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Utility Gas Fund Shifts Into High Gear

NEW YORK ( TheStreet) -- For much of the past decade, shareholders had little reason to cheer the performance of FBR Gas Utility Index (GASFX).

Annual returns were generally in the middle of Morningstar's group of utilities funds. But lately FBR has caught fire. While the S&P 500 has lost 6.4% this year, FBR has gained 10.1%. During the past three years, the fund has outpaced the S&P by a wide margin and ranked as the top performer in the utilities category.

FBR holds about 60 stocks, including producers of natural gas as well as utilities that have both gas and electric operations. Those stocks typically deliver solid dividends and unexciting total returns. But a number of factors have combined to make gas an outperformer.

Beginning several years ago, companies discovered that they could exploit new gas fields by a using a technique known as hydraulic fracturing, or "fracking," which involves pumping water into underground rock layers. Thanks to fracking, new wells have begun delivering profitable supplies in the Marcellus Shale of Pennsylvania and the Barnett Shale in Texas.

Relying on the new techniques, gas producers increased their sales and profits. In some cases, staid distribution companies found that it was possible to go into the more exciting field of exploration and production. As gas supplies increased, prices declined. But producers compensated by increasing their sales volumes. "We have seen companies increase their production business and double total revenues," says Skip Aylesworth, FBR's portfolio manager.

While gas prices have plummeted, oil prices climbed. That encouraged more demand for gas. In some cases, cheap domestic gas has replaced expensive imported oil. All in all, the long-term future of the gas companies has begun to look brighter. "Many of these gas companies are sitting on large proven reserves of a commodity that is going to play an increasing role in satisfying the energy needs of the country," says Aylesworth.

What could disrupt the rosy outlook? Environmentalists are trying to stop fracking, arguing that the technique can pollute groundwater. The SEC and other regulators are talking about imposing new rules. But few politicians have been willing to disrupt an industry that is creating new jobs in states that need them. Lower gas prices could also pose a threat to profit margins. But so far declining prices have simply created more demand.
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