How 1 Bean Gummed Up Energy Stocks
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One little bean in India and a warm winter in the U.S. have gummed up energy company margins.
Guar is a plant in northern India, whose seeds are harvested and developed into a gummy substance that is found in an almost unbelievably wide range of places- ice cream, tortillas, yogurt, cosmetics, bread, diapers, explosives, chewing gum, and hydraulic fracturing (fracking). The same bean that keeps ice cream from crystalizing or thickens salad dressing also is used as a viscosifier in fracking fluid. And there is a shortage of this all important bean, causing some expensive problems for the energy industry.
On average, India produces in excess of 1,000,000 metric tons of guar beans annually and exports more than 400,000 tons of guar powder. (The export of guar beans from India is prohibited, and the bean is exported as a powder instead.) U.S. energy companies need 300,000 metric tons of guar gum just for fracking. Farmers in India have responded to the shortage and the high prices by increasing the acreage under cultivation. It is estimated that 10 million acres will be farmed in India this year as compared to 40,000 acres in the United States.
Because of the sudden increase over the past two years in fracking, the demand for guar has skyrocketed, and along with it, the cost. The price two years ago was about $1 per pound for guar powder. The commodity peaked at approximately $12 per pound. The price of guar has come down in recent weeks to about $5 per pound, and that decline is likely to continue.
Meanwhile, the United States experienced an unusually warm winter, decreasing the demand for natural gas (which has affected several companies). The glut of natural gas, combined with higher guar gum prices, have led to energy services companies, like Halliburton (NYSE: HAL), Baker Hughes (NYSE: BHI), and Schlumberger (NYSE: SLB) feeling the pinch. All three companies reported improved second quarter revenues, but decreased margins due to the unusual gum and weather combination.
Under the leadership of CEO David Lesar, Halliburton loaded up on the gummy stuff while prices were still climbing. Afraid of where the price may top off, the company placed large orders and created a large stockpile. The price has since fallen. But not before the company's order caused even more of a shortage and demand for other companies.
Halliburton reported second quarter revenues of $7.2 billion, up 21.9% greater than the same quarter the year previous, beating analysts' expectations. However, Halliburton's North American operating margins fell 5%, much of which is attributed to guar gum demand, and the glut of natural gas.
Baker Hughes reported a profit of $439M, compared to the year previous results of $338M. Quarterly revenue rose 12% to $5.33B, beating analysts' expectations. Operating margins decreased 1% to 12%, as costs and expenses rose 14%.
Just like its competitors, Halliburton and Schlumberger, the margins decreased due to the rise in the cost of guar gum, and the overabundance of natural gas in the U.S. market.
Profits for Schlumberger increased in the second quarter despite these new challenges. The world's largest oil field services company saw Q2 earnings rise 4.8% over the year previous. Revenue was up to $10.45B, over $9B in 2011. However, CEO Paal Kibsgaard said the company expects its margins for hydraulic fracturing services to continue to shrink in the third quarter as costs remain high and demand for dry natural gas drilling has dropped substantially. Fracturing margins are down 20% from their peak. (Darn that little bean!)
As mentioned earlier, guar gum is used in far more products than just hydraulic fracturing. However, the price increase and shortage of guar gum is only merely a nuisance and not a major problem for companies such as Nestle or Unilever that use it in hundreds of products. A gallon of ice cream calls for just a tiny touch of the beans, whereas to fracking fluid takes as much as 20,000 pounds of guar beans.
Substitutes and synthetics are being implemented across the various industries to fill the shortage. (Not to mention, Indian farmers (as well as Pakistani) are jumping on the bandwagon, anxious to get their piece of the pie.) The food industry is turning to xanthan and tara gums, while Baker Hughes and Halliburton have developed two separate products that could be used as a synthetic replacement. Halliburton has implemented PermStim in 40 wells, in the last quarter. The company hopes this new synthetic will help to stabilize costs and improve its profit margins in the coming period. Baker Hughes said it replaced 5% of its guar with AquaPerm last quarter, and that this share could double by the end of this year. The energy companies have also invested in guar production in Texas.
The guar gum challenge should not leave a lasting deficit on any one energy company. But if errors occur with the synthetic developments, they will be expensive and difficult to overcome. Another mild winter will also not help the companies. But as their revenues and profits have shown, these are good companies for the long-term. But as the stock drop for two of the three has shown, it would be wise to take a second look before jumping in right now.
ErinAnnie has no positions in the stocks mentioned above. The Motley Fool owns shares of Halliburton Company. Motley Fool newsletter services recommend Halliburton Company and Schlumberger. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.