How to Profit from the "Shale Oil Bubble"

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It's true: French, Japanese, and Chinese energy companies cannot seem to get their hands on a big enough slice of U.S. shale oil deposits these days.

However, that doesn't mean this investment frenzy is evidence of a "shale oil bubble."

Instead, it's a classic sign of an investment trend - one that will continue throughout 2012 creating an opportunity for investors to profit.

Consider that in just the past two weeks:

  • French oil major Total S.A. (NYSE ADR: TOT) invested $2.3 billion in Chesapeake Energy Corp.'s (NYSE: CHK) Utica Shale operation in eastern Ohio.
  • China Petroleum & Chemical Corp. (NYSE ADR: SNP), spent $2.2 billion for a 30% stake in five Devon Energy Corp. (NYSE: DVN) shale projects.
  • And Japan's Marubeni Corp., a commodities trader, agreed to pay $1.3 billion for a stake in Hunt Oil Co.'s Eagle Ford shale property in Texas.

The Reality Behind the Shale Oil Bull Market

That's a clear sign to investors that interest in shale deposits among foreign energy companies is beginning to heat up.

And to hear the mainstream media tell it, these companies are overpaying for access to U.S. shale deposits.

In fact, they claim that has led to astronomical valuations and the formation of a "shale oil bubble."

But that that perception is actually only half right: While the value of shale deposits has skyrocketed, the reality is that the higher prices are fully justified based on the increasing demands for oil and gas.

What's more, the foreign companies that are paying top dollar for access to U.S. shale assets aren't just paying for access-they're also paying for expertise.

"Foreign majors needaccess to technology andexpertise, as well as being able to putsome portion of reserves on their books," said Money Morning Global Energy Strategist and Editor of the Oil & Energy Investor Dr. Kent Moors. "For that they are quite prepared to farm in for a minority position in development projects."

In return, U.S. energy companies get the investment dollars needed to develop costly and complex reserves.

These foreign investments also give U.S. companies the money they need to acquire more land leases and increase their odds of hitting an especially productive gas or oil reservoir known as a "sweet spot."

That, Dr. Moors says, is where the "bubble" talk comes from.

"U.S. operators cannot afford to under-commit and that has led to an inflation in land prices," Moors said. "Those prices are nowrather out of proportion toa NYMEX gas price of $2.60 per 1,000 cubic feet and hugestorage volume dueto amild winter."

Still, the demand curve for gas will eventually move up as a result of increased usage in electricity generation, replacement of crude oil in petrochemicals, and a renewed emphasis on liquefied natural gas (LNG).

These energy companies, therefore, are taking a medium-term view. In short, they believe that once demand and prices begin to rise, these higher land values will be justifiable.

So where do investors fit in?...

"Shale Oil Bubble" Fears are Overblown

Investors can profit from this frenzy by looking for prospective takeover targets in the energy sector.

According to Subash Chandra, an analyst specializing in energy stocks for Jeffries Group Inc., the stocks to watch are SM Energy Co. (NYSE: SM) and Oasis Petroleum Inc. (NYSE: OAS).

"With independents being bought out, these two have the credentials that buyers are looking for," Chandra told SmartMoney.

Another oil sector analyst, William Featherston of UBS AG (NYSE: UBS), screened 40 potential takeover targets for the best combination of desirable characteristics. Traits that would appeal to the big oil suitors include untapped energy deposits and the financial ability to extract those deposits.

Featherston agreed with Chandra's choices, and came up with several more: Texas-based Anadarko Petroleum Corp. (NYSE: APC), Houston-based Cabot Oil & Gas Corp. (NYSE: COG), and Southwestern Energy Co. (NYSE: SWN).

For investors who'd like exposure to the entire group, there's also an exchange-traded fund (ETF), the Powershares S&P SmallCap Energy Portfolio (Nasdaq: PSCE). Those who want to cast an even wider net can try the IQ Global Oil Small Cap fund (NYSE: IOIL), which also includes small oil companies outside the United States.

Meanwhile, Money Morning's Moors advises investors to look for small companies that already are operating successful oil shale fields, have good prospects for expansion, and are well managed financially.

"On average, we will once again find that small companies that satisfy these criteria tend to produce higher return for investors than larger vertically integrated oil companies," Moors said.

Moors also advises investors to not overlook the most promising players in the oil industry, the midstream providers, which are involved in the transportation and storage of oil, and particularly Master Limited Partnerships (MLPs).

"The market will produce a rising number of pipeline, processing, gathering, and storage facilities mergers, with the position of MLPs and the equity issuances from them, becoming even more decisive," said Moors.

(Note: To get the full benefit of Dr. Moors' expertise, you can sign up for his free newsletter, the Oil & Energy Investor, by clicking here.)

As for the "shale oil bubble", today those fears are completely over-blown.

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