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Why UK shale gas should be on investors’ radars

UK investors should be keeping a close eye on the domestic shale gas industry, according to Mark Holden, manager of the Ignis UK Focus fund, who says it has huge money-making potential.

The UK Government has said it is determined to open up the UK’s shale gas reserves using the fracking techniques that have slashed the US’s energy costs and helped revitalise its manufacturing base.

Holden (pictured) says that while there are limited options for those who want to invest in the industry at the moment, this is likely to change in the coming months and years.

I think it’s becoming much more investable, Holden said. I have a small position in IGas, the only UK-quoted company in the area, although it is the smallest position in my portfolio as I took it down after the recent rally.

IGas is an AIM-listed company that holds around one-third of the country’s shale gas licenses.

The company’s share price spiked in January when it was announced that Nexen, which owns 25 per cent of the company, was being taken over by China’s CNOOC.

Performance of stock over 1yr

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Holden explains that it is harder to gain access to the largest company involved in the exploration.

There were expectations that Cuadrilla would come to the market in an IPO, and that’s still expected to be the case in the next couple of years, but that has been delayed a little because their drilling has been delayed a little.

They are a bigger company, but still private equity unfortunately. It is possible to get in through Lucas, a listed Australian company that holds 42 per cent of its shares.

Cuadrilla is headed up by Lord Browne of BP, who is no fool, and he’s very interested in the long-term future of shale gas.

They were meant to be drilling a new test well but that has been delayed a few months.

Many of the delays encountered by the companies exploring the UK’s vast shale gas reserves are due to concerns over the environmental impact of the work. Holden thinks this is manageable.

Probably the biggest issue is dealing with local communities, he said. There were scare stories about earthquakes which were blown out of proportion in my view. It does generate movement, but to a minimal degree.

The manager says that investors who want exposure to this theme may wish to consider buying shares in the big companies such as BP and Royal Dutch Shell, which are likely to get involved in the future.

BP’s chief executive Bob Dudley told a shareholders’ meeting last week that the company could be involved in shale gas exploration in the future, and Holden thinks this is likely given the huge potential for rewards on offer.

The British Geological Society is to announce how big the reserves are and it’s expected to be enormous, to the extent that it could drive down the UK’s energy costs, he said.

I know the press has speculated about names, but the super majors will get involved at some point with their big cheque books.

I will be very surprised if they do not get involved, as they have experience in the US.

Holden thinks this experience could be invaluable when it comes to dealing with environmental and social concerns.

The environment still splits people, which is why you need to have the experience of dealing with the local communities, he said.

In America, people are much more willing to allow drilling on their land because they get a big share of the profits.

US law means that the owner of land has rights over the minerals extracted from beneath it, unlike in the UK where it is the property of the Crown.

Holden says that the oil companies will find ways to make up for this by offering sweeteners to local communities, perhaps in the form of improving roads and infrastructure.

However, the experience of the US suggests that when production does get underway it may not be the producers that benefit.

Cheap gas prices equate to lower revenues per barrel for the companies that are selling it, and some of the companies to have benefited the most are actually those outside the sector, which have seen their input costs reduced. Infrastructure has also struggled to keep up with the supply glut.

Eric Gordon, energy analyst at Brown Advisory, said: Fracking in the US is a case-study of how top-down investing in a sector can lead to poor outcomes if you don’t spend time to look under the hood.

Shares of oil producers and oil services companies actually stumbled 10 to 20 per cent over the course of 2011 to 2012, versus an 18 per cent gain for the S&P 500 index, as companies have struggled to manage the ocean of oil that is trying to push through the supply chain.

Some of the companies to have done the best out of the US revolution are chemicals and plastics producers, while other firms that supply the fracking industry have prospered.

One company that was recently added to our US Equity Growth Fund is Ecolab (ECL), a fast-growing, diversified company with industrial solutions built around a specialty chemical business, Gordon said.

It is Ecolab’s fast-growing energy business, which provides specialty chemical-based solutions in the extraction and processing segments of the energy industry, that is of particular interest to us as investors.

Among other things, the company focuses on providing solutions that minimise the use of water in the fracking process and maximise the production of wells.

It is possible to find oil producers that have done well out of the new techniques though, Gordon explains.

Fortunately, the energy sector offers us a strong collection of innovative and well-run businesses to choose from.

One example would be Occidental Petroleum, which has had some set-backs but is run by a strong team with an excellent track record of execution and capital allocation.

It is sitting on vast resources in the Permian Basin in Texas and as new infrastructure comes online in that area, we anticipate that local prices may normalise and positively impact Occidental’s earnings.

Brown US Equity Growth is a $1.16bn Dublin-domiciled fund. The fund was launched with a USD share class in November 2009 and a sterling share class was launched in June 2011, according to data from FE Analytics.

Holden has run the 75m Ignis UK Focus fund since October 2011, in which time it has lost 3.07 per cent while its FTSE All Share benchmark has made 27.05 per cent.

Holden runs a highly concentrated portfolio with a large weighting to the volatile oil and gas sector.

He told FE Trustnet last year that he was positive about the prospects for oil explorers operating in the Falklands and that he retains a large position in Borders & Southern, one of the key players off the islands.