Back in early 2007, at the dawn of the revolution, it was easy for me to go out on a limb when it came to rise of shale gas and tight oil.
In fact, in an interview at time, I suggested two things that were rather “unconventional” themselves.
One was that the rise unconventional oil and gas would accelerate U.S. domestic availability. The other was the prospect that it would reverse the long time decline in overall production.
For that second point, I was roundly criticized by some of the “seasoned” talking heads sitting around the same table, fingering their empty cups of coffee.
Then, the whole idea of unconventional oil and gas was thought of as just a “flash in the pan.”
Well, here we are less than seven years later and boy have things changed…
Today, the prospects for unconventional oil and gas have gone through the roof – even much quicker than I had anticipated.
For investors, that continues to hand us new ways to profit…
Underestimating the Unconventional
Frankly, at the time, we had no idea there was as much available volume or that technology would rise to capture more oil and gas than ever before.
Back in 2007, over 60% of all crude oil produced in the U.S. came from stripper wells. By definition, a stripper well is one that produces 10 barrels or less under very low well pressure.
These wells require considerable artificial lifting, along with often high water displacement producing up to 18 barrels of water for each barrel of oil. At an early point, that makes any attempt at additional extraction economically unfeasible.
There is an example I often use to demonstrate this point.
During the second week of July in 2008, when crude oil was reaching its numerical high of $147.27 a barrel, there were over 3 million orphan wells in West Texas. These wells had been capped, had millions of barrels in known reserves just sitting there, and could be cheaply operated. But even at that historic price, these stripper wells would cost too much to reopen. They were just wouldn’t be profitable.
I calculated at the time it would take a market price of more than $183 a barrel to justify their operation. That was the state of oil production at the time and the primary reason it was cheaper to import crude produced elsewhere.
In this case, the simple economics of pricing was making us more dependent upon imports.
On the natural gas side, we were somewhat better off. But even there, the prognosis was for an intensifying slide in production volume.
More imports from the Western Canadian Sedimentary Basin were viewed as essential to maintain the supply-demand balance south of the border. However, most of the experts (including yours truly) had concluded the U.S. would have to begin importing liquefied natural gas (LNG) from other parts of the world to keep up with longer-term demand projections.
Once again, we significantly under estimated the largess of unconventional reserves and the ability to tap them.
An Astounding Reversal of Fortune
Today, matters are very different, with the report preview issued yesterday by the Energy Information Administration (EIA) adding another exclamation point on the matter. It’s the division of the U.S. Department of Energy that provides a wealth of statistics and analysis on all aspects of the energy sector.
Just yesterday, the EIA released its preview of the Annual Energy Outlook 2014 (AEO2014) containing its latest “Reference case” on the American energy perspective. The full report is slated for publication in the spring of next year. In the meantime, the preview gives us a glimpse of what it will contain.
The “Reference case,” or focusing model, is revised annually. The latest revision is one that sketches developments through 2040. And what it tells us is flat out astounding – especially given what everyone was saying only a few years ago.
Consider these conclusions, taken directly from yesterday’s released preview:
Domestic production of oil and natural gas continues to grow. Domestic crude oil production increases sharply, with annual growth averaging 800,000 barrels per day (MMbbl/d) through 2016, when domestic production comes close to the historical high of 9.6 MMbbl/d achieved in 1970. While domestic crude oil production is projected to level off and then slowly decline after 2020 in the Reference case, natural gas production grows steadily, with a 56% increase between 2012 and 2040, when production reaches 37.6 trillion cubic feet (Tcf). The full AEO2014 report will also consider alternative resource and technology scenarios, some with significantly higher long-term oil production than the Reference case.
Low natural gas prices boost natural gas-intensive industries. Industrial shipments grow at a 3.0% annual rate over the first 10 years of the projection and then slow to a 1.6% annual growth over the balance of the projection. Bulk chemicals and metals-based durables account for much of the increased growth in industrial shipments. Industrial shipments of bulk chemicals, which benefit from an increased supply of natural gas liquids, grow by 3.4% per year from 2012 to 2025, although the competitive advantage in bulk chemicals diminishes in the long term. Industrial natural gas consumption is projected to grow by 22% between 2012 and 2025.
