with

pendingorsettlednaturalgascontaminationlawsuitsincludeDevon,Talisman,EnCana,Southwestern,

EOG,andRangeResources. Supermajoroilandgascompanies,suchasShell,Chevron,ExxonandBP,

whilehaving comprehensiveenvironmentalandbiodiversitymanagement structures inplace,havea

history of controversies and poor performance including spills and contamination of sensitive

environments.Attheotherendofthespectrum,smallerplayers,suchasHess,PioneerorEQT

donot

seem to have the same level of involvement in poor performance while also having adequate

biodiversitypoliciesandpracticesinplace.

FIGURE 9 ProxyforCompaniesCapacitytoMitigateRisksAssessmentofEnvironmentalManagementinFrackingOperations

*DataanalyzedisincludedintheassessmentofcompaniesperformanceonBiodiversityandLandUse,oneoftheindustrykeyissuesonwhich

weevaluateoilandgascompaniesinMSCIsannualESGratingsresearch.Onthiskeyissue,weevaluatecompaniesonboththeirexposureto

andtheirabilitytomanagerisksoflosingaccesstoresourcesandofincurringlitigationandliabilitycostsduetooperationsthatdamagefragile

ecosystems.OtherindustrykeyissuesthatdetermineoverallESGratingsforcompaniesintheseindustriesincludeHealth&Safety,Corruption

&Instability,CarbonEmissions,andToxicEmissions. PleaserefertoIVAIndustryReportsonIntegratedOil&GasandonOil&GasExploration

andProduction,aswellascompanyprofilesfordetails.

EnvironmentalManagementofFrackingOperationsStrong

Weak


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October201

Webelievethat inthemediumterm,companieswithapoortrackrecordofmanagingenvironmental

impactwateruse,waste,spills,aswellasoperationalintegrityandsafetyorwithpoorpracticesof

community engagement, will be less prepared tomeetmore stringent regulations around shale gas

drilling. For companies unprepared to meet higher environmental and community standards,

unanticipatedfuturecostscould include requirements tobuildwaste treatmentfacilities,prolonged

permitting processes, legal costs associated with lawsuits or other environmental liabilities, lost

permits,andcleanupcosts.

Morespecifically,ourrecentanalysisofCabotshowsthat,unlikethemajorityofitspeersintheoil&gas

exploration and production industry, the company lacks a standard environmental policy, makes no

commitmentsrelatedtobiodiversityorlanduseprotection,andlackskeyprocessessuchaseffectiveor

adequateassessmentsofenvironmental impactbeforedevelopinganareaandprograms tominimize

environmental disturbances caused by its operations. Consequently, the company has faced fines,

numerous lawsuits,andtemporarybansfromusinghydraulicfracturingafterrepeated leaksandspills

intolocalwaterways.InonesettlementinNovember2009,thecompanywasorderedtohaveallfuture

casing and cementing plans approved by thePennsylvaniaDepartment of EnvironmentalProtection.

(ForcomprehensivedetailsoninvestigationsandcontroversiesimplicatingCabot,pleaserefertoMSCIs

ESG ImpactMonitor profile). These repeated offenses are indicative that the company is not well

equippedfromamanagementperspectivetoeffectivelymitigateitspropensityforwatercontamination

initshighriskoperations.

CabotisalsoonthePennsylvaniaLandTrustslistof25drillerswiththemostviolations,alongwithEOG

Resources,SouthwesternEnergy,Anadarko,andTalismanEnergy.The LandTrust issueda report in

August2010thatidentifiednearly1,500violationssinceJanuary2008committedby43MarcellusShale

drillingcompanies.ThePennsylvaniaDepartmentofEnvironmentalProtectionhasalso indicated large

numbersofviolationsinconnectionwithwastewaterhauling.Inone3dayperiod,theDEPreported669

traffic citations and 818 written warnings issued to trucks hauling waste water from drilling in the

Marcellus.

Thehigh

profile

nature

ofshale

gas

drilling

inthe

US

means

that

alltop

players

are

effectively

being

put

on watch for how they manage the substantial environmental and social risks involved in these

activities,whichinturnmayinfluenceshalegasdevelopmentglobally,inregionssuchasEurope,South

America, or Asia. For the super oil majors, any poor environmental performance that will generate

healthscaresor impact localwater resourceswill compromise the theirability togainaccess tonew

marketsinotherregions.


