News Analysis date published New: 
Wednesday, January 16, 2013 - 10:00
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Friday, January 18, 2013 - 16:13
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Wednesday, January 16, 2013 - 10:00

Econ Data Turns Market Bearish - Earnings Preview

Wednesday, January 16, 2013 - 10:00am

There's a wave of wealth sweeping rural areas across North America.

Sleepy, rundown towns are bustling with commerce and activity as the new-found money breathes life into the economy. Poor farmers and other landowners of once near-worthless properties are swimming in capital from this new way to exploit a natural resource.

This new method of extracting natural resources isn't really so new, though. It originated in the 1940s, but it wasn't until 1998 that it was perfected enough to be an economically viable, widespread technique.

If you haven't guessed it yet, I am talking about hydraulic fracking, or simply fracking for short.

Simply put, fracking is the process of extracting natural gas from shale rock formations deep underground. We have known about this resource for many years, but only recently has it become economically sensible to drill for natural gas.

Fracking involves forcing a high-pressure mixture of water, sand and lubricants sideways into small cracks in the shale, opening up a natural pipeline for the natural gas to escape into the vertical well to be captured and transported to the final user.

The fracking process

U.S. energy independence is no longer a dream
Fracking is definitely a positive step on the path to U.S. energy independence. It accounts for about one-third of all U.S. natural gas production. The Energy Information Agency estimates the United States has enough natural gas to last for the next 100 years, creating the potential for energy independence a powerful assumption. In fact, Andy Obermueller, chief strategist of Game-Changing Stocks, says the United States "will run on natural gas" in the next few decades. (He's actually putting the finishing touches on a special report on this topic right now, including the names and ticker symbols of the companies that are set to profit from this trend.)

Let's not forget that natural gas is the only practical clean energy source discovered so far. Alternative energy sources such as wind and solar still require tremendous government support to make them cost-effective and viable sources. One day, we will hopefully be able to depend on these clean sources for energy independence, but right now natural gas remains the cleanest, practical fuel available in sufficient quantities.

[See also "How to Profit from "America's Natural Gas Highway"]

It's not just lucky landowners profiting from the natural gas boom. Here are two ways investors can ride along with the explosive growth of this natural resource...

1. Market Vectors Unconventional Oil & Gas ETF (NYSE: FRAK)
With 45 energy-related stocks, this exchange-traded fund (ETF) follows the Market Vectors index of the same name. Its top holdings are Anadarko Petroleum (NYSE: APC), Occidental Petroleum (NYSE: OXY), EOG Resources (NYSE: EOG) and Canadian Natural Resources (NYSE: CNQ).

Because of falling prices, the energy sector was down in 2012 as reflected by the SPDR Energy Select (AMEX: XLE) falling just a little more than 4% on the year. However, FRAK was down nearly 11% during the same period. It's important to note that FRAK was just launched in February 2012 and has only been able to attract about $16 million in total assets.

The ETF is also lightly traded at only about 4,700 shares daily. The record-low prices for natural gas and dropping petroleum prices have likely shifted attention away from this fledging ETF. Because it's so dependent on natural gas prices, I'm keeping it on my watch list for now.

2. C&J Energy Services (NYSE: CJES)
This company provides hydraulic fracking, coiled tubing and pressure-pumping services to fracking firms. It specializes in the Texas, Louisiana and Oklahoma regions of the United States.

More than 70% of its revenue comes directly from fracking. What I like best about this stock is that there is very limited commodity risk. Unlike FRAK, this company has term contracts with the energy companies that are paid regardless of the price of natural gas or oil.

As such, I like to think about this stock as an energy play, but with the insurance of the term contracts secured by the big energy companies themselves. Having said that, massive commodity risk resides in direct energy plays as demonstrated by the FRAK ETF's losses in the past year. The company boasts a market cap of just more than $1 billion and a return on equity close to 46%. Debt-to-equity ratio is just 0.36% pointing toward a solid balance sheet.

Technically, shares have been uptrending since Nov. 15, 2012, but have hit resistance in the mid $22 range. There is a massive double-top formation at this level on the daily chart. This creates a daily breakout close opportunity. Entering a long trade when price closes above $23 makes technical sense. My 12-month target is $33 if price can break out above the $23 level.

Risks to Consider: Despite the success of fracking, the industry faces heavy headwinds from dropping natural gas prices. It's almost like a catch-22 situation. The more efficient fracking becomes, the more supply is available, hence the lower the price, thereby hurting the companies themselves. In addition, pressure from environmental activists remains a sticking point in the industry, since lubricants are mixed into the water to facilitate the fracking of the shale. In fact, it's illegal in some states due to the environmental concerns.

Action to Take --> I like C&J Energy Services on a breakout above $23, but would avoid FRAK due to the heavy commodity risk. However, when natural gas starts to climb, the ETF should reflect this optimism. As such, FRAK is on my watch list.

P.S. -- As I mentioned earlier, Andy Obermueller has been putting the finishing touches on a special report on natural gas for his Game-Changing Stocks readers. In it, he will identify three critical, high-need areas that natural gas can address, including how investors can profit from this incredible trend.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of APC, CJES in one or more of its “real money” portfolios.