GrowthSpotting: The Art of Global Investing
This series cuts through market noise to explore a handful of what we believe are the most relevant and inevitable global trends for investors seeking growth.
These powerful subthemes take a closer look at what we think is a valuable framework for understanding growth drivers worldwide—our “MANTRA” (Mass Affluence, New Technology, Restructuring and Aging).
Today’s post focuses on Pumps, Pipes and Platforms: For Weir, Fracking Is a Gas, Gas, Gas.
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One of the great transformational changes underway is the sourcing of oil and gas from shale, a.k.a. hydraulic fracturing, or “fracking.” The technology has been under development in North America for over 20 years; now, finally, fracking is commercially viable.
The basic process is as follows: Drill down six miles deep, and then drill horizontally for another mile. Then, use pumps to force water and sand through the resulting wells at such tremendous pressure that it fractures the shale rock releasing its small pockets of oil and gas.
One opportunity for investors lies in supplying those pumps. One such provider is The Weir Group PLC (WEIR.LN), a Scottish company that is the market leader in producing the compressors, valves and pumps (known in oil patch speak as “pressure fracturing pumps and fluid ends”) necessary to extract gas and oil from shale.
Weir’s fracking pumps sell for around $250,000 each. More importantly, the extreme pressure at which the pumps operate is such that the cost of maintenance and spare parts is four times the initial investment.1 That could amount to an additional $1 million over the average five-year life of the pump, potentially producing an earnings stream with an aftermarket margin 50% higher than what Weir earned on the original sale.2
For pump purchasers, the speed and reliability of aftermarket service is a critical factor. With an estimated 50% market share, Weir’s dominance creates a virtuous circle that produces a competitive advantage and a significant entry barrier3: The bigger the footprint of a supplier, the better the availability of its aftermarket service, which could lead to a widening of that footprint through more sales to repeat and referred customers. In this market it’s not about price: Dominant players dominate. Therefore, the propensity to return to a proven provider is extremely high.
Whether one agrees with the process or not, fracking has released so much new gas so suddenly across North America that it has helped push the price of U.S. natural gas down 80% from the 2008 peak.4 But investors shouldn’t overlook the fact that production still lags consumption, and that the potential to export natural gas offers even broader demand down the road (see chart). And, there is plenty of supply: North America has enough shale gas to last about 90 years5, whilst shale oil production could triple this decade.6
This is clearly a long-tailed, durable growth story, and I believe Weir can extract value from it by virtue of its position in the industry value chain.
- Weir Group PLC, 6/21/11.
- Kelpie Capital, 4/6/12. http://kelpie-capital.com/2012/04/06/the-weir-group-weir-l-drill-baby-drill/
- Financial Times, “Weir Widens Reach Amid Boom in Fracking”, 1/25/12.
- Bloomberg, 8/3/12.
- Energy Information Administration, 1/30/12. http://www.eia.gov/tools/faqs/faq.cfm?id=58&t=8
- Energy Information Administration, 6/25/12. http://www.eia.gov/forecasts/aeo/
Read more from the series GrowthSpotting: The Art of Global Investing at http://blog.oppenheimerfunds.com/tag/growthspotting/
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