Flotek, Haliburton, Baker Hughes: Fracking Companies Should Be Busy for Quite a While

Includes: BHI, FTK, GSFVF, HAL
by: Michael Filloon

Horizontal drilling has become a dream come true for states like North Dakota and Montana. The Williston Basin has a plethora of light sweet crude. This was first brought to light by the USGS in 1951. At this time, no one thought this oil would ever be cultivated. Then came horizontal drilling and fracturing. Although not a simple process, some companies like Brigham (BEXP) and Continental (NYSE:CLR) make it look easy.

I highlighted the Bakken/Three Forks, but there are several shales of key interest with respect to oil. The Eagle Ford in Texas, the Niobrara in Wyoming, and the Barnett shale to name a few. Recently, there have been several complaints about fracturing, and the supposed health dangers it may or may not cause. As President Obama tries to find out what companies are using to frac, on top of the water and sand, there is a suspicion that ground water is being contaminated.

In 2003, companies that are engaged in fracturing had agreed not to use diesel fuel as one of the additives in solution. This is especially the case with coal bed methane, since its proximity is much closer to ground water. Recently, there has been some concern with companies like BJ Services, which has become part of Baker Hughes (NYSE:BHI). It seems about seven months ago, a House committee stated that BJ Services used diesel fuel in their fracking fluids for approximately two years. With the EPA lurking, companies engaged in fracking are looking into other solutions that not only are not harmful, but might be biodegradable.

There is a current short list of oil and gas companies working on fracking chemicals. Haliburton has created a fracking fluid called CleanStim, which is made from ingredients in processed foods. Baker Hughes is in the process of making BJ SmartCare, which is made of some of the same ingredients as CleanStim. Gasfrac Energy Services (OTC:GSFVF) goes a different route using liquified petroleum gas. Although I am unsure if this process will be considered nontoxic, Gasfrac maintains it is safe. Last is Flotek (NYSE:FTK). This company has had a great year. Most of the excitement has to do with their new trials of a successful fracking fluid made of citrus.

Looking at Flotek as a company, I wonder if fracking chemicals are the whole story. In October of 2007 this was a $50 stock. After a drastic move down, it seemed that the company may fail. At one point this stock was as low as a dollar.

Flotek is a Houston based oil services company. The company has three divisions:

  • The Specialty Chemical Segment is focused on drilling, completing and production of oil and gas drilling. These products are for specialized needs to complete the drilling process.
  • The Drilling Tools Segment is focused on down hole tools and motors.
  • The Artificial Lift Segment is focused on production systems for coal bed methane production. Their Petrovalve is used primarily in international heavy oil applications.

In 2010, Flotek had $145 million in revenue. The fourth quarter of 2010 had revenues of $45 million. Flotek saw sequential growth in each quarter of last year. Their cash position has been improving. The third quarter of 2009 had cash flow of $600,000. By the end of 2010, they had $20 million. They reduced their senior credit facility by 13% by the end of last year. It is expected they will lower it more by the end of this quarter. Flotek self funded operations and capital needs in 2010.

Flotek's specializations in chemicals include drilling and completing, cementing, fracture stimulation, and acidizing. Many of these are patented, or kept as company secrets. Their key product is complex nano-fluids (microemulsifiers), which are environment friendly and are good for improving production and reservoir integrity in unconventional oil and natural gas completions. Flotek believes they will continue to grow on the strength of unconventional drilling in North America. Flotek has recently gone international with examples in Poland, Turkey and Paris Basin. Their nanofluids will be important for growth, as this new part of the business is marketed. They would like to focus on being environmentally safe with all the concern of ground water contamination, and other social concerns.

Flotek's rental tools are on more than 25% of all rigs in the United States. They have a commodity tool and specialty tool line where 2010 was the year of price stabilization and increased market penetration. This year they would like to increase service density per well and continue to grow market share. Flotek is realizing growth in the Eagle Ford. Drilling motors continue to increase in price. International growth in Teledrift is being seen.

Flotek also specializes in full service production and water separation systems for coal bed methane. Their Petrovalve systems are important here, as they are very specialized in the use of coal bed methane. Flotek is finding customers increasing orders. They had one specific customer increase orders from $42000 in the second quarter of 2010 to $1.4 million in the third quarter of last year.

Flotek's outstanding debt totals $144.6 million. They have $33.6 million due November of 2012. $36 million in secured convertible notes. Convertible subordinate debt is $75 million. It is estimated that Flotek's sales will increase by 66.1% this quarter. The following quarter is estimated at 46.7%. Estimated annual sales growth this year is 24%. The last three quarters they have shown a large improvement. They beat the street by 19%, 52% and 82.8%.

Flotek is a very interesting stock. The unbelievable move up is interesting, but it is difficult to know how much this stock will benefit from a fracking fluid that is environmentally safe. It is possible that Flotek, Haliburton, and Baker Hughes could either sell the fluid or make companies use them to make it assessable. Even more important is the current economic condition. Oil and gas exploration and production companies are finding it difficult to find fracking services in most shale areas. Since many of these areas have enough inventory to drill for decades, I would guess these names will continue to be busy for some time to come.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FTK, GSFVF.PK over the next 72 hours.