Don't Believe Water Companies About Fracking

NEW YORK (TheStreet -- Don't believe water companies about fracking.

Traditional water treatment companies are looking at the oil industry as a new source of revenue outside the usual wastewater treatment, but investors should know that breaking into the shale gas produced water market isn't so easy.

These aspiring water companies face a market almost entirely locked up by three companies, a murky profit picture and a changing regulatory environment

"I think a lot of traditional water treatment companies have done very poorly in oilfield water because traditional water companies are not used to water that changes its composition every day," Brent Halldorson, chief operating officer of Fountain Quail Water Management recently told Global Water Intelligence, which provides industry analysis.

Oilfield water is a $2.5 billion a year business, so the lure of a new income stream is high. Oil companies tend to outsource the water treatment and especially water services for shale gas because the work is temporary and moves from site to site.

The business can be unpredictable. For instance, hydraulic drilling in the Marcellus shale area has been challenging as the geological formations there are different from other areas where the drilling hasn't caused problems with water.

Currently, the oilfield water treatment market is dominated by one player. Cameron ( CAM) has more than a 50% market share of the market followed by Siemens ( SI) and Veolia with each owning 8% of the market.

Cameron is the largest player in the market because of an aggressive consolidation strategy. The company is also a Wall Street darling with 85% analysts covering the stock giving it a buy rating.

Two more companies seen as up and coming are Nalco ( NLC) and Heckmann ( HEK).

Nalco has been around since the 1920s and has made a name for itself in the water and oil chemicals business. It has been on an acquisition tear, picking up three companies in 2010.

Heckmann sold its bottled water business in China in November in order to focus on water treatment for the oil industry. The company has also been growing by acquisition as it has purchased two companies in 2011 and is reportedly performing due diligence on more deals.

Xylem ( XYL), which recently split from its parent company ITT ( ITT), is another player in the space. It's focused on testing.

"Clearly the growth we see is in analytics, testing the water making sure of the water quality," says Gretchen McClain, the company's CEO. She said Xylem tests the fracking water and then just reports back to the oil company what contaminants it has found. It is left to the oil company to act.

Traditional water companies that have primarily treated sewage will face difficulties entering into this market. Cleaning sludge out of water tends to be a similar process day in and day out, but cleaning shale gas water can vary and the lack of consistency can cause headaches for the water companies.

There are also future regulatory concerns to consider. The Safe Drinking Water Act protects drinking water, but the Energy Policy Act in 2005 excluded regulatory oversight for fracking - including the effects on drinking water. But the negative reaction to hydraulic drilling in Pennsylvania led to the introduction of the Fracturing Responsibility and Awareness Act in 2009. The legislation hasn't passed and is subject to a study whose final report won't be issued until 2014.

There's already been incidents of hypocrisy when it comes to the government's approach to hydraulic fracturing. For instance, Pennsylvania representatives told Congress in November that they needed no federal oversight.

"It is total fiction that sewage treatment plants are discharging these 'terrible' waste products into the waterways," said Mike Krancer, the state's Department of Environmental Protection Secretary.

But that pronouncement stands in contrast to a $1 million fine that Pennsylvania levied in May against Chesapeake Energy ( CHK) for violations related to natural gas drilling where it determined that 16 families had their water contaminated by Chesapeake.

-- Written by Debra Borchardt in New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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