What Is the Future of Fracking?
May 22nd 2012 11:29AM
Updated May 22nd 2012 11:32AM
Vermont's decision to ban hydraulic fracturing last week put the dangers of fracking back into the public eye. The state became the first to forbid the controversial drilling technique, but the move is largely symbolic since Vermont is not an oil or gas producing state. Gov. Peter Shumlin called it a "big deal," saying, "This bill will ensure that we do not inject chemicals into groundwater in a desperate pursuit for energy." He also said the science behind fracking was "uncertain at best," and hoped other states would follow his lead.
While Vermont is the first state to ban the practice, New York and New Jersey have instituted moratoriums on fracking, waiting until studies are completed to determine the potential risks. The moratoriums have been controversial, especially in upstate New York, where fracking in the Marcellus shale could help revive the struggling local economy.
Like climate change, the science behind fracking has often become politicized as both environmentalists and drillers insist the facts support their position.
So, is it dangerous?
For now, the jury still seems to be out on fracking as a recent EPA report shows. After studying the water quality in Dimock, Pa., which became an issue after residents complained in 2009, the agency concluded that the water was safe to drink. However, the study also found that the water contained dangerous levels of methane as well as lower levels of other chemicals that cause cancer and other illnesses. The problem may lie with the EPA's standards, which do not exist for some of the pollutants.
Other concerns include the disposal of the wastewater used for fracking. Fracking solutions are mainly composed of water, up to 80% of which does not return to the surface after it's injected into the ground. When it resurfaces, it not only includes the original proprietary chemicals in the solution but also radioactive material from the earth. A recent New York Times report found that the radioactivity levels are higher than previously believed as are the dangers to the environment and public health.
Critics are also worried about a greater incidence of earthquakes due to hydraulic fracturing. The U.K. suspended fracking after two tremors near Blackpool last year, and a study concluded that the unconventional process was in fact the cause of the earthquakes. Last month, however, the British government appeared to be taking steps toward lifting the ban after a panel of experts said fracking should be allowed. In the U.S., the increased frequency of earthquakes in the middle of the country has led scientists to believe that fracking is in fact the cause. In the three decades before 2000, there were only an average of 21 "seismic events" per year in that part of the country, where fracking has become widespread. In 2009, that number grew to 50; in 2010, 87; and last year it reached 134. Still, none of the earthquakes have caused significant damage.
What it means for business
The impact of fracking is widespread, as many businesses are banking on a wholesale transition from gasoline-powered vehicles and coal-powered electricity to cheaper and cleaner natural gas. The environmental impacts could influence several industries as well, creating a number of niche businesses in the process.
Perhaps, the most apparent of these is Heckmann (NYS: HEK) , which provides water and wastewater services for shale gas exploration and production such as delivery, disposal, and pipeline facilities. Founded in 2007, the company is not currently profitable, though it appears to be growing fast with revenues tripling and EBITDA more than doubling in its most recent quarter. Its customers include major producers such as Chesapeake Energy (NYS: CHK) , which contributes 25% of revenue, as well as El Paso and Exco (NYS: XCO) , with 16% and 12%, respectively. While Heckmann competes against oil services heavyweights such as Schlumberger, they are the only pure-play water-services company in the hydrofracturing industry. Gross margins are thin at just 20.9% last year, and analysts are expecting minimal profits of just $0.10 and $0.17 per share for this year and next, but if concern over fracking water disposal continues to build, demand for Heckmann's services may increase by greater than expected rates. Shares of the stock are also well off their 52-week highs, having lost about half of their value since the summer.
Another interesting alternative fracking play is Gasfrac (OTC: GSFVF.PK), a company that provides water-free fracking solution, using liquid petroleum gas (LPG) instead. The LPG gel allows up to twice as much gas extraction from the well and enables production sooner than traditional fracking methods. Gasfrac's fluid is also 100% recoverable, creating economic benefits and avoiding the pollution that sometimes comes with the disposal of water-based solutions.
Like Heckmann, Gasfrac is not profitable, but the company's revenue jumped 48% in its most recent quarter to $45 million, and it posited positive EBITDA. Its proprietary methods could see a huge increase in adoption if skepticism toward water-based fracking technique grows.
Complaints about fracking often focus on the huge quantities of water that are used to extract gas out of the shale. It takes 4.5 million gallons of water to frack a well, and with demand for clean water expected to grow as supply declines, fracking could send water prices even higher. One example can be seen in Colorado, where drillers recently outbidded farmers at a water auction. This transition signals not only that water the commodity will become more valuable but also water-focused companies, who specialize in treatment, infrastructure, filtration, and other services. The biggest publicly traded pure play water equipment company is Xylem (NYS: XYL) . Sales grew by 19% last year and should be buoyed by changes in water economics, especially if fracking picks up. It's affordably priced with a forward P/E around 12.
As a new technology, the future of fracking is still being determined, but the level of investment that's taken place so far indicates that it's here to stay. If environmental concerns mount, alternative solutions will have to be discovered to protect drinking water, dispose of fracking water safely, and address other earthbound concerns. With the huge potential of the natural gas boom to remake the American economy, these lesser-followed "picks-and-shovels" plays could yield major rewards down the road.
Alternative fracking plays could be one way to benefit from the changing energy landscape, but before you make any moves, you'll want to find out our experts' pick in the energy industry. It's an oil services provider that's growing steadily with improving margins and looks undervalued at a P/E of 13. Even better, its competitive advantages have given it a 60% market share in the rig equipment market, and its prospects should only improve as the price of oil moves up.
At the time this article was published Fool contributor Jeremy Bowman holds no positions in the companies in this article. The Motley Fool owns shares of Heckmann and Chesapeake Energy. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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