U.S. Energy Department Says Fracking Not A Problem

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Bloomberg reports that U.S. “Energy Department researchers so far have found 'nothing of concern'” in a Fracking contamination study. If the final report is as positive, the U.S. oil and natural gas drilling industry will get a boost. Consider Ultra Petroleum (NYSE: UPL), Hi-Crush Partners (NYSE: HCLP), and pipeline giant Kinder Morgan Energy Partners (NYSE: KMP).

Fracking is a new drilling technique. Its proponents say that it has the potential to make The United States energy independent. Those opposed to fracking claim it contaminates drinking water and endangers lives. There's anecdotal evidence that fracking lives up to its opponent’s claims.

The process requires water, sand, and chemicals to be forced underground to release oil and gas. The soup being pushed underground is largely a secret, but certainly unhealthy. However, if the U.S. Energy Department's research shows that suspected contamination wasn't an inherent result of fracking, the industry will receive a huge boost.

A Cheap Driller

Ultra Petroleum is a driller to watch if fracking gets a clean bill of health. It owns oil and gas lands in southwest Wyoming and Pennsylvania. Ultra's top and bottom lines jump around a lot because it operates in a commodity business, but 2012 was a particularly brutal year for the bottom line.

A large asset write down led to a loss of over $14 a share. According to the 2012 10k, however, low gas prices in 2012 “required [the company] to record a $2.9 billion non-cash, ceiling test write-down” of its oil and gas properties. That write down is likely to be reversed in the future as natural gas prices recover, as they have started to recently. The company made about a dime a share in the first quarter.

The reason to like Ultra, however, is that it's among the cheapest drillers in the country. The company's costs are about $3 per thousand cubic feet (Mcf) of natural gas, while the industry average is closer to $7 per Mcf. With natural gas trading around the $3.50 to $4 mark, Ultra is going to make money a lot quicker than many of its competitors. And if fracking gets a clean bill of health, any social stigma Ultra faces will be gone.

Picks and Axes

Another way to play the space is to buy a company that supplies the materials used in fracking. Hi-Crush Partners sells the proppants, called “frac sand”, to “enhance the recovery rates of hydrocarbons from oil and natural gas wells.” Basically, it's selling the picks and axes that drillers need to use the hydraulic fracturing technique.

The company is structures as a limited partnership, so its yield is notable at around 8.3%. However that comes along with tax consequences, and benefits, and the units aren't appropriate for tax advantaged accounts. In addition, the company has only been public for about a year, so there isn't much financial history to go on.

What Hi-Crush offers investors is a direct play on the fracking technique. If fracking gets a clean bill of health, Hi-Crush's business will continue to expand. If fracking is shut down, so, too, is Hi-Crush. Investors willing to bet that technological advances win out should take a look at Hi-Crush. Note, that it recently bought a competitor, D&I Silica, so it not only offers a large yield, but it's growing its business, too.

A Lower Risk Profile

Kinder Morgan is one of the largest oil and gas infrastructure limited partnerships in the country. It basically takes the oil and gas from where it's drilled to where it's needed. That's a toll taker business with a lot less risk than either drilling or selling frac sand. If Kinder's pipelines are being used, it's getting paid.

Clearly, if fracking stops the flow of oil and natural gas slows down. That would hurt Kinder's business. However, it has such a massive scale, that it would be able to regroup easily enough. Like Hi-Crush, Kinder Morgan is a limited partnership. Its yield is about 6.1%. Unlike Hi-Crush, Kinder has been around for a long time and has an impressive history of regular dividend increases. In 2003 it was paying $2.58 per unit annually, last year it paid $4.85.

Kinder's yield is higher than similarly situated Enterprise Products Partners (4.3% yield) because it has a more complex corporate structure, including a General Partner (GP), two LPs, and a share class that pays its distribution in units instead of cash so it can be owned in a retirement account. Investors should take advantage of that discount and pick up the extra yield. And, for those looking to buy Kinder in an IRA, consider the Kinder Morgan Management version of the company.

Rough Start

Fracking has gotten off to a rough start. That's to be expected of new technology. However, if the technique passes muster with the U.S. government, Ultra Petroleum, Hi-Crush Partners, and Kinder Morgan would all see their fortunes improve. The highest risk and most direct plays are Ultra and Hi-Crush.

Reuben Brewer has positions in Enterprise Products Partners and Kinder Morgan Energy Partners. The Motley Fool recommends Ultra Petroleum. The Motley Fool owns shares of HI-CRUSH PARTNERS LP UNIT LTD PARTNER INTS and Ultra Petroleum and has the following options: long January 2014 $30 calls on Ultra Petroleum, long January 2014 $40 calls on Ultra Petroleum, and long January 2014 $50 calls on Ultra Petroleum. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus