The US Energy Revolution
US oil and gas production is expected to increase significantly over the next five years due to the use of new technologies able to unlock vast previously inaccessible oil and gas (shale) reserve formations creating a US Energy Revolution.
Increasing US energy production and decreasing net energy imports have important implications for global US dollar liquidity going forward.
Increasing US oil and gas production may depress global energy prices, creating substantial risks for major ‘petrostates’. Inherent political vulnerabilities may be exposed, leading to heightened geopolitical risks and risk of major energy supply disruptions.
The current disparity in pricing between US natural gas prices and global gas- and oil prices will gradually be narrowed.
Developments in the US energy sector due to the development of new technologies such as fracking are well known. These developments are expected to lead to a sustained rise in US onshore oil production over the next 7 years, by some estimates from 7mn bpd currently to 11mn by 2020 (Platts/IEA). As we have detailed, if one includes Natural Gas Liquids (NGLs), Natural Gas production growth and exports, the US could, in fact, become a net energy exporter by 2017. A potential impact on global liquidity and as the US trade and current account narrow, the increase in production could also lead to lower global oil and gas prices. This dynamic has the potential to severely undermine key petro states around the world, including Russia, Venezuela, and several Middle Eastern countries. With sectarian tensions already threatening a regional conflict, the risk of a major disruption to global oil supplies will be elevated over the next five years.
The risk of a major disruption in global oil supply will ensure that energy price volatility remains high over the medium term. This environment creates both risks and opportunities for investors. On the hand, higher energy prices would benefit energy producers. However, the risk of a sharp decline in global energy prices as US production increases suggests that the risk and reward of investing in global oil and gas producers is not attractive. On the other hand, however, in the event of a major disruption to oil supplies, the negative economic impact would create a substantial portfolio or general investment risk.
In our view, the best form of insurance to protect a portfolio from elevated energy price volatility or risk, is to allocate capital towards large North American natural gas producers. Although natural gas prices have risen somewhat in 2014, they remain well below the levels required to maintain sufficient drilling activity and sustain current production levels, without even increasing production. The chart below shows that the natural gas rig count in the US remains at the lowest levels in more than 20 years (the number of rigs actively engaged in drilling new natural gas wells). As such, natural gas output is unlikely to increase in order to replenish the storage deficit, which raises the risk of a more sustained spike in natural gas prices as the year progress. Our analysis suggests that sustained prices above $6 per MCF will be required before oil and gas producers to be incentivised to shift rigs away from the more lucrative oil basins currently being exploited.
Tags: Energy, Oil & Gas, US Macro