In this Insights paper, we examine how the self-sufficiency of the US in energy production can have ramifications for itself, others and importantly, for investors. Andy Gardner (Resources Analyst), John Payne (Senior Portfolio Manager Global Resources) and Jonathan Reyes (Senior Portfolio Manager Global Listed Infrastructure) also take a look at the investing opportunities that come from this energy revolution.
Developments in US shale oil and gas resources
Through a combination of horizontal drilling and cost-effective ‘fracking’, US shale gas production has grown from virtually zero in 2005 to 30% of total US gas production (today) and is projected to reach 50% by 2020. ‘Cracking the code’ for shale-liquids has taken longer than for dry-gas, but its growth is expected to be similarly impressive. When these resources are combined, some believe that the US could be almost self-sufficient for its total energy needs by 2020.
What does a self-sufficient US mean?
The projection that the US could become self-sufficient in energy production by 2020 has ramifications for a range of stakeholders, its economy and investors. The development of the US’s shale oil and gas resources has already achieved several things for America.
1 - It has helped reduce geo-political risk for the US, as America imports the majority of its crude oil from the Middle East.
2 - It has improved the US’s industrial competitiveness in manufacturing; given energy costs are a big material cost for manufacturers. A number of US manufacturers in heavy industry, such as chemicals and engineering, have relocated facilities back into the US because of this comparative advantage which highlights the extent of the improvement. Coupled with the current lower US dollar, this is a major competitive advantage for US manufacturers.
3 - The US could become an exporter of Liquefied Natural Gas (LNG).
Investing in the opportunity
With respect to specific areas of opportunity, perhaps the best analogy for the investment framework is to “follow the pig through the python”. The gas revolution (the pig) is expanding through the world (the python), impacting a series of sectors and countries, from coal to chemicals, and from shipping to automotive.
We believe there are three main options: assets – companies that control reserves; infrastructure – the value chain from oilfield services through pipelines, processing and shipping to construction and machinery; and arbitrage – companies able to exploit the gap between low US gas prices and the rest of the world. There are three main groups of countries: incumbents (Russia, Qatar); challengers (US, Canada, Australia) and aspirants (the rest).
What does an increase in energy supply mean?
The increase in supply has resulted in the US enjoying gas prices which are currently 70-80% lower than in Europe or Japan and oil prices which are 20% lower than the rest of the world. This has a number of implications.
With energy being a major input cost, the competitive advantage is so great that a number of chemicals and engineering companies have announced that they are to relocate facilities back into the US. It is estimated that US shale will add 4.7% to US industrial production over 25 years on improved US industrial competitiveness.
The benefits are more than just economic. It has helped to reduce geo-political risk given the majority of crude oil has been sourced from the Middle East.
Gas is also the cleanest burning fossil fuel. With gas displacing coal as a source of electricity, and also beginning to penetrate the transport market in place of petrol and diesel, the US should become gradually less carbon intensive. While in its infancy, Natural Gas Vehicle (NGV) demand is expected to rise sharply from 2016 (approximately) to 2020 as refuelling infrastructure reaches a sufficient scale to incentivise switching, with NGVs anticipated to make up 20% of new long-haul truck sales by 2020.
It was only five years ago that the US was expected to become a major importer of gas via LNG, and it subsequently built a significant amount of LNG regasification capacity (92mmtpa). The US is now in the process of converting these to LNG export facilities to sell gas into the global market, primarily Asia.
The difference in cost of gas to an Asian buyer could be up to $5 GJ or over 30%. We believe a number of other US LNG projects will be successful with the US providing around 40mmtpa of LNG into the global market by 2020. Thus, buyers will benefit from both the increased diversification and availability of gas as well as lower overall average prices.The US in a unique situation
This “overnight” success story has been over 20 years in the making. Shale prospects outside of North America are relatively immature and there are a number of factors which need to be in place for the template to be deployed elsewhere.
Countries with highly prospective shale resources need to undertake a large degree of seismic and geological mapping. This requires having a large pool of readily available expertise, the latest international technology, and access to finance to undertake detailed exploration and appraisal.
A critical step towards development and production is having transparent legislation and the alignment of property and mineral rights. Last but by no means least, is the ability to monetise the gas in the ground, which requires an integrated network of infrastructure and route to accessible markets both domestically and for export.
Shale gas drilling in Australia has stepped up significantly over the past 12-18 months, and foreign majors have farmed into key basins, most recently Chevron into the Cooper Basin.
At the end of 2012, over 60 shale wells have been drilled in China, with a primary focus on the Sichuan Basin. Further drilling and appraisal will be required to determine whether the geological setting can support commercial production.
Perhaps the most exciting potential for shale development could come from one of the world’s largest conventional gas producers, Russia. BP Plc., which has recently taken a 19.9% stake in Rosneft, believes that Russia has a shale oil resource which stretches across continental Russia making “the Eagle Ford shale look like a pebble.”
The greater availability of gas from a larger number of sellers and at an overall average lower price is ultimately a positive for the global economy as a whole.
Investing in shale oil and gas - via direct infrastructure and listed equities
The Global Infrastructure Securities Funds (Hedged and Unhedged) benefit from being exposed to the owners and operators of the energy infrastructure which are seeing huge increases in volume and improved economics. The Natural Gas Association of America currently estimate that over US$10billion per annum will be need to be invested in new pipeline infrastructure though to 2035 to meet demand from the shale basins alone. The sector which should continue to benefit from the multi-decade investment cycle is the US Master Limited Partnerships (MLPs). MLPs were created in the 1980s through laws passed by US Congress to encourage investment in natural resources infrastructure. MLPs are publicly traded partnerships listed on the NYSE and NASDAQ and pay no corporate tax and distribute nearly all of its available cash flow to its unit holders. MLPs are the owner and operators of US energy infrastructure such as natural gas and crude oil pipelines, storage terminals, natural gas processing plants, LNG import and export facilities and other midstream operations. In our view, MLPs are still at the beginning of a secular growth cycle and AMP Capital has been investing in MLPs since the launch of the Global Listed Infrastructure strategy in 2008 and are seen as a market leader and specialist in the asset class.
The Global Resources Fund invests in some of the most compelling areas in gas production and gas arbitrage – North American chemical companies or refiners with a major competitive advantage of low cost raw materials in the form of oil or gas, being able to expand global market share at the expense of competitors in Europe or Asia who are largely reliant on high cost gas or naphtha. We also favour those oilfield services companies who are bringing their technology to the rest of the world. We also invest in some of the world’s best oil and gas majors and exploration and production companies which are directly benefitting from the unlocking of new areas of growth, both in the US and abroad. We are also very selective in owning some of the junior explorers who have the potential for re-rating from the ongoing land grab in new territories. More broadly, we are exposed to the ongoing reindustrialisation of the US, with a particular focus on housing through lumber.
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