Shale ETF (FRAK ETF) – Ride the Boom

The energy sector in the US has experienced a paradigm shift where the oil majors has increased the use of fracking to make up the decline in production dependent on conventional oil and gas extraction methods. Hydraulic fracturing energy companies has been profitable for investors that go into the ground game early with the names likes Chesapeake and Anadarko.

Chart below shows the decline in the oil price and since late last year. Energy companies have been cutting operational rig which is the first decline since the start of the boom in 2008. Due to short term nature of life spans of these rigs, Hydraulic fracturing will also lead the recovery in exploration and production.

Oil Rig Count

(Source: FT.com)

Hydraulic fracturing has become the primary growth engine of the energy production domestically, decreased US dependence on foreign oil imports and a significant driver of economic recovery post recession in the resource rich states.

Broadly there are 2 primary ways for investors to gain exposure to the booming energy sector. First through ETFs that track oil and gas prices (i.e United States Natural Gas Fund, LP – UNG) or Energy Index ETFs (Energy Select Sector SPDR Fund) which tracks a basket of oil and gas companies.

One ETF Unconventional Oil and Gas ETF (FRAK) is designed for investors looking to have a direct avenue to companies in the unconventional energy oil and gas sector. Although the name of the ETF implies it that it includes mostly companies using hydraulic fracturing. FRAK ETF actually tracks the Global Unconventional Oil & Gas Index which also includes other alternative unconventional methods such as coalbed methane (CBM), coal seam gas (CSG), shale oil, shale gas, tight natural gas, tight oil and tight sands.

There are 58 companies in the FRAK ETF split across US (75%) and Canada (25%). It also has exposure to a few Australian companies but overall size of AUM is not material.

The top 10 holdings breakdown below shows that the top 10 firms comprise 49% of the ETF with the 48 companies constitute remainder 51% of the ETF.

One important risk investing FRAK investors should be aware of is the potential liquidity risk of the ETF. Although 88% of the companies included in the ETF are considered to be the large cap with overall market capitalization greater than $5 billion and remainder 12% is focused on companies between $1 – $5 billion range.

The AUM of FRAK itself is tiny, with recent figures pinning at $48 million. Daily volumes in 20k share range. For those that are looking to build a large position, best to add to portfolio overtime.

An alternative option for investors can consider is the Energy Select Sector SPDR Fund (XLE). It is the largest energy equity ETF listed so it avoids potential liquidity risks that FRAK poses. From the analysing the return of both ETF. XLE has outperformed FRAK since FRAK’s inception in early 2012.

From the risk and return prospective Investors would be better off focusing on using a more diverse ETF option to capture exposure to US oil and gas growth.

Appendix: Distribution of Hydraulic Fracking drilling the in the United States

US Shale drilling areas

US Shale drilling areas