the road to US energy independence

Transcription

1 the road to US energy independence Advances in energy technology are significantly increasing US production volumes but causing bottlenecks and price dislocations. Companies that can help build the necessary infrastructure or take advantage of low domestic prices look particularly poised to profit. PAGE 1

2 Washington, USA America has a long history with disruptive technologies. From the industrial revolution to the internet revolution, railroads to airplanes, the telephone to the smartphone, technological leaps have transformed the economy and daily lives. Now, innovation in energy extraction may prove to be the next breakthrough technology. Advances in horizontal drilling and hydraulic fracturing ( fracking ) of shale rock have significantly increased hydrocarbon production in the US, and the implications could be enormous. For the first time in decades, many experts are embracing the possibility that the US could be on the path to energy independence. If the US evolves from a net importer of energy to a net exporter, the effects would ripple through global energy markets and potentially influence geopolitical relations. More From 2007 to 2012, oil production increased 30%, reversing nearly a decade of decline. locally, the increased energy production could impact America s economic growth. Some businesses are already experiencing benefits, while for others the shorter- or longer-term impact may be less positive. However, there is little doubt that virtually every industry in the energy value chain will be affected. Tipping Point: Importer to Exporter The transformational impact of fracking technology is already evident in US energy production volumes. From 2007 to 2012, US marketed natural gas production increased 25% to 69bn cubic feet/day, following 10 years of virtually no growth. Oil production has increased 30% to 6.5mn barrels/day, while in Q it averaged 7.1mn barrels/day (the highest since Q2 1992), reversing nearly a decade of decline. The potential for the US to become a net exporter of natural gas already looks achievable. The US could be sending liquefied natural gas (LNG) to other markets by 2017, having been a net importer of natural gas as recently as Export volumes could increase substantially by 2020 as more LNG liquefaction facilities are permitted. Last year, the US was already exporting 0.5mn barrels/day of refined petroleum products, a big step from importing 2.2mn barrels/day in Imports of crude oil have also been decreasing. In 2012, the US imported 8.5mn barrels/day of crude oil, down from 10mn in Of the 2012 imports, 6.1mn barrels/day were non-canadian, which is 25% less than in The International Energy Agency (IEA) has outlined a case in its latest report where the US could surpass Saudi Arabia as the world s largest oil producer by roughly continued on page 3 FOR THIRD PARTY DISTRIBUTORS USE ONLY - NOT FOR DISTRIBUTION TO YOUR CLIENTS OR THE GENERAL GSAM PUBLIC PERSPECTIVES GSAM PAGE B2

3 The Price of Bottlenecks and Gluts Building the infrastructure to support energy independence takes time, and the rapid increase in US crude oil production has already caused significant bottlenecks, supply gluts and price dislocations. The most notable price differential is between West Texas Intermediate (WTI) crude, the US oil benchmark, and Brent crude, its international counterpart. Since 2011, Brent crude has tended to trade roughly $15-20/barrel higher than WTI crude due to the extra domestic supply. Similarly, Latin American Heavy Crude (Maya Crude) trades at over a $20/barrel premium to Canadian Heavy crude despite being qualitatively comparable. These pricing disparities are beginning to correct as new infrastructure comes online. A successful effort in mid-2012 to reverse the flow direction of the 500-mile Seaway pipeline helped to relieve the crude oil bottleneck at the Cushing, Oklahoma hub. With an expected 400,000 barrels/day flowing to the important refinery complex along the Gulf Coast near Houston, the spread between WTI and Brent crude has narrowed. The proposed 1,179-mile Keystone XL Pipeline would run from Hardisty in Alberta, Canada to Steele City in Nebraska. If the project is approved in 2013, it could be in service by 2015, with the capacity to transport 830,000 barrels/day to US Gulf Coast and Midwest refineries. Canadian imports would likely rise, while the more expensive Maya crude imports from Venezuela would likely fall. That said, certain factors could offset this convergence in global oil prices over the longer term. The US capacity to export crude oil is limited by current regulations. If strong demand in the emerging markets fully absorbs the oil displaced by the US, US Production of Natural Gas and Crude Oil Has Increased Significantly Production Growth (Millions Barrels/Day) Trillion Cubic Feet Production growth in US and Canada is approximately 5 times that of OPEC countries 0.4 Total OPEC* 2012 US + Canada Shale Gas Tight Gas Alaska Coalbed Methane Nonassociated Offshore Associated Offshore Nonassociated Onshore *OPEC countries include: Iran, Libya, Algeria, Venezuela, Angola, Ecuador, Kuwait, United Arab Emirates, Qatar, Nigeria, Saudi Arabia and Iraq. Source: International Energy Agency, World Energy Outlook PAGE 3