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October201

CONCLUSIONS

Companiesintheshalegasmarketmayfacetremendousopportunitiesbutafailuretoproperlyaddressthechallengesmayputthecompanyvaluationsathighrisk

Wateravailabilitymaybecomeaprobleminspecificbasins Waste water generation will increase with growth in production, further raising operational

costsandenvironmentalliabilitiesfromcontamination

Residential and environmental community opposition will likely remain high until adequateenvironmental management practices address water sourcing, waste contamination, and

methaneleaksattheoperationallevel

Themostdiversifiedcompaniesfacelowerrisktotheirvaluationandareinabetterpositiontoadoptbestpractices

Smaller players that are highly reliant on shale interests face the highest risk of longtermcompanydevaluation,especiallyforthosewithpoorrecordsofenvironmentalandsocialissues

andnoclearplanstoimprovethem


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AppendixI:WhatisShaleGasandHydraulicFracturing?

Shaleisgenerallydefinedasfinecompactgrainsofsedimentaryrockthatcontainoilornaturalgas(typicallymethane).

Whileshalebasinsholdlargeamountsoffossilfuelsthatrivalwhatisfoundinconventionalfields,theyhavelow

permeability,makingconventionalextractionmethodsuneconomical. AprocessknownasHydraulicFracturing

(commonlyreferredtoasfracking)isbeingemployedincreasinglybyoilandgascompaniestostimulateproductionof

oilandnaturalgasfromshalebasinsandotherreservoirssuchascoalbeds. Newdrillingtechniquesthatallowfor

horizontalanddirectionaldrillingatthedepthofthetargetedrockformationareopeningupvastnewquantitiesofoil

andgasresourcesthatpreviouslywereconsideredunrecoverable.

Keytotheprocessisafluidmixpumpedathighpressurethroughsteelandconcretewellboresintoshaleformations,

creatingfracturesandfreeingthefossilfuelstoallowfordesirableproductionflowrates.

Thefrackingfluidgenerallyconsistsofabout95%waterandsand,supplementedbychemicaladditivesthattypicallyare

nomorethan1to2%ofthemixbyweight. Whilethechemicaladditivesareproprietaryblendsthatvarybycompany,

theycommonlycontaintoxicsubstancessuchasbenzene,toluene,hydrochloricacidandsodiumhydroxide. These

substancesarelinkedwithcancer,endocrinedisruptionandothermajorhealthhazards.

Hydrocarbonreservesinshalerocktypicallyaredeepundergroundatdepthsof2,000to3,000meters(~6,500to10,000

feet),thoughsomereservoirsaremuchshallowerordeeper. Mostformationsarewellbelowdrinkingwaterresources

andseparatedbyimpermeablelayersofrock. However,productionwellsmaygothroughdrinkingwaterresourcesto

accesstheseresources,andpoorwellcasingscanleadtowatercontamination. Reservoirsatshallowdepths,whicharecommonforothernaturalgassourcessuchascoalbedmethane,presentamuchhigherrisktoshallowwaterresources.

Surfacewatercontaminationisanotherpotentialhazard. Whilealargeamountofthefrackingfluidremains

underground(creatingpotentiallongtermliabilities),alargeproportionalsoreturnstothesurface,dependingonthe

welllocationandunderlyinggeologicalcharacteristics. Thishighvolumeoffluidwastemustbemanagedcorrectlyto

avoidcontaminationofsurfacewatersupplies. Becauselocalwastewatertreatmentusuallyisnotavailable,mostfluid

wastemustbetransportedoffsite. Thiscreatesasubstantiallandfootprintconsistingofwastewaterpits,storagetanks,

transportationlines,trucksandotherequipment. Communitiesnotaccustomedtothislevelofindustrialactivityand

exposuretotoxicwastemayseektoblockdevelopmentactivityandincreaseregulatorycontrols.

Source:ProPublicahttp://www.propublica.org/special/hydraulicfracturingnational


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October201

France

Germany

Netherlands

Norway

U.K.

Denmark

Sweden

Poland

Turkey Ukraine

LithuaniaOthers

UnitedStates

Canada

Mexico

China

India

Pakistan

Australia

SouthAfrica

Libya

TunisiaAlgeria

Morocco

WesternSahara

Mauritania

Venezuela

Colombia

Argentina

Brazil

Chile

Uruguay

ParaguayBolivia

TechnicallyRecoverableShaleGasResources(trillioncubicfeet)

Source:EIA,2009

AppendixII:GlobalDistributionofUnprovenShaleGasReserves


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AppendixIII:CompositionofFrackingFluid

Source:ModernShaleGasDevelopmentintheUnitedStates:APrimer,April2009WorkPerformedUnderDEFG2604NT15455Preparedfor

U.S.DepartmentofEnergyOfficeofFossilEnergyandNationalEnergyTechnologyLaboratoryPreparedbyGroundWaterProtectionCouncil

OklahomaCity,OK.ALLConsultingTulsa,OK.


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Documents

Unconventional Oil Gas_Article_October 2011.pdf