Some of the companies in the exploration and production industry may have underestimated the regulatory risk in the business model as the opponents of hydraulic fracturing ramp up the battle against this controversial drilling technique.

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Any large scale restrictions on the use of hydraulic fracturing or significant added cost to wells would render many unconventional resource basins uneconomic to develop. The industry is currently facing regulatory threats from several different areas.

Federal Level
At the federal level, the Environmental Protection Agency (EPA) announced in early 2010 that the agency was studying the impact that hydraulic fracturing may have on drinking water. The EPA is holding a series of hearings around the U.S. to solicit input from the industry and those Americans who live in areas where hydraulic fracturing is used.

The EPA also requested data on the chemicals used in this process from nine oil service companies that are involved in this sub segment of the industry. These include industry leaders like Halliburton (NYSE:HAL), Baker Hughes (NYSE:BHI) and Schlumberger (NYSE:SLB). Other companies receiving requests included Weatherford (NYSE:WFT), Patterson-UTI (Nasdaq:PTEN), Complete Production Services (NYSE:CPX), Key Energy Services (NYSE:KEG). RPC, Inc. (NYSE:RES) and Superior Well Services (Nasdaq:SWSI). The EPA expects the initial results of the study to be released in 2012.

Some companies have voluntarily released data on the fluid content. Several months ago, Range Resources (NYSE:RRC) started releasing to the Pennsylvania Department of Environmental Protection information on the additives used in fracturing wells in the Marcellus Shale.

State Level
Another front has been opened by the Delaware River Basin Commission (DRBC), which is a federal-state compact government agency formed in 1961 by Congress and Pennsylvania, New York, New Jersey and Delaware. This commission has authority over water issues in the Delaware Basin. In May 2009, the DRBC ordered that companies could not commence any natural gas drilling in shale areas without the commission's approval within the drainage area of the Special Protection Waters of the basin. The drainage area covers several counties in Pennsylvania, New York and New Jersey. The DRBC is expected to release draft regulations by the end of the summer of 2010, to be followed by a public rule making process.

In New York, the State Senate voted in early August 2010 to ban the issuance of permits for hydraulic fracturing of wells through May 15, 2011. The measure passed by the overwhelming margin of 48-9. The New York State Assembly is set to take up the bill in September 2010, and then it would have to be signed by Governor Paterson to become law.

An interesting side note to the hysteria regarding hydraulic fracturing in New York is that the first natural gas well to undergo fracturing was located in Fredonia, New York. The well was drilled in 1857 and failed to produce natural gas. The driller used gunpowder to induce fracturing of the formation, and the well started producing natural gas shortly after this innovative technique was used.

The Bottom Line
The oil and gas industry is facing an onslaught of regulatory burdens as several federal and state entities study and update regulations on hydraulic fracturing. Any significant restrictions or added costs here might threaten the manufacturing business model of oil and gas development used in unconventional resource plays. (For related reading, take a look at Understanding Oil Industry Terminology.)

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