4 Supply Gluts in Natural Gas and Oil are Depressing Domestic Prices Relative to International Markets Gas Price Differentials ($/MMBtu) 30-day Moving Average Brent-WTI Price Differential ($/Barrel) $20 $15 $10 $5 $0 $-5 $ $30 $25 $20 $15 $10 $5 $0 $ Source: Bloomberg, as of June 28, Japan-US Gas Differential UK-US Gas Differential Brent at Premium Brent at Discount the price of Brent or Brent-like crudes could stay elevated. At the same time, an oversupplied US market could keep WTI prices down. Unless exploration and production companies set constraints on output, US oil prices may behave similarly to the US natural gas market, where domestic prices have lagged global prices. But US natural gas prices may begin to rise. In May 2013, the Freeport LNG terminal received authorization from the US Department of Energy to export domestically produced LNG. The emergence of the US as an exporter of natural gas might not only alleviate the domestic supply glut and low prices, but also alter the way global natural gas prices are set. Global natural gas prices have generally been linked to the price of crude oil. Prices in Japan are around $15/ thousand cubic feet, while European prices are around $10/thousand cubic feet both substantially higher than the $4/thousand cubic feet in the US (Henry Hub). This differential has been the primary impetus for LNG exports from the US and could disrupt the pricing formulas in place for LNG. Gas importing nations may demand indexation formulas to start incorporating the lower delivered cost of Henry Hub gas versus imports from Russia and Qatar, the largest gas exporters in the world. Europe could be one of the biggest beneficiaries of US LNG exports, having long been reliant on gas from Russia. Indeed, European buyers have contracted to become some of the first importers of LNG from the US. Russia may be relatively disadvantaged by increased supply from the US and in light of additional recent discoveries in the eastern Mediterranean. continued on page 5 FOR THIRD PARTY DISTRIBUTORS USE ONLY - NOT FOR DISTRIBUTION TO YOUR CLIENTS OR THE GENERAL GSAM PUBLIC PERSPECTIVES GSAM PAGE D4

5 Tollkeepers on the Highway Companies and industries that can help relieve the bottlenecks and oversupply situation look poised to profit. Many of them also have business models that will benefit predominantly from increased volumes, with little impact from energy prices. Midstream and infrastructure companies own the pipeline, processing, fractionation and storage facilities and are typically operated by Master Limited Partnerships (MLPs). These companies collect fees for their service, like tollkeepers on a highway, and are less exposed than most of the energy industry to the underlying commodity prices. Rail companies are well-positioned as transporters beyond the pipeline, and increases in oil and gas volumes may help to offset declining coal freight. Oilfield services companies provide drilling rigs, pressure pumping, well stimulation and other services related to oil and gas extraction. These companies are involved early in the production process and can generate revenues on hydrocarbons even before they are extracted. Engineering and construction companies could benefit from significant new projects to support the expected increases in natural gas and ethylene volumes. The US petrochemical industry is building nearly 15bn lbs of ethylene capacity that is expected to come online during What about oil and gas producers? The industry is one of the largest, most visible and most investable parts of the value chain. However, the implications of the energy revolution for these companies are more equivocal, as they are probably the Continued production growth can create long-term structural advantages for US refiners and petrochemical companies vis-à-vis their European counterparts. most exposed to commodity price risk. Moreover, producers must spend significant amounts of capital up-front to drill, while the hydrocarbons generally take several years to produce, and profits may take several years to be realized. Producers can also become victims of their own success. Increased natural gas production eventually proved too much of a good thing, as demand failed to keep pace with supply growth, and prices fell from highs of around $13/thousand cubic feet in 2008 to around $4/thousand cubic feet currently. As profitability on gas drilling eroded, the industry focused more on crude oil and natural gas liquids (NGLs). However, oil and NGL prices need to hold firm at or above $80/barrel and $32/barrel, respectively, for producers to be truly profitable over a fiveto seven-year timeframe. Value Add: Buying Low, Selling Higher The tollkeepers profits are largely linked to increasing volumes. Further downstream, however, several industries stand to benefit from the lower prices resulting from increased production. Refiners convert the unprocessed commodity into something usable, such as gasoline or diesel. Prices for the refined product tend to be set in a global context using the international Brent Crude benchmark. The increase in US production volumes, which has depressed the price of WTI Crude relative to Brent Crude, has produced the strongest margins for US refiners in over a decade, as they essentially buy low (WTI prices) and sell high (Brent prices). For the last several years, the benchmark refining margin, the Crack Spread (which approximates the product yield at a typical US refinery for every three barrels of crude oil the refinery processes, it makes two barrels of gasoline and one barrel of distillate fuel) has stayed well above historical levels. Expectations of continued supply growth could benefit refiners for several more years. Similarly, US petrochemical manufacturers are enjoying the advantage of cheaper ethane. Ethane is one of the liquid byproducts of natural gas extraction and commonly used in the production of ethylene, a widely used chemical particularly in the production of plastic materials. US petrochemical companies are building nearly 15bn lbs of ethylene manufacturing capacity, a 25% increase over the next four to six years, the majority of which will use PAGE E5

