Term Sheet

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The fracking hedge

January 6, 2012: 12:36 PM ET

How investment firms protect themselves from a ban on fracking.

Last month, some fracking chemicals allegedly found their way into a Wyoming aquifer. Then there were a pair of mild earthquakes in Ohio, which some geologists claim were caused by fracking in that state.

It still seems highly unlikely that the EPA would institute any sort of blanket ban on fracking – particularly given that the U.S. is now a net refined fuel exporter – but even a small chance could cause worry within a private equity sector that has invested tens of billions into such projects over the past couple of years.

So I rang up a private equity exec whose firm has made several large shale bets to see how he's hedging against the potential for EPA action.

He began by saying that you need to bake in the likelihood of tighter regulations going forward, since this is still an emerging industry – particularly in terms of emissions management and waste disposal. In terms of a doomsday hedge, he says the key is making sure the fund also has plenty of existing production properties (either conventional or already fracked):

"If fracking was totally banned, then existing production would be worth a whole lot more because natural gas prices would suddenly spike on the decreased supply," he explains. "If you ban fracking the supply of natural gas evaporates in the course of a month, so commoidty prices expand from $3 to $7 in a heartbeat... Unconventional assets are obviously the future, but you need to protect yourself by also having some of the past."

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About This Author
Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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