What Can Investors Hope to Extract From This Energy ETF?

The recently launched Market Vectors Unconventional Oil & Gas ETF (AMEX: FRAK  ) is just one of the creative ways investors can add some energy spice to their portfolios. Does this niche play have a spot in your portfolio? Let's take a look.

Pump it up
The stated purpose of the ETF is "to track the overall performance of the largest and most liquid companies involved in the exploration, development, extraction, production, and/or refining of unconventional oil and natural gas."

The bulls will claim this ETF allows you diverse exposure to a volatile sector, and that's true. In the tug-of-war between environmentalists trying to derail fracking, and conventional oil and exploration costs upping the need for it, there will be guaranteed big winners and losers. If you're a fracking bull in the long run, you can dodge the landmines by spreading your chips over just one fund.

That diversification also allows investors to capture gains should any of the smaller, more speculative companies become takeover targets of the supermajors. That's good news for investors banking on a Kodiak Oil & Gas (NYSE: KOG  ) buyout, but with a measly 0.66% weighting in the ETF, even a fat buyout premium is unlikely to move the needle much.

Blast away
And that's where my apprehension comes in with this ETF. It doesn't have the weightings I would expect or want in this space. I believe investors would be better served constructing their own more focused and still relatively safe version. One big problem is the ETF's mandate that "(positions) must generate, or own properties that have the potential to generate, at least 50% of revenues from unconventional oil and gas."

These constituents number 43 at last tally. Occidental Petroleum is the most heavily weighted, representing 7.9% of the portfolio. The top seven positions make up 44% of the ETF. Inside that top-seven ranking, I'd certainly expect to see the largest fracker in the world: Chesapeake Energy (NYSE: CHK  ) . Instead, it's been relegated to a 4% weighting in the eighth spot. Interesting.

The revenue requirements also disenfranchise some of the best fracking plays out there, simply because they profit indirectly. Notably absent from the list are Schlumberger (NYSE: SLB  ) and Halliburton (NYSE: HAL  ) .

Despite cautioning that downward price pressure for their fracking services will take a bit out of performance this quarter, Schlumberger remains a great long-term fracking play. The company is healthily diversified with a big global footprint. Its HiWAY fracturing technique, in use in the U.S. and Russia, both reduces water usage and ups overall production. The company's size lets it ride out rough times that crush lesser, more speculative companies, and its focus on technology and development as opposed to acquisitions means its growth is more organic than in the broad industry.

Halliburton is the largest provider of hydraulic fracturing services in North America, so it seems strange that it also would be omitted from this ETF, especially considering it holds only North American companies. Fellow fools have repeatedly highlighted how cheap this company is right now, and I agree.

The "Frac of the Future" project is expected to greatly improve global operational efficiency in the future and continue Halliburton's commanding position as a fracturing service provider. When you're buying Halliburton, you're also diversifying away from fracking, though you're still staying in the same sector. Finally, the company provides a huge amount of mature field maintenance, and we've seen an uptick in global deepwater drilling activity.

The liability relating to the Macondo spill in the Gulf of Mexico continues to hang over this company like a dark cloud, though, but at these multiples it seems more than baked into the price.

To frack or not to frack
I'm going to say this ETF isn't the best way to get exposure to the fracking space. The fund seems to omit key players without rewarding big on the upside. For those who like the exposure to the long-shot buyouts like Kodiak, at this weighting you're better off buying them directly. Eleven of 11 Wall Street analysts are calling it a stock to outperform anyway.

For investors who were hoping for some safety by diversity here, you can still get fracking exposure in nicely diversified companies like Schlumberger and Halliburton.

If you're still having a hard time deciding how to add energy to your portfolio, don't worry: Our top energy analysts have made the decision for you. You can read all about The Only Energy Stock You'll Ever Need. The special report they compiled is only available for a limited time. Download your copy today.

Austin Smith owns no shares of the companies mentioned here. Motley Fool newsletter serviceshave recommended buying shares of Chesapeake Energy and Schlumberger. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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