With all the attention paid recently to fracking – and the oil and gas sectors generally – many want to know where the good investment opportunities are. Are fracking companies set on finding oil or natural gas a good bet? Do we need to invest in fracking infrastructure?

Defining Fracking

Fracking is short for hydraulic fracturing, also known as hydrofracking, which is a process that allows companies to more easily extract oil and gas by artificially breaking up rocks in the way. Typically, a fracking process involves drilling a well, which is designed to go horizontally through the rock. Then water is pumped into the well, mixed with a substance called a "proppant," which is usually sand. A trace of other chemicals is often added to increase the viscosity of the fluid, such as guar gum.

The pressure fractures the rock, allowing whatever hydrocarbons are in it to flow more freely and exit through the well. The proppant helps keep those cracks open, and the result is more natural gas and oil. Hydraulic fracture is generally used on rock that ordinarily wouldn't be permeable enough to allow oil and gas out fast enough to be profitable.

It's an old technique, but it was only the twin pressures of higher oil prices and improved technology for digging that made it what it is today: the source of nearly two-thirds of the natural gas production in the United States.

Key Takeaways

  • Fracking companies are responsible for extracting natural gas and oil by artificially breaking up rocks to speed up the process.
  • Approximately two-thirds of U.S. natural gas production comes from fracking, signaling a big dependence on the controversial process.
  • Fracking companies make up a competitive market, including involvement from energy giants such as Chevron, ExxonMobil, and ConocoPhillips and many others.

Big Companies Trailing

The companies that do the fracking are a varied lot. There are some big, familiar energy giants in that group, such as Chevron Corp. (CVX), ExxonMobil Corp. (XOM), and ConocoPhillips Co. (COP). However, the big petroleum companies have more often been on the trailing edge of the boom that fracking has produced; only Conoco is primarily a natural gas company and it has shifted away from that recently. More often the traditional oil producers own the leases to the land on which fracking is done and contract the work out to oilfield services companies.

Marc Bianchi, an analyst at Cowen and Company, notes that the pressure pumping and drilling businesses don't have high barriers to entry, as getting the pumping equipment is relatively easy to do. At the same time, that also puts a cap on profit margin growth, as competition holds prices down. And big players, like Halliburton Co. (HAL), are still in the industry as well. "It ends up with some pretty severe booms and busts in that business," he says.

Growing Demand

The bust, though, might still be some years away. The demand for energy – and natural gas – has been increasing steadily. It is, after all, a big reason why hydraulic fracking is worth doing to begin with. In 2019, the United States set a new record using 85.0 billion cubic feet per day of natural gas, up 3% from the previous year.

Then there are the companies that provide the equipment to do the fracking, and the sand that goes into the water used to fracture the rock. Bianchi says one interesting area regards proppant providers. U.S. Silica Holdings Inc. (SLCA) and Emerge Energy Services LP (EMES) are two examples of companies that have both benefited from the increased activity in both oil and gas extraction. It's actually more difficult to add supply in this market, Bianchi says, so the proppant providers tend to be more insulated from competition. The stocks of both U.S. Silica and Emerge have produced five-year returns measured in the hundreds of percentage points at certain points in time.

Not Just Gas Prices

For anyone wanting to play in the fracking space, oil prices are going to be a factor. Natural gas and oil are different markets, in the sense that oil is basically global and natural gas is more localized. The extraction of natural gas, though, tends to track oil production because the types of rock that produce natural gas also happen to be the ones that carry oil. Historically, a lot of natural gas production is a byproduct of oil production.

Areas such as the Marcellus Shale in the eastern U.S. produce natural gas, an area that's frequently in the news because hydrocarbon production isn't typically associated with upstate New York. However, a sizable portion of new production sites are also in Texas or North Dakota, says Bianchi.

That's changing – in the future, there are likely to be more "pure" gas plays as the technology develops for getting gas out where oil isn't worth it. But for now, it's a good rule of thumb that as oil production rises, so does natural gas. The converse is also true.

Exports Still Factor

Another factor to consider in investing in fracking infrastructure is exporting natural gas. In 2018, the U.S. actually exported some 3.61 trillion cubic feet of natural gas to 33 countries, according to the EIA (the latest figure available). That's the highest on record; in fact, the trendline has been steeply rising since 2000, when the U.S. sent out 243 billion cubic feet. Almost all of it leaves the country via pipeline to Canada and Mexico.

The wild card in this is Europe and Japan. To be sent to either place, natural gas has to be liquefied, which costs a significant sum to make economic sense. The price of natural gas has to stay relatively high in Europe and Asia while staying low enough in the domestic market that it isn't simply more profitable to sell it here.

It's possible the European Union may want to reduce its dependence on Russian natural gas, but as Russia already has the infrastructure in place to deliver it, prices would have to be high in order for imported gas to be competitive, unless there is a political decision to stop importing Russian gas.

The Bottom Line

With a low barrier to entry, the amount of competition to drill for and extract oil and gas via fracking tends to keep profits down – not to mention the relatively low price for gas. Assuming that, the companies that provide the implements and services to frackers could be the better bet.