Higher natural gas production also supports increased exports of both pipeline and liquefied natural gas (LNG). In addition to increases in domestic consumption in the industrial and electric power sectors, U.S. exports of natural gas also increase in the AEO2014 Reference case. U.S. exports of LNG increase to 3.5 Tcf before 2030 and remain at that level through 2040. Pipeline exports of U.S. natural gas to Mexico grow by 6% per year, from 0.6 Tcf in 2012 to 3.1 Tcf in 2040, and pipeline exports to Canada grow by 1.2% per year, from 1.0 Tcf in 2012 to 1.4 Tcf in 2040. Over the same period, U.S. pipeline imports from Canada fall by 30%, from 3.0 Tcf in 2012 to 2.1 Tcf in 2040, as more U.S. demand is met by domestic production.
Car and light trucks energy use declines sharply, reflecting slow growth in travel and accelerated vehicle efficiency improvements. AEO2014 includes a new, detailed demographic profile of driving behavior by age and gender as well as new lower population growth rates based on updated Census projections. As a result, annual increases in vehicles miles traveled (VMT) in light-duty vehicles (LDV) average 0.9% from 2012 to 2040, compared to 1.2% per year over the same period in AEO2013. The rising fuel economy of LDVs more than offsets the modest growth in VMT, resulting in a 25% decline in LDV energy consumption decline between 2012 and 2040 in the AEO2014 Reference case.
Natural gas overtakes coal to provide the largest share of U.S. electric power generation. Projected low prices for natural gas make it a very attractive fuel for new generating capacity. In some areas, natural-gas-fired generation replaces power formerly supplied by coal and nuclear plants. In 2040, natural gas accounts for 35% of total electricity generation, while coal accounts for 32%. Generation from renewable fuels, unlike coal and nuclear power, is higher in the AEO2014 Reference case than in AEO2013. Electric power generation from renewables is bolstered by legislation enacted at the beginning of 2013 extending tax credits for generation from wind and other renewable technologies.
Here’s the Payoff for Investors
Among a number of other conclusions in the AEO2014 Reference case preview, energy investors are well advised to note these:
The Brent crude oil spot price (set in London each trading day and comprising the primary crude benchmark price used globally) declines from $112 per barrel (bbl) (in 2012 dollars) in 2012 to $92/bbl in 2017. After 2017, the Brent spot oil price increases, reaching $141/bbl in 2040 due to growing demand that requires the development of more costly resources. World liquids consumption grows from 89 MMbbl/d in 2012 to 117 MMbbl/d in 2040, driven by growing demand in China, India, Brazil, and other developing economies.
Total U.S. primary energy consumption grows by just 12% between 2012 and 2040. The fossil fuel share of total primary energy demand falls from 82% of total U.S. energy consumption in 2012 to 80% in 2040 as consumption of petroleum-based liquid fuels falls, largely as a result of slower growth in LDV VMT and increased vehicle efficiency.
Energy use per 2005 dollar of gross domestic product (GDP) declines by 43% from 2012 to 2040 in AEO2014 as a result of continued growth in services as a share of the overall economy, rising energy prices, and existing policies that promote energy efficiency. Energy use per capita declines by 8% from 2012 through 2040 as a result of improving energy efficiency and changes in the way energy is used in the U.S. economy.
With domestic crude oil production rising to 9.5 MMbbl/d in 2016, the net import share of U.S. petroleum and other liquids supply will fall to about 25%. With a decline in domestic crude oil production after 2019 in the AEO2014 Reference case, the import share of total petroleum and other liquids supply will grow to 32% in 2040, still lower than the 2040 level of 37% in the AEO2013 Reference case.
Needless to say, these provisional conclusions are going to allow us make some attractive moves in energy sector investing in the near term. In fact, I intend to fashion a strategy that will benefit from what is now almost certainly to be a new renaissance of American energy independence.
I’ll begin to bring you the details behind this approach in future issues.
However, there is another matter that may also hand us a short-term spike in our investment. By Thursday’s issue, we may finally have a real signal of how serious the Fed is about tapering.
If signals emerge over the next two days of Fed meetings that point toward an early phase-in of tapering, I will be sure to address them here in the next issue.
What I can tell you now is that the ending of tapering promises to provide us with some immediate (and profitable) energy plays.
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