How to Profit From the Energy Boom

| March 25, 2014 | 0 Comments

March 4, 2014

The U.S. is experiencing a remarkable energy revolution, and exchange-traded funds that focus on energy stocks may seem an obvious way to benefit. But selecting the right ETFs to tap a gusher of profits isn’t as simple as it seems.

U.S. oil and natural-gas production have surged. More than eight million barrels of crude are pumped a day, up from five million barrels a day a few years ago, thanks to newfangled techniques such as horizontal drilling and multistaged hydraulic fracturing in rock once deemed too challenging.

Many analysts and advisers say the U.S. energy renaissance will last for many more years and note that there are few other areas of impressive growth in the economy.

One challenge for investors, though, is that companies discovering huge amounts of oil and gas aren’t always the ones seeing their shares soar. Natural-gas prices collapsed in recent years, thanks to a glut resulting from improved production methods. And while “the industry is undergoing a revolution,” says John Gabriel, an analyst at fund tracker Morningstar Inc., “that doesn’t mean that all firms will make the right capital-allocation decisions and succeed.”

An added complication is that ETFs tend to track groups of companies or indexes. That provides helpful diversification but it also makes it challenging for those searching for a “pure bet” on a particular theme, such as the rise of “unconventional” drilling, the kind responsible for the U.S. energy resurgence.

Some advisers recommend SPDR S&P Oil & Gas Exploration & Production,partly because this ETF includes some midsize energy producers, like SandRidge Energy Inc., the kinds of companies responsible for the biggest leaps in U.S. production. But this ETF includes companies that don’t focus on unconventional drilling.

A more concentrated bet is Market Vectors Unconventional with the fitting symbol of FRAK. This fund invests in companies that employ hydraulic fracturing—or fracking—to unlock oil and gas from shale formations. Shale is a type of rock packed with oil and gas but until recently considered too difficult to drill. Among the fund’s recent holdings are EOG Resources Inc. and Pioneer Natural Resources Co., among the big winners from Texas’ booming Permian Basin.

The fund has about $50 million in assets and sees under 50,000 shares traded some days. Companies in the fund must have the potential to generate at least 50% of revenue from unconventional oil and gas, but that still means an investor is exposed to traditional drilling.

Companies in the ETF generate earnings “from sources other than just fracking and shale,” says Scott Miller Jr. a managing partner of Blue Bell Private Wealth Management LLC in Blue Bell, Pa. But “I would still advise investors who really want to invest in fracking and shale companies to buy FRAK over individual stocks as they would be buying a portfolio of the dominant players in the space,” he says. (His firm isn’t using the fund because its clients haven’t asked for this focused exposure.)

Direction Unclear

Though natural-gas prices have jumped lately, amid a frigid winter for much of the country, it isn’t clear where they’ll be going from here or how leading gas producers will fare. Ryan Issakainen, ETF strategist at ETF sponsor First Trust Advisors LP, says fundamentals look good for natural gas over the long term. More electricity is coming from gas, rather than coal, and manufacturers are moving to the U.S. to take advantage of natural-gas prices that remain lower than those around the world. As the U.S. begins exporting natural gas that also will help push prices higher. His firm’s First Trust ISE-Revere Natural Gas Index is among the ETFs that aim to track an index of companies involved in natural-gas exploration and production.

The Market Vectors Oil Services is recommended by some advisers as a safer wager on companies providing services to oil and gas producers. The service business can be more stable than searching for oil and gas. This ETF tracks the performance of 25 of the largest U.S.-listed, publicly traded oil-services companies. But these companies, such as Schlumberger Ltd and Halliburton Co., do conventional and unconventional drilling, a reminder that it’s hard to find a perfect way to play the U.S. energy revolution.

Shipping It

Matthew Tuttle, president of Tuttle Tactical Management LLC in Stamford, Conn., favors iShares Global Infrastructure, which tracks 75 companies that profit from building the infrastructure necessary for energy to be shipped, such as Enbridge Inc. ENB -0.89% But the ETF includes companies active abroad and non-energy companies, such as toll-road operators.

Darren Schuringa, managing partner at Yorkville Capital Management LLC, notes recent estimates that as much as $900 billion in new infrastructure investments will be required to transport this new production in the years ahead. His firm’s Yorkville High Income Infrastructure MLP ETF invests in master limited partnerships, or MLPs, which are companies that own and operate pipelines, primarily for natural gas and oil. This fund has less than $40 million in assets, but has an annualized yield of 6.3%.

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