6 Trans-Alaskan Pipeline, Alaska ethane as the primary feedstock. Ethane and overall NGL production have both increased markedly since 2009, following nearly a decade of declines. With limited capability to export ethane and limited capacity to produce it in high-cost regions like Europe, US petrochemical companies appear likely to benefit from lowcost feedstock for several years to come. Already the growth in NGL production from the US shale revolution, particularly ethane, has made the US one of the most costcompetitive manufacturers of petrochemicals in the world, behind only the Middle East and Canada. The boom in natural gas production is also an advantage for utilities, which are increasingly switching to gas as a lower-cost and cleaner alternative to coal. In 2003, coal accounted for 51% of total power generated in the US, compared to 17% for natural gas. By 2012, coal s share had fallen to 37%, while that of natural gas had risen to 30%. The trend is likely to continue following the EPA s clean energy rules, which render the construction of new coal-fired plants challenging. Furthermore, multiple and prolific gas fields, combined with low capacity utilization on existing natural gas-fired plants, mean that utilities can switch from coal to gas in a cost-effective manner without compromising on reliability. There could be periods where natural gas prices spike and coal-fired generation appears temporarily cheaper, but gas generation currently looks likely to be the more cost-effective option over the medium- to long-term. The Benchmark Refining Margin Has Remained Above Historical Levels for Several Years NYMEX Crack Spread ($/Barrel) 100-day Moving Average $35 $30 $25 $20 $15 $10 $5 Average Spread $ Source: Bloomberg, as of June 28, Utilities should benefit from low-cost gas coming from the shale gas renaissance. However, the regulated nature of the industry suggests that the bulk of this cost advantage would flow to end-users. Indeed, home heating costs have declined for consumers. At this point, the delivered price of power to end-users has not necessarily declined, but that may be due to additional surcharges and recoveries that utilities include in their tariffs. Independence May Be Closer Than It Appears North American energy independence is closer than many people realize. The US is already exporting refined oil products and has greatly reduced oil imports. Gas exports looks realistic in the next few years. The renaissance in US energy production is benefitting many energy-related companies, particularly those related to the build-out of critical infrastructure or those able to take advantage of current low prices coming from the rapidly increased supply. However, cheaper and more accessible energy could lead to a resurgence of US-based manufacturing and even further-reaching economic and geopolitical implications. One thing looks certain the road to energy independence will be horizontally drilled, fracked and laid with miles of pipeline. FOR THIRD PARTY DISTRIBUTORS USE ONLY - NOT FOR DISTRIBUTION TO YOUR CLIENTS OR THE GENERAL GSAM PUBLIC PERSPECTIVES GSAM PAGE 6F

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