12 Stocks to Cash In on the Energy Revolution

We name a dozen attractive stocks in four key areas: shale, sea, service and sun.

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.”

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.”

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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 (opens in new tab)), Cabot Oil & Gas (COG (opens in new tab)) and Southwestern Energy (SWN (opens in new tab)). 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.

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One of them is Anadarko Petroleum (APC (opens in new tab)). Some of its most promising projects are located in the Gulf of Mexico and off the shores of Brazil, Colombia, Kenya and Mozambique. Analysts praise Anadarko for its skill in finding large-scale discoveries at a low cost. At $94, the stock sells for 18 times projected earnings—not terribly expensive in view of Anadarko’s expected long-term earnings growth rate of 22%.

The other company, Apache Corp. (APA (opens in new tab)), has gone through a rough patch over the past couple of years. Shares of the Houston exploration firm, which peaked at $133 in April 2011, sank to $69 two years later, thanks to a combination of low gas prices and operational missteps. Investors also fretted that political instability would derail Apache’s joint ventures on some 10 million acres in Egypt. But Apache launched an aggressive restructuring program this year, selling off one-third of its Egyptian assets as well as fields in Canada and the Gulf of Mexico. It is using the $7 billion in proceeds to pay off debt and buy back shares.

Apache says that recently completed wells in the North Sea contributed 16% of the company’s worldwide production revenue in 2012. The firm is also developing projects in Alaska’s Cook Inlet and off the shore of Australia. At $87, the stock is cheap, trading for just 11 times projected profits.

Cashing in on the Helpers

The exploration boom is also fueling blockbuster business at companies that provide everything from drill bits to well testing. Many of them, including all five mentioned below, are headquartered in Houston.

If you plan to build a deep-water rig, you’ll almost certainly turn to National Oilwell Varco (NOV (opens in new tab)) for supplies. “There’s a joke in the industry that NOV stands for ‘no other vendor,’ ” says analyst Stephen Gengaro, of Sterne, Agee & Leach. Indeed, the typical deep-water rig will cost $650 million to $700 million to build, and roughly one-third of that will go to NOV for the parts, Gengaro estimates.

With deep-water exploration going gangbusters, NOV has a backlog of orders worth $13 billion. Ironically, that has hurt NOV’s stock price because some investors worry that the business has nowhere to go but down. Gengaro thinks the worries are overblown and that NOV will produce robust results for years.

Wunderlich’s Scholl is equally enthusiastic about the prospects for offshore contractors. His favorites, Rowan Companies (RDC (opens in new tab)) and Diamond Offshore Drilling (DO (opens in new tab)), rent their crews and equipment to drillers that want to explore in waters both deep and shallow. Scholl thinks Rowan is an especially compelling value. The stock sells for 13 times predicted year-ahead earnings, which seems modest considering that analysts expect Rowan’s profits to expand 27% annually over the next few years. Scholl attributes the bargain price to uncertainty over a corporate makeover. Rowan sold its onshore business in 2011 to purchase deep-water rigs. Those rigs will supplement Rowan’s shallow-water drilling, now largely concentrated in the Gulf of Mexico, but they’re not expected to be operational until late 2014.

Diamond Offshore also has a number of new deep-water rigs that should come online over the next two years. Thanks in part to a long-term drilling contract with Apache, Diamond is expected to generate annual profit growth of 18% over the next few years. But the stock sells for just 12 times estimated year-ahead earnings.

If your oil rig—on- or offshore—requires anything from project management to telecommunication services, you’re likely to turn either to Schlumberger (SLB (opens in new tab)) or Halliburton (HAL). Schlumberger is the world’s largest energy-services company and is particularly strong internationally; Halliburton is number two worldwide but the market leader in North America.

In addition to dominating their markets, both firms have been buying back billions of dollars worth of their own shares. Schlumberger sells for 16 times estimated year-ahead earnings, and Halliburton trades for 12 times profits. Gengaro thinks these are bargain prices for dominant players in a booming market.

Solar Gets Serious

Tapping the sun’s energy to fuel homes and industry has been a fond wish of clean-energy advocates for decades, but solar still accounts for less than 5% of the nation’s energy production. Many investors in solar-related stocks got burned when the sector started to implode late in the last decade. For example, shares of First Solar (FSLR (opens in new tab)), one of the leading players, plunged from $311 in May 2008 to less than $12 by June 2012.

Still, solar power is growing at a blistering pace, and many of the factors that had clouded the industry’s future appear to have disappeared. Angelo Zino, an analyst with S&P Capital IQ, says he’s bullish on the sector because of improved technology, new financing options and the departure of many marginal players, leaving the industry less ruthlessly competitive. Although industrial demand for solar has slowed in the U.S. and Europe, Zino says, Asia will pick up the slack. Residential demand is also revving up in sun-drenched parts of the world,

including the U.S. Southwest, as more manufacturers offer financing packages that can make solar as affordable as conventional electric power.

Zino’s favorite stock is SunEdison (SUNE (opens in new tab)). The St. Peters, Mo., firm, formerly known as MEMC Electronic Materials, has announced that it is spinning off its unit that develops and sells the silicon wafers used in making semiconductors. What will remain is a pure play on the sun—a company that makes solar equipment, buys and develops the land for solar farms, and sells power to businesses and consumers. SunEdison is expected to lose money in 2013 but to turn a profit next year. The imminent breakup has already caused the stock to triple over the past year, but Zino thinks it will continue to shine because the company is likely to take part in major solar projects in Japan and China.

A former highflier, Sunpower (SPWR (opens in new tab)), one of the largest manufacturers of residential solar equipment in the U.S., traded at $142 in December 2007, then began a sickening slide that ended with the stock dipping below $4 in November 2012. But after losing nearly $1 billion over 2011 and 2012, the San Jose, Cal., company returned to profitability earlier this year, and analysts see earnings growing 30% annually over the next few years. If they’re right, the stock, which has recovered to $29 and trades at 26 times estimated year-ahead earnings, could continue to power ahead.

Kathy Kristof
Contributing Editor, Kiplinger's Personal Finance
Kristof, editor of SideHusl.com (opens in new tab), is an award-winning financial journalist, who writes regularly for Kiplinger's Personal Finance and CBS MoneyWatch. She's the author of Investing 101, Taming the Tuition Tiger and Kathy Kristof's Complete Book of Dollars and Sense. But perhaps her biggest claim to fame is that she was once a Jeopardy question: Kathy Kristof replaced what famous personal finance columnist, who died in 1991? Answer: Sylvia Porter.