My recent trip to the United States included two days as a guest of BHP Billiton, where I inspected America's shale gas and oil fracking boom at close quarters. BHP has spent $US20 billion ($19 billion) on two US shale acquisitions, and the tour gave me greater confidence that it will get the return it requires. There is undeniable environmental event risk attached to the fracking play, but it appears to be acceptable.
The shale boom has generated a surge in US gas production at a time when US exports of gas are prohibited, pushing the domestic gas price lower. Between February 2011, when BHP first bought in, and March this year, the gas price halved to $US1.84 a thousand cubic feet.
It was recovering by August when BHP booked a $2.8 billion pre-tax write-down on its first $US4.6 billion shale acquisition, and at $US3.61 a thousand cubic feet is now close to where it was when BHP arrived.
The petroleum boss, Mike Yeager, has nevertheless refocused BHP's well development program on leases that are much richer in more highly valued oil and other liquids that it acquired in a later $US15 billion shale acquisition of the Petrohawk group. Shale production fell from initial rates fairly quickly but remains commercial, and BHP will book volume gains by aggressively developing its acreage.
The group needs strong gas prices to extract full value however, and that will involve the US allowing gas to be exported, creating new markets and opening up market price arbitrages that will pull up on the US price.
The BHP chief executive, Marius Kloppers, said on Thursday it could take five to 10 years, but it all depends on complicated political and economic cost-benefit analysis. Gas exports would reduce the size of the gas resource available to Americans, and push domestic prices higher. But they would also underpin a shale boom that has the ability to make the US energy self-sufficient, and as fracking technology goes global, to break the pricing power of the Organisation of the Petroleum Exporting Countries.
Environmental concerns about the shale oil and gas boom throw up similar social, economic and political trade-offs, and for the shale producers themselves, including BHP, one commercial risk is that rock-fracturing technology will create an environmental shock or series of shocks that halt production, or trigger rules and regulations that significantly increase development costs.
My feeling so far, informed by what I saw with BHP in Texas, where its best fields are located, and on what I was told in my subsequent talks with analysts, economists and other experts in New York, is that the most commonly cited environmental risk from fracking, groundwater contamination, is overstated but that the boom is not risk-free.
Shale fracking involves drilling down through water tables that typically extend down as far as 300 metres to shale beds that are typically between 1500 and 1800 metres below the surface - much deeper, by the way, than the drilling and fracking of coal beds for methane gas that is occurring elsewhere, including in northern Queensland, where it underpins Australia's liquefied natural gas export boom.
Wells in the US shale fields that have reached their target depth are gradually angled until they extend horizontally inside the shale for a few hundred metres. The shale is then perforated with explosive charges, and a mix of 90 per cent water, 9.5 per cent sand and 0.5 per cent chemicals is injected under pressure into those holes to create a network of fractures, freeing up gas, oil and other hydrocarbon liquids to flow up to the surface.
Although the chemical cocktail is only 0.5 per cent of the total volume injected, that is still about 5000 barrels a well, and it is not benign. It includes acids used in pool cleaning products, salt, polyacrylamide, which is a soil conditioner, glycol, better known as automobile anti-freeze, borate salts and common salt, disinfectants and isopropanol, a viscosity agent that is also found in glass cleaners and antiperspirants. Almost all of the slurry returns to the surface after the rock has been cracked, however, and in a typical well there is about 1600 metres of impervious rock between the fracking area and the water table above.
The risk of contamination of the water from fracking that occurs that deep is low. More than a million producing wells have been drilled using the technology, and the US Environmental Protection Agency has documented only one clear case of groundwater contamination, near Pavillion, Wyoming. That well was fracked at much shallower levels, and much closer to a water table that was already showing signs of hydrocarbon contamination.
The Pavillion incident shows that regulations that ensure that fracking occurs deep below the water table are a minimum requirement, and there are other important environmental issues. About 100,000 barrels of water are needed to frack each well, for example. Sourcing it is a logistical problem already in the US and will be a bigger one in other places around the world where the same shale resource exists, notably in China.
Processes for either recycling or safely disposing of the fracking slurry are also not fully developed, and because the fracking liquid is basically a slippery gel, it can and has caused rock fault slippage, and minor earth tremors. Claims that fracking slurries are "earthquake viagra" are almost certainly hyperbolic, but this subject needs exploring.
A final objective risk is connected to the fact that it takes many, many more wells to extract a given amount of oil and gas from a shale resource than it takes to extract the same amount of oil or gas from conventional reservoirs. If you use a satellite view of the fields in Texas, for example, drilling pads dot the landscape like stars in the Milky Way. Every one of those wells has to go through the water table that lies close to the surface.
