by Aaron Levitt | April 24, 2012 11:29 am
What a difference a few years makes. After facing a future filled with imported energy and higher prices, the United States is now sitting on a virtual ocean of oil and natural gas. U.S. production of onshore oil, natural gas and natural gas liquids (NGL) continues to skyrocket. So much energy is being produced — and still so much remains in the ground that finally can be tapped.
The reason for all of this new-found energy abundance stems from new advances in drilling technology. Hydraulic fracturing, along with horizontal drilling rigs, has allowed a variety of exploration and production firms the ability to tap the various shale rock formations and unconventional fields dotting the countryside. At the same time, previously dry or dying fields have been given new life using the drilling techniques.
Fracking isn’t without its controversy or critics. The drilling process has raised concerns about everything from water safety to earthquakes. Some of these concerns have led to temporary bans across New York and New Jersey. But where it has been embraced, fracking has led to monumental increases in job growth and energy production.
Given that technique is responsible for the sheer amount of energy the U.S. is now “burdened” with, its long-term dominance seems assured. And for those wanting to get in near the ground level of the revolution, there’s a number of ways to invest. Here’s a look at 10 ways to play the fracking boom:
Like its recent foray into Arctic drilling, Exxon Mobil’s (NYSE:XOM) forward-thinking purchase of XTO in 2009 made it the king of the natural gas sandbox. At the time, XTO was the second-largest gas producer, owning a substantial portfolio of fields and holding a diverse knowledge in advanced extraction techniques. CEO Rex Tillerson said of the $31 billion deal: “This is not a near-term decision; this is about the next 10, 20, 30 years. We think there will be significant demand for natural gas in the future.”
“Long term” seems to be in Exxon’s blood. The firm predicts overall energy demand will rise 30% by 2040 and natural gas will replace coal as the second-most popular fuel by 2025, so Exxon has increased its focus on developing natural gas over the last few years. Since that time, the energy giant has become the largest producer of natural gas in the U.S. and receives about 50% of its production from the fuel. Likewise, more than 50% of BOE reserves are in natural gas.
Exxon and Tillerson have made a calculated bet on the fuel’s future, and so far investors have been rewarded with 77% returns since he became CEO in 2006. The fracking boom undoubtedly will continue to boost Exxon’s performance.
The shale boom certainly has been kind to CARBO Ceramics (NYSE:CRR). Producing one of the key ingredients needed to “crack” the hard rock and release the trapped gas, CARBO has been riding high for the past few years.
The company’s ceramic proppant, which replaces sand used in the hydraulic fracturing process, has been in high demand since the fracking boom started. At its core, CARBO’s artificial sand helps drillers improve productivity. With the bulk of new wells doting the U.S. landscape of the hydraulically fracked variety, CARBO is seeing huge demand for its cost-saving products.
CARBO shares have plunged about 50% since their 2011 peaks; the culprit could be the recent shift from away from natural gas toward more profitable shale oil and natural gas liquids. Drilling for these fuels require a different set of proppants called guar gel — something CARBO doesn’t manufacture. However, with the U.S. getting ready to begin exporting natural gas, well production will increase, which ultimately means more business for CARBO.
Analysts expect good things too, forecasting 12% earnings growth for FY12 and 30% growth in 2013. The firm also has zero debt and throws out a modest 1% dividend. At a price/earnings-growth ratio of 0.39, shares are deliciously cheap right now.
One of the chief ingredients in hydraulic fracturing — as well as one of its chief concerns — is water. To frack a well, millions of gallons of water are needed to adequately crack the shale rock. At the same time, disposing of these used fracking liquids and other waste created in the drilling process is quickly becoming a prime sticking point for legislators and residents living near wells.
One of the major hidden beneficiaries to this demand on both fronts will be the various environmental service companies in the water industry. Water utility Aqua America (NYSE:WTR) CEO Nicholas DeBenedictis recently said there are “growth opportunities provided by the shale drilling industry, as well as the ‘clean water’ aspects of the drilling business.”
To that end, the PowerShares Water Resources ETF (NYSE:PHO) could be a great bet on the “water-energy” nexus. The fund tracks a variety of utilities and firms that produce products designed to clean wastewater. As fracking continues to gain prominence as the No. 1 drilling method, odds are these sorts of water services will follow suit — most likely by legislation.
There are pipeline companies, and then there are giants. Already a giant, Kinder Morgan’s (NYSE:KMI) recently approved $21 billion bid for rival El Paso (NYSE:EP) will make it the pipeline firm for a shale boom. The buyout would create the largest pipeline owner in the country, with more than 80,000 miles of pipelines under one roof. Kinder Morgan’s network of infrastructure will cross 35 states and link the majority of all the new unconventional fields with most major markets.
At the same time, the takeover puts Kinder Morgan in a prime position to benefit from a coming wave of pipeline construction. Thousands of miles of new pipelines will be needed to serve wells in fast-growing shale fields. These new pipelines most likely will be tied into KMI trunk-ways. For example, El Paso’s 14,000-mile Tennessee Gas Pipeline cuts directly through the rich Marcellus shale, where hundreds of gas wells have been drilled but are not yet hooked up to a pipeline.
The deal ultimately will benefit Kinder Morgan and its shareholders for years to come.
