The EPA And Fracking: How To Capitalize-Part 5

Includes: FTK, NR, TTI
by: Michael Filloon

In previous articles (see part one, part two, part three and part four), I have written about different companies that stand to benefit from EPA and state regulations designed to protect water resources used in the process of fracking. It is possible there will be no regulations on a federal level; there is little proof this practice is unsafe. If the EPA finds proof, there could be a significant number of new regulations. New regulations could be problematic, as these may increase costs and slow down development in US shale plays. There are several ways these rules could help conserve water and decrease chances groundwater contamination.

First, we must look at the problems associated with the process of fracking. One is groundwater contamination. This has been a heated topic. Environmentalists believe companies have polluted ground water with methane gas. There has been little proof of this, so it will probably not be the focus of possible regulations. Even in cases of rig explosions, there were no fracking fluids found in surrounding water supplies. In my opinion, rules governing the ingredients of fracking fluid would stop contamination at its source. There are several ways to play this, as fluids seem to be the key going forward.

Flotek (NYSE:FTK) has significant upside. In March of this year, I discussed Flotek in the article, In Search of Green fracking Fluids: Flotek, Tetra Technologies, Newpark. The fracking fluids market is dominated by Schlumberger (NYSE:SLB), Haliburton (NYSE:HAL) and Baker Hughes (BHI), but the bulk of sales are from the older types, such as oil based systems. Looking at the fracking fluids industry, only a small portion of revenue comes from green types. Much of the reason is cost, but there are other variables with reference to performance creating a preference to the older styles of fluid. Flotek provides a broad range of chemicals used in cementing, stimulating, acidizing, drilling and production.

Most important are its complex nano-fluids. Not only is this environmentally friendly, but Flotek states it increases production and improves well integrity. This company is beginning to see exceptional growth in sales of its fluids to be used in unconventional plays. In the third quarter of this year, its chemicals segment's revenue grew 139.7% year over year. Significant company growth in this area is from the adaptation of its natural gas effective complex nano-fluids to oil effective complex nano-fluids. Growth was mostly seen in the Bakken and Niobrara. Flotek also saw increases in overseas sales, and believes this will be a slow transition, but marketing has shown decent results. Flotek is not a fluids pure play, but has seen nice growth in its other two divisions.

Newpark (NYSE:NR) has increased revenues as a green company. It not only produces water based drilling fluids, but also provides environmental services to clean up exploration and production waste. 83% of revenues from the first nine months of 2011 were from its fluids systems and engineering division. 57% of Newpark's operating income was produced here. The worldwide drilling fluids business is a $10 billion market. Newpark has the fourth largest share at 7.5%, and has increased market share in 2010 and 2011. This has been driven by a larger international presence. In 2006, 81% of revenues were from the United States. In 2011, that number decreased to 68%. Newpark has a big presence in United States shale plays with a 17% market share:

  1. Woodford 27% market share
  2. Haynesville 26% market share
  3. Eagle Ford 19% market share
  4. Bakken 18% market share
  5. Barnett 17% market share
  6. Fayetteville 15% market share
  7. Niobara 14% market share
  8. Marcellus 8% market share

Newpark drilling fluid's customers in North America are:

  1. Chesapeake (NYSE:CHK)
  2. Chevron (NYSE:CVX)
  3. ExxonMobil (NYSE:XOM)
  4. BP (NYSE:BP)
  5. Devon (NYSE:DVN)
  6. Cimarex (NYSE:XEC)
  7. Occidental (NYSE:OXY)
  8. ConocoPhillips (NYSE:COP)
  9. Apache (NYSE:APA)

Newpark drilling fluid's customers in the EMEA are:

  1. ENI SpA (NYSE:E)
  2. Repsol (OTCQX:REPYY)
  3. Hess (NYSE:HES)
  4. Total (NYSE:TOT)

Newpark drilling fluid's customers in Latin America:

  1. Anadarko (NYSE:APC)
  2. Petrobras (NYSE:PBR)
  3. Statoil (NYSE:STO)

Revenues from 2010 to 2011 increased slightly in the EMEA. Significant revenue increases over the same time frame in North America and Latin America. In April of this year, Newpark purchased Rheochem. This purchase has produced $15 million in revenues so far this year. More importantly, it added instant exposure to the Asain Pacific. Newpark is interesting here, as it has beat earnings estimates for at least 4 straight quarters.

