Next Fracking Boom May Be Closer Than You Think

July 2015, Vol.242, No. 7

Michael McDonald,

Even as the fallout from the Greek debacle continues to hammer oil prices, investors need to be on the lookout for future opportunities in the industry. One country that has generated a lot of interest among energy companies and investors is Mexico. Now, as America’s southern neighbor moves to reinvigorate its energy industry, U.S technological advances seem to be moving south.

Recent reports suggest that fracking is beginning to take hold in Mexico with numerous wells being drilled. Unsurprisingly given the state of oil prices and the resources Mexico has available, thus far the fracking appears concentrated on natural gas, rather than oil. The important point though is that the use of the technology on a broad scale suggests a new opportunity for investors.

Fracking requires a very specialized set of skills and consistently significant capital expenditures given the substantial decline rates in those wells. This combined with the new infrastructure needs creates some intriguing possibilities for profits at firms in the space.

Fracking in Mexico is very controversial, just as the energy sector overhaul in the country itself is. Water scarcity in Mexico for instance may limit the country’s ability to engage in long-term fracking. In many respects, these challenges create opportunities for companies like Haliburton and Schlumberger, which have technical advantages over smaller operators. Similarly opportunities for fracking offshore in the Gulf of Mexico, a technologically challenging feat, offers new business opportunities for the major servicing companies as well.

The oil and gas industry in Mexico is dominated by state giant Pemex, and while the state may be giving up some control over the industry, investors should not expect that Pemex’s dominance in the market is going to evaporate overnight. Pemex appears to be very interested in fracking opportunities, but with the potential for local uproar given environmental and water concerns, the company is playing things close to the vest.

Mexico’s business climate differs greatly from that of the United States, and many U.S. firms in the past have tried unsuccessfully to expand there. Given that risk, investors interested in capitalizing on the evolving Mexican energy landscape, and in particular the stealth growth of fracking, are probably wise to look at investments that will be able to navigate the business terrain.

Local partners who understand the country and have political clout will be key to any investment projects. For that reason, major service companies like HAL and SLB are good choices. The firms will likely have significant opportunities to do work on behalf of Pemex, which in turn will keep them out of the local theatrics surrounding energy reform.

Similarly, Kansas City Southern (KSU) is very well positioned to benefit from an improving Mexican economy, especially in the energy sector. The railroad benefits most from increased South-North trade, and any increase in Mexican oil output will likely lead to greater crude by rail movement eventually.

Further, any dramatic increase in natural gas production as a result of fracking would likely lead to significant infrastructure import needs for Mexico, and greater manufacturing output across the country. All of that is good for Kansas City Southern.

Finally, perhaps the best opportunity of all to capitalize on energy opportunities in the Mexican energy space is not with energy stocks at all. Instead, investors should look at financial firms that will act as investment partners on Pemex led projects. For instance, Blackrock (BLK) announced a deal to act as an investment lead on a major new Pemex pipeline in March.

More such deals will follow both based on fracking opportunities and other investment options across the energy sector. Blackrock, Goldman Sachs, and potentially alternative investment firms like Blackstone (BX) and Apollo (APO) all are likely to become significant investors in major projects across the country over the next few years. Sage investors should look to these names as a stealth way to gain exposure to Mexico’s low-profile energy industry expansion.

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