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Morningstar | Colorado Proposition 112 Threatens Statewide Fracking Operations

Shares of Anadarko Petroleum and Noble Energy have underperformed in the past couple of months as Proposition 112 has gained traction in Colorado. If the referendum passes on Nov. 6, it would effectively shut down drilling operations in the state, rendering undeveloped leases worthless. The proposed legislation would ban all activity within 2,500 feet (approximately half a mile) of buildings, playgrounds, amphitheaters, parks, or bodies of water. That's a much higher hurdle than the current setback rule, which only protects land within 500 feet of homes, schools, and hospitals. The Colorado Oil & Gas Conservation Commission estimates that 94% of land in the five counties that account for most of the state's output would be off-limits. In that scenario, no new drilling would occur. But as production from wells already on line would be unaffected, shale production in Colorado would not go to zero overnight.

Previous ballot initiatives aimed at stifling shale activity in Colorado have fizzled out. Proposition 112 does appear to have more momentum, with one poll showing 60% support. But because the fiscal consequences would be devastating, the current initiative has bipartisan opposition (Republican and Democratic gubernatorial candidates are both against extending the setback rule). According to a Common Sense Policy Roundtable study, 43,000 jobs would be lost in the first year of implementation and almost 150,000 jobs could be lost in total by 2030 (77% of which would be outside the oil and gas industry). In addition, lost tax revenue could surpass $1 billion by 2030. Accordingly, we see little chance that Proposition 112 will succeed, and our fair value estimates for both Anadarko and Noble remain unchanged.

Media reporting on the setback issue picked up steam in late July. Subsequently, shares of Anadarko and Noble declined by about $12 and $5, respectively. For the former we assign a value of about $25 per share for Colorado production that could be at risk if Proposition 112 is successful. That suggests that the market is assuming a 50% chance that the legislation passes. But the full value of Noble's DJ Basin operations is $6 per share, and only half of that is potentially at risk (as wells already on line are very unlikely to be be affected). Therefore the market has potentially overreacted in the latter case, although in practice it is impossible to determine how much of the observed decline is actually attributable to the proposed ruling. In any case, both stocks still trade above our fair value estimates, reflecting our bearish take on midcycle crude prices.