Profit From More Fracking Regulation

Frackers use large amounts of water to help extract hydrocarbons, and it is common for water to be shipped on expensive trucks. Environmentalists are concerned about the large amount of water used to drill every new well. In desert-ridden states like Texas, this can become a very contentious issue. To help decrease the effects of droughts, states are proposing laws to make companies recycle a significant portion of the water used in the fracking process. As more states come to grips with the impacts of fracking, expect water recycling to become a required part of drilling. 

Halliburton (NYSE: HAL  ) and Baker Hughes  (NYSE: BHI  ) are two big oil service firms that will benefit from mandatory water recycling. Halliburton runs its H2O Forward Service and is reported to have saved drillers up to $400,000 per well by increasing water efficiencies. Offering water recycling services to frackers is important for the company: In the second quarter of 2013 a full $3.8 billion of its $7.3 billion in revenue came from North America and $3.0 billion of its total revenue came from drilling and evaluation services.

Baker Hughes is in a similar position. It recently jumped on the recycling boat with its H2prO service. In the second quarter of 2013 $2.7 billion of its $5.5 billion in revenue came from North America. Its latest quarterly SEC filing does not state revenue by product line, but its 2012 yearly filing shows that $7.2 billion of its total $21.4 billion in revenue came from its drilling and evaluation segment.

Schlumberger  (NYSE: SLB  ) has a strong international focus, making North America's fracking industry of relatively little importance for the company. In the second quarter of 2013 just $3.4 billion of its $11.2 billion in revenue came from North America. On a product segment basis, only $4.3 billion of its revenue came from drilling activities.

Recent market trends

HAL Income from Cont. Ops Quarterly Chart

HAL Income from Cont. Ops Quarterly data by YCharts

Recently the North American oil services market has faced a number of difficulties. While natural gas prices have come up, there is a large amount of natural gas production that is being burned off due to lack of pipeline capacity. Given the inevitable expansion of pipelines into new areas like the Bakken, drillers are very hesitant to spend on natural gas rigs.

Field owners are looking to save costs by drilling multiple wells on the same pad. Oil field service firms are forced to do more with fewer rigs. Also, the wide spread between America's WTI oil price and Canadian oil prices has caused many Canadian drillers to cut back.

Recently North American focused oil and gas service firms took a big hit. Year over year Baker Hughes's 2013 second quarter North American profit before taxes fell by $146 million. In the same time frame Halliburton saw its North American operating income fall by $191 million. Schlumberger is the exception. Thanks to strong offshore drilling, its North American income before taxes fell by just $31 million in the same period.

In the short term the pressure on the inland North American market is expected to continue. The roll out of major pipeline upgrades like Enbridge's expansion of Line 61 from 0.4 million barrels per day (mmbd) to 1.2 mmbd should boost Canadian oil prices and drilling activity; though if fully approved the project will not be completed until 2015. As the Canadian market improves, Halliburton should be able to grow its quarterly earnings per share (EPS) beyond $0.70. Also, Baker Hughes should be able to get its quarterly EPS back up to the $0.86 to $1.00 levels it posted in the first half of 2012.

The up and coming player
Nuverra Environmental Solutions (NYSE: NES  ) is a small player that is a direct play on environmental management services for the oil and gas industry. It is trying to differentiate itself by offering complete lifecycle services, from the delivery of water to its final disposal.

Nuverra is still rolling out its full product lineup, but it is already stabilizing its spending. Its cash capital expenditures fell from $240 million in 2011 to $129 million in 2012, while its revenue grew from $548 million to $730 million in the same time period. Thanks to drillers' desire to cut costs and pressure to make fracking more environmentally friendly, Nuverra is expected to stop its EPS losses by 2014.

Foolish conclusion
Reducing water usage helps drillers be greener and boost their bottom lines. Halliburton and Baker Hughes are two major oil field service firms ready to benefit from increased water recycling. Nuverra is a small firm that is a direct play on water recycling. If you are willing to deal with the increased risk and reward that comes from investing in a small company dependent on a volatile industry, then Nuverra is worth a second look.

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