Two stock picks for the new American energy landscape

Author: Tyler Kocon, Split Rock Private Trading

Covestor models: Bakken Shale, Equity Rotation

Oil and natural gas prices are continuing to fall. The precipitous and unprecedented drop in the prices of these commodities is putting increasing pressure on the stock market of countries and regions across the globe.

So what gives? The most precious and sought after commodity in the modern world, the liquids that heat our homes and power our cars are suddenly an afterthought. The exponential global slowdown is causing oil and natural gas to lose value in the eyes of the user.

This fact, coupled with drastic domestic overproduction is ushering in a completely new American energy landscape. Who would have thought that something sought after so aggressively, would ultimately impact energy investors so immensely. So what is an investor to do? The answer lies in the process behind the production of an oil well.

The creation of an oil well is a slick and messy process. After about a month’s worth of drilling, readings, sediment analyses, course corrections, hoisting, casing, and evaluating, most oil and natural gas exploration and production companies ultimately find pay dirt.

At first, this oil well is likely to be erupting so aggressively that containing the liquid gold flowing from the earth may be a difficult process. Ultimately, however, as pressure drops and the well ages, the flow rate of that well will continue decline until it dries up. The problem is, this process can sometimes take up to 30 years. Each oil well created by a drilling company is essentially a 30-year annuity; with a large amount of maintenance, cleanup, and logistics necessary to keep operations at an optimal level.

Portfolio Manager Tyler Kocon of Split Rock Private Trading manages the Bakken and U.S. Energy Shale separately managed account with the idea that there is more to the puzzle than simply drilling and finding oil and natural gas.

This SMA, which is available at Covestor, includes several holdings that make their living by working in conjunction with exploration and production companies. Their difference is that these companies contribute a specialized or derivative product contrary to the traditional idea behind oil and natural gas investing. These companies make the exploration and production aspect of the business possible. They clean up the mess or transport the product.

One particular holding maintained in the Bakken and U.S. Energy Shale portfolio is a company called Ecosphere Technologies (ESPH). This company provides a derivative activity to the exploration and production companies that are often discussed in the news or seen n the logos at your local gas station.

ESPH’s primary area of operation involves treating water used in hydraulic fracturing in order to recycle it to be used again. Split Rock sees an incredible value for this firm in two ways. First, we understand that in order to “frack” a well, an enormous amount of water must be used. In turn, this means that the same enormous amount of water must also be disposed of in some form. In contrast, ESPH provides an eco-friendly method to this growing problem.

Another derivative play currently employed by Split Rock Private Trading involves a position in Trinity Industries (TRN). It might sound weird to hold a company that primarily produces rail cars in a portfolio centered around the energy industry, but think about this. The fundamental problem surrounding booming shale oil and gas plays like the Bakken revolves around the idea of logistics.

Oil is erupting from the soil at a rate never before seen in the history of this country. At the same time, there are very, very limited means to move that oil to a place where it can be refined into a product usable by the masses. Without this transport, it is simply the same as it was 10,000 feet below the surface.

Now consider the reality that rail companies are literally chomping at the bit to get their hands on transportation routes from this area to the refineries on the Gulf Coast. More rail indirectly means more rail cars and Trinity Industries produces a vast majority of those rail cars used in the U.S. Regardless of which company ends up gaining exposure to those lucrative transport contracts, they will still need to buy the cars to build their trains. Trinity will be more than willing to sell to them.

This is how Split Rock Private Trading portfolio manager Tyler Kocon has decided to inject some derivative potential into the Bakken and U.S. Energy Shale separately managed account. Both of these holdings are small examples of how an investor can find value in the shale oil and gas space without tethering themselves to the juggernauts pulling the oil from the ground. This tree of profit has many branches. It all depends how far out you want to travel.