Fracking hits home

Is fracking the next boom to go bust?

One by one, they filed into the city council chambers. They took their seats and waited their turn, and once there weren’t any seats left, they moved to the seldom-used overflow seating. When the overflow seating filled, they moved to the civic center so they could watch the meeting on a closed-circuit feed.

There were more than a dozen items on the council’s agenda that Tuesday evening in July, but there was only one item that the massive crowd was concerned with. As each of them took their turn at the microphone, some cited health risks, earthquakes and pollution as drawbacks. Others cited jobs, commerce and energy independence as benefits. 

Both sides made point after valid point. For nearly 10 hours. 

Finally, after Tuesday evening had melted into Wednesday morning, the seven members of the Denton City Council decided that the prospect of banning hydraulic fracturing within the city limits was an issue better left for the people to decide.

Now, residents of the Texas city, located roughly 40 miles north of Dallas, will go to the polls in November to decide whether Denton will become the first city in Texas to ban the practice known as fracking.

Fracking, or hydraulic fracturing, is the practice of injecting a mixture of water and chemicals into underground rock formations to release previously inaccessible oil and gas reserves that were trapped within the rock.

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In many cases, these shale formations are located underneath developed areas, including neighborhoods. Unconventional gas drilling, or horizontal fracking, allows the wells to be built hundreds or thousands of feet away from the developed land while still allowing access to the valuable energy buried within the earth.

The safety of fracking is being debated all over the country, but the perception of its safety is just as important when it comes to the housing market.

“I don’t want to live in a place where there are earthquakes, or where you can light water on fire,” Denton resident Denise Clyne-Ruch told HousingWire at the July city council meeting.

Despite all the statistics, data and economic factors, a property’s value is truly determined by what someone is willing to pay for it. And if no one wants to live in areas with fracking, then property values in those areas will plummet.

And that would lead to a potentially massive problem that many aren’t considering. We may be teetering on the verge of another financial crisis in this country and it could be because of what’s buried thousands of feet beneath the earth. 

In the New York State Bar Association Journal, Elisabeth Radow, the managing attorney of Radow Law PLLC, and chairwoman of the League of Women Voters of New York State’s Committee on Energy, Agriculture and the environment, wrote an article that examined that possibility. 

“The question arises then, whether there could be another mortgage crisis if a cumulative number of mortgaged homes in the 30 to 35 states with current and intended residential fracking experience water contamination or structural damage as a result of, or coincidentally with, unconventional gas drilling operations, rendering the residential mortgage collateral unmarketable and the borrower unable or unwilling to pay off the loan,” Radow writes.

Fracking 3The health of the country’s economy is dependent on property values increasing. If the tide turns on fracking and properties in fracking areas suffer a dramatic decrease in value due to a definitive connection being drawn between fracking and earthquakes, or if science proves that fracking causes significant health issues, for example, plummeting property values are exactly what could happen.

On the other hand, the development of horizontal fracking has enabled homeowners to lease their mineral, or subsurface, rights to oil and gas companies for mountains of cash. With all of that money to be made, gas wells have become a common sight in Texas, Pennsylvania, West Virginia and North Dakota. 

But those aren’t the only states where fracking has become common practice. According to an article published in the Albany Law Review’s April issue, there are between 30 and 35 states where unconventional gas drilling occurs or is planned to occur.

An October 2013 article in the Wall Street Journal stated that at least 15.3 million Americans have lived within a mile of a gas well that has been drilled since 2000, but those figures are based only on the gas wells in 11 states. 

The actual total number of Americans affected by fracking is unknown, but fracking’s impact is unquestionably widespread, and it’s growing.

“This is not a short-term boom,” Harry Weiss, a partner with Ballard Spahr’s Environment and Natural Resources Group, said in an April webinar titled “Oil and Gas Exploration for Mortgage Bankers.”

Weiss told attendees that shale production will continue to climb exponentially as additional states allow fracking.

