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Sunday, July 18, 2010

**[investwise]** Ken Fisher: Shale Gas Is The Future

 

Despite its many critics, hydraulic fracturing will change the nature of energy production. Your investments in the energy sector should reflect that fact.
 
Fracking, as it is called by insiders, means injecting fluid at very high pressure into a well used to produce oil, water or natural gas. The most important application is in natural gas production. The injections produce tiny fissures in underground rock, allowing the gas (or whatever you are trying to extract) to seep out.
 
While fracking is a decades-old process, it has made great technological strides in the past few years. It will make and keep natural gas cheap for a long, long time. Gas that now costs $5 per thousand cubic feet at the wellhead could come down in price to $2. The consequence will be a large-scale displacement of competing energy sources by gas.
 
The losers in this technological shift will be energy sources that are either dirtier than natural gas (coal, especially) or much more expensive (wind and solar). The winners will be the suppliers of fracking technology.
 
Environmentalists have their misgivings about gas and about the methods used to get it out of the ground. But there's no denying that burning natural gas (methane, that is) produces less carbon dioxide per unit of energy than burning coal. The consequence is that electric power production is going to migrate from coal to gas.
 
Windmills and solar cells are carbon-free sources of electricity. But they are costly. If you've been investing in those, give it up. That game is effectively over.
 
Natural gas has the additional benefit of being a domestic energy source. Fracking opens up vast tracts of the U.S. to exploitation by gas drillers. There's enough energy under our feet to last us for decades, maybe centuries.
 
The impact of cheap methane on the petroleum business will be less pronounced and slower in coming. That's because crude oil can be turned into very convenient transportation fuels (gasoline and diesel).
 
You can power a truck with natural gas, but it needs an expensive retrofit. This is in contrast to the situation in electricity production, where gas-burning plants are cheaper to build than coal-burning ones.
 
Environmentalists should like fracking for its relative cleanliness. But they don't. They have made a bugaboo out of the chemicals in fracking fluids, which supposedly can leach into groundwater sources. I'm convinced they're dead wrong. Ultimately good technology with a cost advantage will win out over paranoia.
 
One pure play is Carbo Ceramics (CRR, 73), a Houston firm that makes various forms of "proppant," particles (sand or a synthetic substitute) injected along with the fracking fluid to keep the fissures propped open after the pressure is withdrawn. Carbo is also a leader in fracture design, consulting services and simulation software.
 
Its products are made in America, China and Russia and sold worldwide. This small technology firm is about to take off. It has a great balance sheet and sells at only 18 times my estimate of 2010 earnings, with a 1% dividend yield. In two decades institutions everywhere will own this stock. Get in ahead of them.
 
Another small Houston player is Complete Production Services (CPX, 14), which offers the full array of oilfield services necessary for fracturing and is particularly strong in Texas' Barnett Shale deposit. Its fracturing pumps operate at pressures up to 10,000 pounds per square inch. It sells at one times annual revenue, 1.5 times book value and 20 times my estimate of 2011 earnings (it has been losing money but is turning that corner right now).
 
Don't chase the stock. The market value is only $1 billion.
 
In my June 7 column I recommended both Halliburton (HAL, 23) and Baker Hughes (BHI, 38) on the theory that these broader oilfield services firms would benefit as fracturing led to more exploration and drilling. I didn't anticipate the overall market correction or the BP oil spill, which has caused peripheral damage to all drillers. The market reaction is excessive. So I'm doubling down here. If you bought, buy more. If you didn't, do it now.
 
Other smaller indirect fracturing beneficiaries that should do well include: Key Energy Services (KEG, 10), LUFKin Industries (LUFK, 41), RPC Inc. (RES, 14) and Unit Corp. (UNT, 43). They all boast reasonable prices, good management and strong balance sheets

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Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.
 
Nothing in this article is, or should be construed as, investment advice.
 
 
 

 
 

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