The proliferation of exchange-traded funds (ETFs) has certainly changed the way modern investors construct portfolios. Everything from Chinese technology stocks to water-related companies can be added to one’s holdings via a single ticker. ETF issuer Van Eck, best known for its Market Vectors Gold Miners ETF (NYSE:GDX) and Agribusiness ETF (NYSE:MOO), recently unveiled a new fund that could appeal to a variety of energy investors.
A Bet on Unconventional Assets
As the emerging world has continued to grow at the breakneck speeds of modernization, global energy demand continues to skyrocket. But supplies continue to remain restricted. This has pushed prices up. These higher prices, coupled with long-term demand, have created an opportunity for those E&P companies (and investors) looking to extract energy from once-inaccessible locations. The new Market Vectors Unconventional Oil & Gas ETF (NASDAQ:FRAK) allows investors to directly tap into the growth of these unconventional and alternative sources of energy. The key to unlocking these hydrocarbons is new advances in technology, such as hydraulic fracturing and horizontal drilling. Energy companies now have the ability to tap rock formations and breathe life into old/dry wells using these advances.
FRAK defines unconventional energy as one of three broad groups: shale, coal-bed methane/seam gas and oil-sands assets. Shale sedimentary formations, such as the Marcellus and Bakken, have seen surging interest from E&P companies as “fracking” the hard rock has become commonplace. Using this drilling technique, the U.S. now has access to an abundance of natural gas and shale oil.
Natural gas prices have fallen from a peak of around $15 per million BTUs in the early 2000s to today’s $3. While not as familiar to many investors, coal-bed methane refers to natural gas that has been absorbed into coal and is extracted much the same way as shale gas. Oil-sands assets refers to Canada’s vast fields of sand/clay that are mixed with petroleum. Companies either mine the soil or use a combination of horizontal drilling and steam injection to extract the hydrocarbons locked within. Interestingly, Van Eck’s “industry spotlight” white paper says the company doesn’t include ultra-deepwater salt formations or Arctic drilling in its definition of unconventional assets.
Breaking Down the New ETF
Van Eck’s new fund will track 43 companies that derive more than 50% of their revenues from the previously defined unconventional sources of oil and gas. The bulk of the ETF’s holdings are in the U.S. (71%), followed by Canada (29%). Major integrated oil company Occidental Petroleum (NYSE:OXY) is the top holding, at 8.49% of assets. Oxy has been pretty successful in using enhanced oil recovery (EOR) techniques to gain access to a variety of shale reserves. This includes more than 200,000 net acres in the oil-rich Bakken as well as the Three Forks Basin.
Oxy recently reported brisk fourth-quarter earnings, with the only drag attributable to lower results from its commodity-trading division. Other top holdings include perpetual buyout/M&A target EOG Resources (NYSE:EOG) at 7.42% of assets and Canadian Natural Resources (NYSE:CNQ) at 7.6%. The remaining holdings are a virtual Who’s Who of top natural gas and oil-sands companies.
Expenses for the new Van Eck ETF aren’t outrageous at 0.54% and are below the category average of 0.58%. While not as inexpensive as, say, the broader-based Vanguard Energy ETF (NYSE:VDE) at 0.19%, the ETF is relatively cheap for a specialty fund. For example, Van Eck’s own Market Vectors Africa Index ETF (NYSE:AFK) charges 0.79%. Van Eck also has a history of lowering expenses for its ETFs as they accrue popularity and assets. That potential is certainly here since FRAK’s underlying holdings represent a longer-term bet.
While many of its underlying holdings are available in more broader-based energy ETFs, such as the SPDR S&P Oil & Gas Exploration & Producers (NYSE:XOP), FRAK could be used as an attractive satellite play when coupled with a more wide-reaching commodity fund. Van Eck’s own Market Vectors RVE Hard Assets ETF (NYSE:HAP) makes an ideal choice. Using FRAK with a broader play, investors can potentially gain additional alpha by overweighting the more volatile sector.
Investors may not need to use FRAK at all, though. Guggenheim Canadian Energy Income (NYSE:ENY), which I’ve written about before, tracks a basket of 34 Canadian oil-sands and natural gas companies, many of which are included in FRAK. The fund’s underlying index shifts exposure to natural gas or oil based on trends in commodity pricing.
The Guggenheim fund yields a healthy 2.71% and charges 0.65% in expenses. Perhaps the best way to profit from the shift to unconventional drilling is a bet on the companies that provide the equipment. The oil-services industry has seen tremendous growth over the last few years as fracking, deepwater drilling and oil-sands production have taken off. The SPDR S&P Oil & Gas Equipment & Services ETF (NYSE:XES) might make a better overall play on unconventional drilling than the FRAK unconventional ETF.
Overall, FRAK represents a unique opportunity in the energy space. For investors, the best way to use the new fund would be in a core-and-satellite approach rather than on its own. Still, given the other options out there to play the unconventional space, it remains to be seen if the new ETF will catch on.
The author is long XES.