Investec’s Whall and Nelson review the myth of US energy independence
Charles Whall and Tom Nelson co-portfolio managers of Investec’s Global Energy portfolios, are firmly of the belief that US energy independence is a myth.
There has been a lot of noise around the US becoming energy independent, but while this might sound like an appealing concept, we believe these aspirations are unrealistic and likely to remain a political catchphrase rather than an economic reality.
This is due to two largely improbable scenarios, the first of which being that the US can grow domestic production of crude oil and liquids by at least five million barrels per day from 2012 levels. On the contrary, we believe that US tight oil will prove more difficult than shale gas and the early success in the Bakken and Eagle Ford formations will not be easily replicated in the none-core areas and the new plays.
In our view, growth of two million barrels per day from 2012 levels is more realistic, and in this scenario the US will need to import at least a quarter- of its liquids requirements.
The second path to energy independence – which we see as firmly blocked – is the substitution of natural gas for oil as a transportation fuel on a substantial scale. There is neither government policy incentive, nor infrastructure, nor consumer appetite to transition a meaningful proportion of the US vehicle fleet to natural gas vehicles in the foreseeable future.
Indeed, one of the reasons for this is misinformation: for as long as leading energy agencies continue to talk about stellar US oil production growth, the fallacy will persist that the oil market is well supplied. This will hold back the move to natural gas for transportation and the need for behavioural change and greater efficiency. We can also not contemplate an alternate fuel for air transportation within our investment horizon.
We believe that North American – rather than US – energy independence is more realistic, particularly if the current administration can approve the Keystone XL pipeline, which will limit incremental investments for Canadian exports to Asia.
However, we are still in the midst of a profound period of change in the North American oil and gas industry and there are significant investment opportunities. We are particularly optimistic about the longer-term implications for US oil services and drilling companies.
The rig count is currently falling, at precisely the moment it needs to increase if the growth in liquids is to be sustained (we calculate the wells drilled need to double in tight oil plays by the end of 2015). The total land rig count has fallen 15% since November 2011, while the oil-directed rig count has fallen 7% in the last four months, as companies have reduced capital expenditure and concentrated capital in the most prolific areas.
Positioned for increased investor appetite
We envisage a snap back in profitability and investor appetite for US service and drilling companies in 2013 and are positioning our portfolio accordingly.
We also expect sustained merger and acquisition activity in the energy sector: we believe integrated oil and gas companies are unable to replace existing production and will continue to buy barrels more cheaply than they can discover and develop them organically. Independent exploration and production companies with high quality resource bases will remain the primary target. National oil companies (NOCs), particularly the Asian NOCs, will continue to be acquirers as well.
We expect to see continued press coverage and attention directed to shale gas and tight oil this year. .By the end of 2013, we expect the significant physical and economic challenges to tight oil production to have become better understood, and therefore the market’s confidence in a long-term higher oil price to have risen.
This in turn should cause the valuation gap between the energy equities and the oil price to narrow, as we believe oil equities are discounting a crude price which is far too low. The Non-OPEC world is relying on US tight oil to provide the incremental production to meet production declines and new demand from the developing world, but the market will soon wake up to the fact that a greater dependence on unconventional tight oil and deepwater production will increase overall depletion rates, and further tighten the oil supply situation.