Tetra Technologies (NYSE:TTI) is a play on completion fluids and frac water filtration. This company's chemical business produces revenue through the sale of calcium chloride. It sells bromides which are specifically used in oil and gas drilling and completion fluids. Bromides are non-damaging to the formation and chemically stable. Tetra Technologies also has a large assortment of additives for use by oil and gas production companies. It is focusing on increasing the utilization of its fluids in United States shale plays. At the same time, it will market its frac water treatment equipment. These units specifically filter brines, gels, chemicals, and produced water in completion, stimulation and work overs. In the first three quarters of 2011, Tetra's fluids division had revenues of $231 million. Total company revenues for that time frame were $659 million. In the first nine months of 2010, its fluids division had revenues of $203 million. Tetra states much of this revenue increase is due to domestic shale plays. This company has beat earnings estimates for at least the past four quarters. Because of the growth in the Bakken, Eagle Ford and Niobrara, I would guess Tetra will continue to grow its fluids division.

Gasfrac Energy (OTC:GSFVF) is a very interesting company. It uses gelled liquified petroleum gas as a fracking fluid. There are several advantages to this method:

  1. Less damage to formations
  2. Up to 50% of the liquefied petroleum gas is recovered
  3. Less material expenses
  4. Decreased cleanup
  5. Increased well productivity

This process is safe as it has been used in over a thousand fracs on 400 wells. It is also much better for the environment.

  1. Eliminates the use of millions of gallons of potable water
  2. Eliminates the transport of millions of gallons of non-potable water.
  3. Eliminates the use of biocides
  4. Smaller footprint from trucking

Gasfrac has worked with big names in the oil and gas production industry:

  1. Apache
  2. Angle Energy (OTCPK:ANGZF)
  3. Artek Exploration (OTCPK:ARKXF)
  4. Bonavista Energy (OTCPK:BNPUF)
  5. Caltex Australia (OTCPK:CTXAY)
  6. Devon (DVN)
  7. Husky Energy (OTCPK:HUSKF)
  8. Paramount Resources (OTCPK:PRMRF)
  9. Murphy Oil (NYSE:MUR)
  10. Penn West (PWE)
  11. Pengrowth Energy (NYSE:PGH)
  12. Seaview Energy (OTC:SVWYF)

Recently it worked with Chevron (CVX). It currently works with 50 different companies. In third quarter of 2011, two of Gasfrac's customers accounted for 47% of its revenue. Until the second quarter of this year, Gasfrac only operated in Canada. It has worked in the Cardium, Viking, Cadomin, Alberta Bakken, and Ellerslie. This year, Gasfrac expanded into the United States. Gasfrac is currently followed by 8 analysts. Care should be taken in this investment, as it has missed estimates in 3 of the last 4 quarters. Estimates have Gasfrac earning 87 cents/share in 2012, which is considerably higher than the 5 cents this year. The results from last quarter show growth in revenues of 116% year over year. EBITDA increased 125% and net income 155% over the same time frame. Gasfrac estimates pressure pumping will remain strong in 2012. It currently has six sets of equipment, with four in Canada and two in the US. Four additional sets will be added in the first quarter of 2012.

In summary, these companies have all have a lot to gain from possible EPA regulations governing fracking. Some companies like Heckmann (HEK), benefit from transporting frac water and depositing it into its disposal wells. Others produce mobile frac water filtration systems that are able to clean the water on site for re-use, like Ecosphere (OTCPK:ESPH). Risk is still high with some of these names, as we are in the beginning phase of developing a safe plan for fracking without destroying all of the profits.

Disclosure: I am long HEK, FTK. The list of companies in the article is of those that could benefit from EPA and state regulations in the handling of frac water. It is just a list and not a buy recommendation.