The Marcellus shale, which stretches from Tennessee to upstate New York, has seen natural gas production “skyrocket,” according to Weiss. “Marcellus production has enormous potential for growth,” he said. “New York state has not allowed drilling yet, but when it does, production will be off the charts.”

But in areas where gas wells have become a constant presence, many residents haven’t exactly extended a warm welcome to the oil and gas companies that have now become their neighbors, as evidenced that July evening in Denton when several in the crowd used the term “motherfrackers” in regards to the gas companies.

For those in the anti-fracking faction, the risks that stem from the drilling are significant. Radow presents a laundry list of potential hazards presented by fracking.

“The gas companies‘ 10-Ks, filed with the Securities and Exchange Commission, characterize unconventional gas drilling as subject to many risks,” Radow wrote.

The SEC’s list of hazards includes blow-outs, fires, explosions, cement and pipe failure, casing collapse, pipeline ruptures or spills, chemical spills, mechanical failure, craterings, pressure or irregularities in formations, accidental, uncontrollable flows of oil, natural gas or well fluids, pollution, releases of toxic natural gas and other environmental hazards and risks.

Notably absent from that list are earthquakes, but many fracking opponents claim the drastic increase in earthquakes in fracking regions is caused by the drilling and its related practices. The numbers appear to be on their side.

Radow cites a study from the United States Geological Survey (USGS), which states that earthquakes have spiked in areas that were nearly earthquake-free before fracking became commonplace.

“The number of earthquakes has increased dramatically over the past few years within the central and eastern United States,” Radow wrote. “Nearly 450 earthquakes magnitude 3.0 and larger occurred in the four years from 2010-2013, compared with an average rate of 20 earthquakes per year observed from 1970-2000.”

Radow added that USGS scientists have found an increase in seismic activity at some locations coinciding with the injection of wastewater in deep disposal wells.

During the fracking process, wastewater is produced and must be disposed of because it contains a potentially toxic mix of chemicals. The wastewater is injected back into the ground to avoid contamination of fresh-water sources.

Proponents of fracking say that there is no direct connection between fracking and a rise in significant earthquakes, but some do acknowledge the possibility of a connection between fracking and an increase in low levels of seismic activity.

The American Petroleum Institute, which refers to itself as “the only national trade association that represents all aspects of America’s oil and natural gas industry – speaking for the industry to the public, Congress and the Executive Branch, state governments and the media,” funds the website as part of its Energy Tomorrow project.

Under a section on the site titled “Does Fracking Cause Earthquakes?” the organization concedes that fracking does indeed generate “micro-seismic” activity.

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“During hydraulic fracturing, the micro-seismic events are generally less than magnitude minus two or minus three on the Richter scale,” the site states.

“A study of hydraulic fracturing-related seismic activity in England found that the combination of geological factors necessary to create a higher-than-normal seismic event was ‘extremely rare’ and such events would be limited ‘to around magnitude 3 on the Richter scale as a worst-case scenario.’”

A July article in Scientific American identifies a particularly troubling scenario in Oklahoma. “More than 230 earthquakes with a magnitude greater than 3.0 have shaken the state of Oklahoma already this year,” the article begins. “Before 2008, the state averaged one such quake a year.”

The article references a recent study that posits that the increase in earthquakes in that region may be due to wastewater injection. “It really is unprecedented to have this many earthquakes over a broad region like this,” study co-author Geoffrey Abers of Cornell University told Scientific American. 

“Most big sequences of earthquakes that we see are either a main shock and a lot of aftershocks or it might be right at the middle of a volcano in a volcanic system or geothermal system. So you might see little swarms but nothing really this distributed and this persistent.”

Whether the increased rate of earthquakes is actually caused by fracking and wastewater injection is still up for debate, but no one can argue that there are more earthquakes in fracking regions than there were before.

Another serious concern is the potential health risks for the people that live near fracking wells. 

In North Dakota, gas wells have turned the state into “the Saudi Arabia of the United States,” according to Weiss.

