12 Stocks to Cash In on the Energy Revolution
Decades of importing crude from the vast arabian deserts left many people believing that America’s dependence on foreign oil was as inevitable as the tide. But sweeping changes in the way oil and gas are extracted have created a Lawrence of Arabia twist in the energy-market plotline: “Nothing is written.”
See Also: North America's Next Energy Hot Spots
Once so dependent on imported oil that energy laws were designed to conserve domestic reserves, the U.S. is now expected to be energy-independent by 2020. In fact, the nation is rapidly overtaking Russia to become the world’s largest producer of oil and natural gas. The U.S. already produces more gas than it consumes, exporting some of the excess to Canada and Mexico. If protectionist measures are lifted, U.S. energy firms are primed to export gas around the globe. They are especially eager to sell gas to countries in Europe and Asia, where prices are two to four times higher than they are here.
The transformation from energy consumer to exporter creates opportunities for investors in a wide array of U.S. firms, particularly those that focus on the industry’s four s’s: shale, sea, sun and service. But there are plenty of risks, too. When it comes to energy, a whole new script is being written, and no one is quite sure how it will turn out. “There is more diversity and more segmentation in this industry than at any time in the past,” says Morningstar analyst Allen Good. “The space offers a lot of opportunities, but you have to be aware of the risks that affect each segment of the market.”
Chief among those risks is the price of energy. Falling oil and gas prices can turn a profitable company into a money loser. The gamble is heightened by the fact that oil and gas companies must constantly explore and innovate, often spending billions of dollars looking for new energy reserves and ways to tap them. Though still bit players, newer sources of energy, such as solar power, are gaining ground, too, creating opportunities and risks of their own.
That said, investing opportunities in this field are as abundant as new-discovery announcements. Below, we identify a dozen promising companies that focus on the four s’s of energy.
The Wonders of Shale
The natural gas market was transformed when the 60-year-old process of hydraulic fracturing was revamped for use in horizontal wells. A technique developed in 1997 added chemicals to the water-and-sand mix that’s shot into the well, and that vastly increased the amount of oil and gas extracted from shale. Within a decade, America’s dwindling oil and natural gas production began to soar.
The ability to pull gas out of previously unfriendly rock has been a boon for production but a bane for prices. Natural gas, which sold for $10.91 per thousand cubic feet in 2005, was selling for $3.41 in July. That's partly because domestic use of energy is on the decline, leaving newly prolific producers with more supply than demand.
U.S. companies are also hampered in their ability to sell gas overseas, where prices are far higher. As a result of laws passed during the energy-starved 1970s, energy companies can export oil and gas only if the government deems such moves to be in the nation’s best interest. Some two dozen applications that propose to cool natural gas into liquid form and export it to high-priced markets in Asia and Europe have been filed since 2010, but only a handful have been approved. Many have languished for years. Nonetheless, energy bulls hope that the bureaucratic logjam will eventually clear, leading to increased overseas demand. “I don’t think there is any question that the Department of Energy will eventually have to give in and allow the exports,” says Ryan Berney, an analyst at Raymond James. “It doesn’t make sense not to.”
Opening the export market should boost demand and create greater parity between international and domestic prices, a move almost certain to boost domestic gas prices. Meanwhile, cheap domestic gas is causing more manufacturers and utilities to convert their plants and factories from coal to gas, which should help strengthen prices, too. But because no one knows when supply and demand will come into better balance, your best bet is to invest in low-cost producers that can make money even when gas prices are low.
Three attractive producers are Range Resources (symbol RRC), Cabot Oil & Gas (COG) and Southwestern Energy (SWN). All three, favorites of Canaccord Genuity analyst Robert Christensen, have stakes in the Marcellus Shale basin in southwestern Pennsylvania, which produces prolific amounts of energy for a relative pittance. All three are growing and profitable. But earnings could soar if gas prices rise to $4.50 to $5 per thousand cubic feet, where Christensen predicts they’ll settle.
Range, which has a one-million-acre shale-bearing property in the Marcellus region, predicts that its gas production will soar seven- to tenfold over the next few years. The Fort Worth–based company reported that revenues rose 50% and profits soared 159% in the second quarter from the same period in 2012. Its stock isn’t cheap, however. At $77, Range sells for 42 times projected earnings for the next 12 months. Still, if the projected growth rates hold, Range’s stock price could prove to be a bargain. (Share prices are as of October 4.)
Cabot sells for a similarly lofty price, trading for 33 times estimated year-ahead earnings. The Houston concern expects to boost gas production in the Marcellus region by 30% to 50% annually over the next several years.
Southwestern started to lease Marcellus land in 2007, making it one of the newer players in the region. Although the bulk of the Houston firm’s energy production is from the Fayetteville Shale of northern Arkansas, gas production from the Marcellus piece is growing at a rate of 50% per year. Southwestern’s overall growth rate is slower, so its stock, selling for 17 times forecasted year-ahead profits, is less pricey than the other two.
Riches Beneath the Sea
Anyone who has seen the classic 1956 film Giant or the TV series The Beverly Hillbillies knows that drilling for oil in America is as old as the hills. But that history means that opportunities for land-based drillers are limited. “The largest onshore oil fields have been developed,” says Todd Scholl, an analyst at Wunderlich Securities. “All the low-hanging fruit is gone.”
Drilling at sea, on the other hand, offers a new frontier, especially as rigs and drilling techniques become more sophisticated and are better able to probe into deeper waters. Scholl is especially bullish on offshore contractors that don’t own the wells but hire out their crews and equipment for offshore exploration (see the section on service companies below).
Most offshore producers also have onshore operations. We’ve identified two companies with major water-based projects that are certain to play a key role in their growth.