Small and nimble, wildcat E&P firms serve as some of the main providers of new supplies. These companies find new deposits and bring them into production, often on a shoestring budget. Major producers see these junior corporations as a way to add to their overall reserves and often will partner with or buy out these mid-tier producers. And for investors, these junior E&P firms might provide a portfolio boost. After all, it only takes one gusher to turn a small company into a superstar and send its stock rising.
With the recent closure announcement of the Jefferies TR/J CRB Wildcatters E&P Equity ETF (NYSE:WCAT), one of the easiest ways to play a broad basket of these firms is gone
However, the bulk of the ETF’s holdings — such as Rosetta Resources (NASDAQ:ROSE), EXCO Resources (NYSE:XCO) and Gran Tierra Energy (NYSE:GTE) — still can be had for a song relative to their future prospects and read like a who’s who of buyout targets and upcoming players.
The fracking boom has driven natural gas prices below $2 per 1,000 cubic feet for the first time in decades. That has prompted many firms to begin the process of exporting that bounty to places like Asia, where it fetches a higher price.
With the U.S. on the cusp of becoming one of the world’s largest exporters of liquefied natural gas, the firms that do the exporting will continue to benefit from the abundance of energy produced via fracking.
Cheniere Energy’s (AMEX:LNG) Sabine Pass liquefaction facility last week received the final stages of federal approval and could open the floodgates for other new exporting facilities. Several firms with import terminals are following Cheniere’s lead and are applying for export permits, including Sempra Energy (NYSE:SRE) and Dominion Resources (NYSE:D). At the same time, day rates for LNG shippers like Golar LNG (NASDAQ:GLNG) continue to hit new highs as demand increases.
Basically inventing the process of hydraulic fracturing, oil services stalwart Halliburton (NYSE:HAL) should remain firmly as a top play in the shale boom. The firm’s high-pressure pumps are the industry standard when it comes to fracking and have seen higher demand as the boom presses on.
More importantly, unlike rival Schlumberger (NYSE:SLB), Halliburton received nearly three-fourths of its 2011 revenue from fields in the U.S. While margins should feel the pressure as energy firms shift toward more shale oil and natural gas liquids over natural gas, the long-term picture is rosy for the oil service stock.
Investors can have that rosy outlook at a current 45% discount to the company’s historical valuations, despite the fact that it recently reported record quarterly earnings.
One great example of a stock that embodies the shale boom in the U.S. is Range Resources (NYSE:RRC). The firm was a pioneer in the most economically valuable shale formation in the nation — the Marcellus in Pennsylvania — and owns arguably some of the best land across the region.
Most of the E&P firm’s production stems from dry natural gas, but it does see around 20% coming from gas liquids and oil. The focus on straight natural gas has hurt shares recently, but that could be changing. The bulk of Range’s acreage in the Marcellus contains liquids-rich gas and oil. Shale oil and NGLs offer firms higher returns and higher margins as their pricing is tied to crude.
The real win for shareholders could be a potential buyout. Analysts estimate that as takeout candidate, Range’s shares could fetch about 50% more than where they currently stand. That would be a roughly $20 billion acquisition, meaning only a handful of energy majors like Royal Dutch Shell (NYSE:RDS.A, RDS.B) or state-backed interests would apply.
To realize the full potential of the shale boom, countless pipelines, storage tanks, gathering systems and export terminals will need to be constructed. Analysts at Deutsche Bank predict that spending will need to average around $15 billion a year until 2035. That equates to roughly $210 billion spent on new energy infrastructure.
Netherlands-based Chicago Bridge & Iron (NYSE:CBI) could be seeing the bulk of that work. The firm is a petrochemical and pipeline construction powerhouse, with projects ranging from LNG facilities in Australia to huge offshore/underwater pipeline networks in the North Sea. The firm’s backlog stands at an impressive $9 billion and could grow as these projects in the U.S. get under way.
Also featuring an impressive backlog is Halliburton spinoff KBR (NYSE:KBR). Like CB&I, KBR is focused on building a wide variety of petroleum-based infrastructure projects and grew its backlog by $5 billion in 2011 to sit at $10.9 billion. As one of the leaders in the pipeline and LNG space as well, KBR could find its way onto any shale portfolio.
While there’s a number of spot plays to invest in the shale and fracking boom, other exchange-traded funds can get you exposure to the phenomenon, too:
The new Market Vectors Unconventional Oil & Gas ETF (NYSE:FRAK) allows investors to directly tap into the growth of these unconventional and alternative sources of energy. Aside from the ETF’s oil-sands/bitumen holdings, shale and coal-bed methane make up the bulk of the portfolio. 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 — i.e. through hydraulic fracking. The fund’s holdings are spread across 43 firms that derive more than 50% of their revenues from the previously defined unconventional sources of oil and gas. This includes top weightings to Devon Energy (NYSE:DVN) and Occidental Petroleum (NYSE:OXY).
Also featuring a broad energy mandate that is benefiting from the shale boom is the iShares Dow Jones US Energy ETF (NYSE:IYE). That fund tracks 91 different E&P firms and provides access to the valuable oil services sector. The U.S. focus assures that many of the firms in the portfolio — including 11 on this list — have some exposure to the fracking revolution. In addition, the fund trades more frequently and is cheaper than FRAK.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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