The state is producing so much gas right now that the energy companies don’t have the ability to capture and transport it all, so the companies have resorted to burning off the excess gas. The North Dakota Industrial Commission recently had to issue a new policy designed to reduce the natural gas flaring that takes place in the state.

However, despite all of the potential negatives, the benefits of fracking are bountiful as well.

Most significant among those is the amount of oil and natural gas that is now being produced domestically. In North Dakota alone, over 1 million barrels (or 42 million gallons) of oil are produced daily.

In November 2013, the U.S. crossed a critical threshold on its journey towards energy independence. “In October, domestic oil production exceeded crude oil imports for the first time since 1995, while petroleum net imports were the lowest since February 1991,” Dan Utech, the director for Energy and Climate Change at the White House Domestic Policy Council, said at the time.

Utech credited new technology — fracking — which “helped to unlock domestic energy supplies in places like North Dakota and Texas,” as a driver of the increase in oil production.

At this point, it seems that the fracking debate is approaching critical mass. Cities with new energy reserves are seeing home prices increase (see map), while other cities like Denton are considering bans. 

Lenders are starting to respond to the issue. The Federal Housing Administration is directing appraisers to consider the impact of current or future gas drilling on a property’s valuation.

And with the outsized portion of the mortgage market being guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae, the banks that issue mortgages may need to think twice about lending in fracking areas.

“It is possible that certain originating banks have continued to make residential mortgage loans on properties encumbered by gas leases, which are then sold into the secondary mortgage market, possibly due to underwriting that did not include a review of the full lease or an appraisal that does not reflect the full scope of future gas drilling operations,” Radow writes. 

This action could expose these originating banks to liability at a later date if the Federal Housing Finance Agency or harmed investors in the secondary mortgage market seek recourse against the originating bank because the residential collateral supporting the residential mortgage backed security experiences adverse impacts, such as water contamination or structural damage transforming it into a toxic asset.

Some banks have begun requiring borrowers to sign a rider on their mortgage, preventing the borrowers from entering into a gas lease.

“It‘s becoming wide-spread across the industry. Servicers and lenders are becoming more unwilling to approve a loan on these properties,” Amy Bonitatibus, vice president of communications for JPMorgan Chase told in 2013. “At the end of the day, we may not even own the loan.” 

When contacted by HousingWire, Fannie Mae said that its policies allow for oil and gas activities on properties that secure Fannie-backed loans. “In all cases, the homeowner must contact their servicer to make sure the proposed activities meet our standards and that they take the required steps for approval,” Fannie said. 

“The homeowner must also work with their servicer to submit information about the proposal to Fannie Mae. We would then work with the servicer to determine if the proposal is acceptable.”

Freddie Mac’s policies are similar. “Our seller/servicer Guide does not explicitly prevent the sale of a mortgage secured by a property where gas extraction is occurring,” Freddie Mac said. 

“The same is true of a mortgage secured by a property where extraction is occurring on an adjacent property. That said, our guide (which has the force of contract) includes a number of provisions dealing with appraising/inspecting a property with oil and mineral rights.”

Among those conditions is that the lender must tell the appraiser if they are aware of any detrimental conditions on the subject property caused by subsurface drilling. Those conditions must be taken into account “when determining the property’s value and marketability,” Freddie said.

Radow outlines the possible threat. “The cumulative effect of unconventional gas drilling on residences poses a potential threat to the nation’s $6.7 trillion secondary mortgage market, since the secondary mortgage market is supported by an unknown number of mortgages affected by residential fracking,” she wrote.

In case anyone forgot, it was a secondary market crash that nearly destroyed this country’s economy just a few years ago. In that case, corporations were operating in an environment where lax regulations allowed for huge profits. In some quarters, fracking sounds all too familiar in that respect. 

“An America where residential fracking operates at the intersection of Wall Street and Main cannot proceed as it is without fallout ahead,” Radow said.

But before that happens, we may all get rich. The boom before the bust. Where have we seen this before?

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