It seems odd that hydraulic fracturing — a revolutionary technology that has unlocked vast deposits of previously inaccessible natural gas and oil reserves — should find itself at a crossroads in the quest for America’s energy future. But that’s where energy companies and investors find themselves now.
On the upside, accessing vast energy reserves buried in North American shale deposits has been a bonanza for companies like Cabot Oil & Gas (COG), Halliburton (HAL) and Baker Hughes (BHI). But fracking’s opponents got a boost last week when an Environmental Protection Agency document revealed that the method may have caused methane to leak into household water wells in Pennsylvania, according to a Bloomberg report. Recent studies also say fracking increases the likelihood of earthquakes.
While the jury is out on fracking’s future, don’t expect an outright ban in the near term. But if public safety concerns rise — and citizen support for stronger regulation rises with them — energy investors should be prepared to roll with boom or bust scenarios.
Here are two stocks each to play winning — and losing – fracking scenarios:
If you’re bullish on the future of fracking, Halliburton (HAL) should be near the top of your list. The oil services giant is the largest player in the fracking services marketplace with nearly $42 billion in market cap — and it has massive exposure to North America, from which it derived more than half its revenues last year.
The company’s strength in the shale oil/gas space cuts both ways, however: Recent oversupply has caused has prices to slip, although recovery is likely later this year and into 2014. A Justice Department antitrust probe of Halliburton and rival Baker Hughes is also a threat.
HAL’s fundamentals are compelling: The price/earnings-to-growth ratio of 0.67 and forward P/E of around 11 make it look cheap — even though it’s up more than 50% since November and trading near multiyear highs. HAL pays a nominal current dividend yield of 1.1%, but I like it more for the recent aggressive stock repurchases.
Boom: Continental Resources
If the Bakken shale formation — which sits under Montana, North Dakota and parts of southern Canada — is a mine of black gold, then Continental Resources (CLR) is the modern-day Jed Clampett.
As the region’s largest lease owner, producer and driller, CLR is well positioned to cash in on a fracking boom that could generate 850,000 barrels of oil per day — just this year. The company believes it easily could triple its production volume over the next four years.
CLR has a puny PEG ratio of 0.49 and trades at 13 times forward earnings. The stock has gained more than 50% since last August, but that doesn’t mean it’s all out of growth. The company recently won a 10-year federal minerals lease for 400 acres of prime land in Mountrail County, N.D. On the downside, though, CLR’s cash flow is pretty grim.
If you’re betting big on fracking, the two “boom” stocks above are attractively valued to buy and hold. But if you believe the golden goose of fracking is about to be cooked by regulators or short-term pricing woes, you’ll want to consider the next two stocks:
Bust: Kinder Morgan Energy Partners, LP
Even if tougher fracking restrictions come to pass, it won’t wipe out the market for shale oil and gas — and that’s where Kinder Morgan Energy Partners, LP’s (KMP) value proposition sits.
As a well-diversified midstream operator with enviable pipeline and storage assets (it owns an interest in or operates approximately 51,000 miles of pipelines and 180 terminals) KMP stands to gain from oil and gas transport growth.
As a high-yielding and investor-friendly master limited partnership, KMP is an interesting take on the sector. Its current distribution yield is 6.2%, though it looks awfully overvalued with a PEG ratio above 5 and a forward P/E of nearly 30.
Bust: GasFrac Energy Services
If you’re not afraid to take a wild ride with a $120 million microcap stock that boasts a greener alternative to traditional fracking methods, GasFrac Energy Services (GSFVF) could be an interesting play.
Unlike conventional methods, GasFrac’s proprietary technology injects liquefied petroleum gas gel to break up shale deposits instead of water, potentially reducing groundwater contamination and earthquake risks. One notable risk, however, is the need to truck in (and store on site) vast quantities of highly flammable propane.
Scotiabank analysts recently raised their price targets on the stock from $2 to $2.50 — a potential upside of more than 40% over its recent price range. As expected for a microcap stock with a bleeding-edge technology, it will take time for GasFrac to start making money. GSFVF clearly has the potential to pay off big if traditional fracking methods are restricted or banned. But buckle up — it’s going to be a bumpy ride.
By their nature, microcap stocks tend to be riskier than their large-cap peers. Such companies often are focused on new technologies and have fewer tangible assets (in GasFrac’s case, only about $1 million in operating cash flow). They also usually are more thinly traded (GSFVF’s average daily volume is less than 100,000 shares) — so it doesn’t take much for a trade to have a great impact on the stock.
Still, if GasFrac’s waterless fracking technology hits big, the potential reward is huge. With traditional water-based hydraulic fracturing methods under fire by environmentalists and the public increasingly favoring tougher fracking regulations, this company could find itself in the catbird seat if its technology can maintain cost-efficiency and boost safety. Obviously, GSFVF is not a stock to sink your life savings on, but the risk-reward ratio is probably OK if you’ve got a little mad money lying around.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.