In the past couple of years an industry that has been gaining increasing popularity is hydraulic fracturing or, Fracking for short. This process has created a natural gas bonanza in many shale regions like Barnett Shale Basin in Texas and Bakken Formation in North Dakota and some parts of Canada. Investors looking to capitalize on this growing popularity have a number of options right from an industry ETF to those providing auxiliary services to the industry. Before I discuss the 5 great opportunities in the sector, let me quickly talk about the basics of Fracking.
Simply put, fracking is the process of extracting natural gas from shale rock formations. It involves forcing a high-pressure mixture of water, sand and lubricants into small cracks in the shale, which opens a natural pipeline for the natural gas to escape. This new method of extracting natural gas isn't really new and has been around since 1940. But only recently it has become an economically viable and sensible technique to drill for natural gas.
Why should you look to invest in the fracking industry?
Fracking accounts for one-third of US natural gas production and is a positive step towards US energy independence. The Energy Information Agency estimates that the US has enough natural gas to last for the next 100 years. Furthermore, there are various alternative energy sources like wind and solar energy, but natural gas is the only practical more or less clean energy source. Other alternative sources require government support to make them cost-effective and viable options.
Just like two sides of one coin, although this process is bringing jobs and money to depressed areas, it has been under the scanner for related environmental and health problems. Within the US, Hancock in New York is waiting to hear if a moratorium on drilling will be lifted and outside the US, Britain has placed a ban on the process.
Now here are my 5 picks in this interesting sector.
Market Vectors ETF Trust (NYSEARCA:FRAK)
This is an exchange-traded fund, which targets unconventional oil and gas industry including shale oil, shale gas, etc. Investors looking for diversification can consider this ETF, which includes around 40 companies from US, Canada and Australia. Go for this if you want the diversification.
C&J Energy Services (NYSE:CJES)
This company is an independent provider of hydraulic fracturing, coiled tubing, and pressure pumping services. 73% of its revenue comes from hydraulic fracturing services as it manufactures equipment needed for the process and also provides services like stimulation and work over operations for existing wells and overlooking well completions.
The company has strong performance and efficiency metrics vs. its peers, corroborated by its high margins. This enables it to provide a strong return on equity of 29%. Further, this company has limited commodity risk as it has term contracts with energy companies that are paid regardless of natural gas prices. However, it posted lower utilization levels and limited increase in rig counts in its 1Q13 results. This raises a concern because its strong 2013 outlook was based on the assumption of stronger fracturing utilization in early 1Q13.
Halliburton Company (NYSE:HAL)
Halliburton provides services related to exploration, development, and production of oil and natural gas. Though it has a lesser percentage of revenue coming from fracking it is one of the largest and oldest player in the oilfield services industry. The company has posted strong growth rates leading to a 16% return on equity. It is a much larger company in terms of revenue and market capitalization and provides a sense of stability with its strong growth and diversification, geographically and operation wise.
CARBO Ceramics (NYSE:CRR)
CARBO Ceramics supplies ceramic proppant and the resin-coated sand (a cheaper option than ceramic proppant) used in fracking. For a company with just $600 million sales, much smaller than Halliburton, it provides a similar return on equity of 16%. Its revenues have doubled in the last five years with strong average gross and operating margins of approximately 35% and 25%, respectively.
Kinder Morgan (NYSE:KMI)
Kinder Morgan is a pipeline operator providing transportation solutions. It has approximately 37,000 miles of pipelines and approximately 180 terminals. Further, in 2012, increasing its reach even further, it acquired El Paso Pipeline Partners, which has 67,000 miles of pipeline in North America. With its strong pipeline, it is expected to benefit from the recent boom in the North American shale formations, which have few or no transportation infrastructure.
In January 2013, it released its 4Q results with a 30% increase in revenues and 11% increase in its quarterly cash distribution. The company is poised for growth with $2.7 billion projects that are currently under way and plans to spend approximately $11 billion in organic projects till 2015. Furthermore, it plans to take over Copano Energy (NASDAQ:CPNO), which will increase its reach to Texas, Oklahoma and Wyoming.
The US is forecasted to be the largest oil producer by 2020 and given the increased demand for shale gas/oil, the fracturing industry is bound to do well. The 5 companies above are some of the many good options available among others. However, investors in this space should understand that there exist two key risks inherent in this industry - ongoing regulatory risk and the risk of increasing pressure on natural gas prices due to increased supplies (natural gas is expected to drop as low as $2.20).