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Can investors gain from shale gas?

By Sheyna Steiner · Bankrate.com
Monday, May 20, 2013
Posted: 3 pm ET

Hydraulic fracturing, the controversial method of extracting natural gas from shale rocks deep beneath the surface of the earth, has investors excited. Fracking, as the process is more commonly called, remains controversial because it's not entirely clear that it's always done safely. Another drag on the industry: Recent surpluses in production have driven prices down, according to Bloomberg.

The Department of the Interior may limit drilling on federal lands, which could slow down production somewhat. Last week, the agency released a second set of draft rules to regulate drilling on public and Native American lands.

Despite the coming federal regulation, the political winds are clearly blowing in favor of the domestic energy boom. Hopes are high for natural gas in the future. Heady phrases such as "energy independence" and "making the U.S. the next Saudi Arabia" get thrown around, so it's easy to think investing in natural gas would be a slam-dunk -- but not so fast. There are a few things to think about before jumping in.

It's still early

Shale gas may be the future, but it's too soon to tell which companies are going to pull ahead.

"There are definitely opportunities, and it's a large, growing industry that will have a major impact on the U.S.," says Daniel Dingus, director of portfolio management at Fragasso Financial Advisors in Pittsburgh. "It's exciting, but we're in the early innings of knowing which companies will be there for the long term."

Look for growth potential in indirect businesses

While companies directly involved in the extraction business may experience some volatility, the companies that supply the drillers may be a more stable investment.

Investors who are looking for a piece of the action could investigate "some of the companies supplying picks and mechanics to the industry including transportation, pipelines and the infrastructure that is needed for this boom," says Dingus.

Keep an eye on taxes

Investing in mutual funds or exchange-traded products that focus on natural gas can be a little tricky due to the fact that many oil and gas companies are organized as master limited partnerships, or MLPs.

The limited partners in master limited partnerships are investors. Because of their structure, MLPs don't pay federal and state taxes the way corporations do. Instead MLPs pass profits to investors through quarterly distributions, a portion of which is taxed as ordinary income.

The taxing structure of MLPs can be pretty complicated; the topic is covered in the Bankrate story "What are MLPs?"

"If you own the MLPs directly, you have to file a K-1," Dingus says. The K-1 is a tax form sent out to investors by MLPs in place of the usual 1099. It shows the investor's share of partnership income, gain, loss, deductions and credits, according to the National Association of Publicly Traded Partnerships.

Though investing in an exchange-traded note, or ETN, or even exchange-traded fund, or ETF, will get rid of the tax complications, those investments often come with their own complicated structures and high costs.

"You have to be careful of how they tackle the tax difficulties of owning the infrastructure stocks that are structured in a tax-sensitive way," Dingus says.

Have you or are you planning to invest in the shale gas industry?

Follow me on Twitter: @SheynaSteiner.

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Senior investing reporter Sheyna Steiner is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.

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