Global demand for natural gas is rising as the world’s population expands and developing markets industrialise. This demand is increasingly being met by vast discoveries of shale gas reserves in North America where advancing technology is enabling profitable recovery, even at ever lower global energy prices. This will deliver revenue growth to pipeline businesses which are currently valued at a discount to highly cyclical extraction and refining businesses. This creates an attractive opportunity for astute investors with exposure to this market.
- Population size and economic development stage – determine global energy demand. The world’s population will increase by 1.8 billion over the next 25 years. This growth will mainly come in Africa, India, Pakistan, Indonesia and the United States. World GDP will double over the next 25 years, with Asian economies including China and India growing strongly.
- World energy consumption - is driven by population growth and economic development; but restrained by improving energy efficiency. It is expected to grow at an annual average rate of approximately 1.3% over the next 25 years. Natural gas will be the fastest growing fossil fuel as environmental concerns restrain coal and oil use in electrical power generation.
- North American shale gas reserves – are set to deliver much of this increase in natural gas production, where improving fracking technology is enabling the profitable exploitation of these vast resources. Production will grow at a faster rate than that of the US demand for natural gas, leading to a growing surplus that will be exported through pipelines and LNG terminals. Therefore a major programme of pipeline construction will take place over the coming years to meet this demand.
US Natural Gas Exports (trillion cubic feet)
- Mid-stream infrastructure businesses - which are active in this market, benefit from stable and high quality cash flows, supported by strong regulation, a predictable legal system, fee-based contracts and a fossil fuel-friendly US Federal Administration. Whereas those companies engaged in the extraction and processing stages of production are exposed to sudden swings in the crude oil price and face a more volatile cost of capital.
Extraction and processing assets have outperformed mid-stream pipeline businesses that are supported by stable fee-based income streams as commodity prices have risen and the cost of capital has fallen.
However, historically and rationally, the higher quality long haul pipeline companies have traded at a market premium that reflects their more stable dividend yield and defensive qualities.
Therefore the significant discount at which midstream infrastructure assets are currently valued is unlikely to be sustained over the long-term. Hence the current price dislocation is a compelling value opportunity for investors able to access this market.