T. Boone Pickens' new private equity fund is getting off to a fast start in its efforts to profit from the unique advantages of low-cost domestic natural gas. Just recently, the fund made a major investment in Moser Energy Systems, a small private maker of engines and generators that are used at oil and gas wells to generate power. While this isn't directly an opportunity for individual investors, there's one growing engine maker that just happens to be a big supplier to Moser: Power Solutions International (PSIX -1.34%). Will Pickens' big investment to help this private reseller crank up its sales move the needle for Power Solutions International?
Pickens is putting his money where his mouth is in advocating for using natural gas in traditional diesel applications. Source: Clean Energy Summit
What makes this a big deal?
Oil and natural gas production is booming in the U.S., which means demand for power systems at remote well sites will continue to grow. Historically, the engines at these sites are diesel, such as those made by Cummins (CMI 0.66%), one of the largest engine makers in the world. Cummins is renowned for the reliability, durability, and consistent power output of its engines. However, one of the dirty secrets of the oil business is a practice called "flaring."
At most oil wells, a small amount of natural gas also comes out with the oil; but the unfortunate reality is it's not cost-effective to capture and sell the small volume of gas produced by many of these wells, and the gas is actually burned off at the wellhead. While this is an economic reality, it's a sad environmental practice.
The good news is Power Solutions International's engines -- the ones that Moser uses to build its generators -- are set up to use the natural gas byproduct that oil producers are just burning off today. Not only is this a big environmental plus, since natural gas engines are around 20% cleaner burning than diesel, but the cost savings can be as much as $250,000 per year for each site. That's compelling for drill operators.
Gas is flared on offshore and onshore oil sites, and diesel is brought in to run generators. Natural gas engines are changing this practice. Source: Wikipedia
Power Solutions International's stake
Power Solutions International is incredibly well positioned in off-road engines, such as those that end up powering generators in oilfields. One of the company's strengths is in its technology that allows operators to run a single engine on different fuels. This flexibility can make all the difference for a well site that may not produce enough natural gas to support 100% of the generator's requirements, meaning the flexibility to run diesel at times.
How big is this specific area for Power Solutions International? The company did just under $238 million in total sales in 2013, $60 million of which (25% of total sales) was tied to heavy-duty engines for oil and gas. CFO Dan Gorey said on the February earnings call that the company was projecting a 25% increase in this category in 2014, to $75 million in sales.
Competitive challenge
Cummins is one of the most recognized names in diesel-powered generators worldwide, and is always a worthy foe in any segment it competes in. Considering that 95% of the generators at these sites are diesel today, rest assured that Cummins already has a stake in this market. Its current answer to this is the company's dual-fuel engines, which burn a mix of diesel and natural gas together, with natural gas offsetting as much as 70% of diesel consumption. Though not ideal when compared to the ability to completely substitute diesel with Power Solutions International's engines -- while still maintaining the ability to use diesel if natural gas isn't available -- Cummins' reputation and history of quality do carry a lot of weight.
The key here is it's tough to really understand how much of a threat this really is to Cummins. After all, the global engine maker's 2013 revenues were $17.3 billion, and this is only one narrow market where it sells engines.
Huge growth potential, but watch for on-road growth as well.
Power Solutions International is very well positioned to grow its business, and this was true before Pickens' company invested in Moser. The reality is, Moser isn't one of Power Solutions International's largest customers, making up much less than 10% of the company's engine sales. However, seeing Pickens invest in this growing part of the market bodes well for continued expansion of natural gas generators at well sites, especially as state regulators tighten down on the practice of flaring.
The key for Power Solutions International today is also tied to the company's plans to expand into on-road engines, a market it has never participated in before. While the growth story looks great, I wouldn't go "all-in" on the company just yet. Now is a time to invest small, and watch for the results of the on-road business over the next year before taking a large stake. Historically the company has done well in new markets, but it's probably prudent to let the company prove it can perform in on-road engines before taking a full position. Better to be right a little late, than wrong, way too early.
