O&G regulation risk

[snow pea]

O&G are pretty far outside of my circle of competence so I generally leave such companies in the 'too hard' pile, but I am nonetheless curious to what degree those of you who have knowledge, interest, and/or investments in O&G pay attention to / quantify regulation risk, and in particular macro regulation risk due to (for example) climate change activism, such as the possibility of carbon taxes and/or broad carbon emission regulations?  To the degree that I have read through O&G related threads here, I can't recall seeing much discussion of this.  Maybe it is generally considered a non-factor as politically unlikely?  Or perhaps I have just missed it - I would be happy with a link to a thread where it has been discussed if this is not a new topic.

 

I am somewhat spurred to this curiousity by this (not particularly new) article, which in a long winded way describes a tool which has apparently been added to Bloomberg terminals and which apparently allows modelling not only of how various O&G companies' assets and profitability would be affected by changing commodity prices, but also seemingly of at least some effects of potential regulation, such as "loss of earnings because of "prompt decarbonization"; and loss of earnings because of "last-ditch decarbonization"".  (I don't know exactly what is being referred to as 'prompt decarbonization' or 'last-ditch decarbonization' - the terms aren't defined in the article.)

 

http://insideclimatenews.org/news/20131203/bloomberg-lp-launches-first-tool-measures-risk-unburnable-carbon-assets

 

 

[ItsAValueTrap]

In theory, the North Dakota / Bakken shale producers are at risk because they flare a lot of wet natural gas.  They just burn it, it goes to waste, and contributes to more carbon dioxide in the atmosphere.

 

The economics of wet natural gas aren't that great if the area lacks infrastructure.  You cannot sell wet natural gas because it burns too hot.  Most pipelines won't accept it because (I'm not sure but I think this is the reason) the ethane will turn into a liquid if the pipeline is applying lots of compression.  So you need cyrogenic processing plants to get rid of the ethane in the natural gas so you have "dry" natural gas.

 

2- There are major environmental movements against:

A- oil and gas pipelines like Keystone XL.  There are also environmentalists who want to stop Kinder Morgan's Canadian pipeline expansion.

B- fracking.  Environmentalists have concerns about water pollution and whether fracking might cause earthquakes.  In New York fracking is banned.

 

In my opinion, a lot of environmentalists are misguided.  The real problems with water pollution happen when companies improperly dispose of the water that flows back after fracking.  The right way to do it is to inject the water into a well.  The wrong way is to dump it into rivers (e.g. they send the water to a plant for processing, the plant doesn't process it properly so they make easy money, and they just dump the water into the river).

 

3- IMO the biggest risk in oil and gas stocks is reserve inflation.  Almost every company does it.  You can commit fraud without almost no consequences or repercussions, and most investors are too unsophisticated to ask the right questions.

[bizaro86]

There are two types of regulatory risk, imo.

 

Project regulatory risk is easier to estimate for someone with domain knowledge. As an example AOS.TO was an easy short a few years ago, because their main project had no chance of being approved for a number of critical reasons (depth of resource, pressure required, proximity to an airport, etc).

 

Macro regulation changes are harder for me to quantify, because they depend on politics. I have occassionally run sensitivities in a model on how much I would expect a given price/tax for CO2 to affect different producers as part of a downside valuation, but I have a hard time predicting actual changes in regulation. If gov'ts worldwide started taxing all petroleum products at $2 per gallon for environmental reasons, that would destroy most O&G economics due to demand destruction. I have no good way of accounting for that, so I usually just put it in my "only buy things with a margin of safety" bucket.

[snow pea]

Thank you both very much for your thoughtful responses.  Very interesting and helpful points of reference.