There is however a well-established process that sees wells drilled with a wide bit down below the water table, a smaller drill casing inserted, and the outer ring back-filled with cement to create a water-tight shield.
It works when done properly, almost always is done properly, and companies like BHP that use high-end drilling contractors are further minimising the risk: BHP's main contractor is Schlumberger, which in terms of technical proficiency is about as good as it gets.
My second to last thought is that while more drill rigs per barrel of oil increases drilling risk, the flip side - lower production per well and lower well pressure - teams up with the fact that the drilling is on dry land to reduce the risk of a major accident being caused by one fracking mistake. Risk is distributed more widely in a fracking field just as it is, say, in the finance sector in retail lending compared with wholesale, corporate lending.
And my final thought is that if environmental concerns about fracking are overcome and the boom continues, the push for lower emission energy sources is going to be more difficult.
There's enough oil, liquids and gas in the shale fields that are amenable to fracking around the world to suppress "peak oil" price pressure for decades. Oil and gas might still be discouraged by carbon pricing regimes, but their policy-free, base price will be lower in a world where fracking is ubiquitous, and the economic and geopolitical dividends on offer from the boom that could end OPEC's stranglehold will be hard for policymakers to ignore.
Frequently Asked Questions about this Article…
What exposure does BHP Billiton have to the US shale fracking boom and how might that affect investors?
BHP Billiton has invested heavily in US shale: the group spent about $US20 billion on two US shale acquisitions (including a $US15 billion Petrohawk deal) and booked a $US2.8 billion pre‑tax write‑down on its first $US4.6 billion acquisition. Management has refocused development onto acreage richer in oil and liquids to improve returns. For investors, that means BHP’s returns are tied to shale production performance, commodity prices and execution risk on aggressive development.
How has the shale fracking boom affected US gas prices and what could change prices in future?
The US shale boom pushed gas production up and domestic gas prices down — the article notes prices halved from February 2011 to March (to about $US1.84 per thousand cubic feet) and were recovering to around $US3.61 by August. A key potential price driver is US gas export policy: allowing exports would open new markets, create price arbitrage and likely pull US prices higher. BHP’s CEO estimated exports could take roughly five to ten years, depending on political and economic decisions.
What are the main commercial risks for companies involved in shale fracking?
Commercial risks include low domestic gas prices (unless exports are allowed), the need to drill many more wells per unit of output than in conventional fields, rapid early production declines from shale wells, potential environmental shocks that could halt production or trigger costly regulation, and logistical challenges such as water sourcing and slurry disposal. These factors can increase development costs and add volatility to returns.
How real is the groundwater contamination risk from fracking, and what has been documented?
The article says groundwater contamination risk is often overstated but not zero. Most US shale fracking occurs 1,500–1,800 metres down while water tables typically extend to about 300 metres, with around 1,600 metres of impervious rock between the frack zone and groundwater in a typical well. The US EPA has documented only one clear case of contamination (near Pavillion, Wyoming), and that well was fracked much shallower and closer to an already affected water table.
What chemicals and water volumes are used in fracking wells, and why does that matter for investors?
Fracking fluid is roughly 90% water, 9.5% sand and 0.5% chemicals. Although 0.5% sounds small, the article notes it can be about 5,000 barrels of chemicals per well, and total water needed can be about 100,000 barrels per well. This matters because sourcing large water volumes, handling returned slurry and safely disposing or recycling fluids are logistical and cost issues that can affect project economics and lead to regulatory scrutiny.
What operational practices do companies use to reduce environmental risk in fracking?
Common risk‑mitigation practices include drilling well below the water table, inserting a smaller production casing and cementing the outer ring to create a water‑tight barrier, and using high‑end drilling contractors. The article cites Schlumberger as BHP’s main contractor, noting that established contractors and correct procedures substantially reduce contamination risk when done properly.
Could widespread fracking change global oil and gas markets and OPEC's pricing power?
Yes — the article argues that if fracking technology goes global, the shale boom has the potential to make the US energy self‑sufficient and to weaken OPEC’s pricing power by increasing global supply. That would likely lower the policy‑free base price of oil and gas for decades, although carbon‑pricing policies could still influence demand and returns.
What should everyday investors consider before investing in fracking or shale energy stocks?
Everyday investors should weigh exposure to commodity price swings (especially gas and liquids), operational execution (drilling performance and decline rates), environmental and regulatory risk (potential rules that raise costs), and logistical challenges like water and waste handling. Company‑specific factors matter too — for example, BHP’s large spend, its shift toward oilier leases, past write‑downs and choice of contractors — all of which affect risk and return profiles.
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