Oil Boom Shakes the Industry

12/18/2013 11:00 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Recent oil and natural gas news, coming from the US Energy Information Administration, forecasts big numbers in the coming years that will rock, not only the industry, but the entire global economy, thinks MoneyShow's Jim Jubak, also of Jubak's Picks.

The US oil—and natural gas—boom continues to shake up the global oil industry (and, actually, the global economy).

The latest energy-shaking news comes from projections in the US Energy Information Administration's (EIA) annual energy outlook: US crude production will hit 9.5 million barrels a day in 2016. That's significantly higher than the 7.5 million barrels a day that the EIA was projecting just a year ago, and close to the peak production level of 9.6 million barrels a day in 1970. (For the record, the low in US crude production was 5 million barrels a day in 2008.)

US oil output, the EIA estimates, will start to tail off slowly after 2020, but that projection, the agency notes, is close to a guess since no one knows the precise decline rates of wells drilled in oil shale geologies.

Natural gas production, the EIA projects, will keep growing indefinitely—or at least to the end of the study period. By 2040, production will be 56% higher than in 2012.

What effects can investors expect from the boom?

  • 1. Natural gas will continue to expand its share of the market for power generation at the expense of coal. Natural gas will, the agency projects, pass coal in that market in 2030. (This isn't good news for coal companies. How bad the news is will depend on whether current big coal export markets in China and India decide to tighten environmental regulations on coal.)

  • 2. Exports of natural gas, after changes in rules prohibiting US oil exports, will boom with, surprise(!), the largest volume of natural gas exports going through, as yet to be built, pipelines to Mexico. Shipments of liquefied natural gas will also soar. (Think of the effect on pipeline MLPs and on economic growth in Mexico as energy prices in that country fall toward US levels.

  • 3. Despite exports, the US will have lower energy costs than any country outside the Middle East. (Think of the advantages to US manufacturers, and of the continued movement of energy-intensive industries to the United States in order to take advantage of those lower costs. Think of the relative cost disadvantage facing European and Japanese manufacturers.)

The high cost of US oil production from shale geologies will put a floor under oil prices (short of a big drop in global oil demand). US production volumes will also help set a rough ceiling too. Production from US shales will be profitable at $90 a barrel, and oil producers will probably be willing to pump oil from these reserves at $80 to $85 a barrel. The benchmark West Texas Intermediate sold at $97.31 a barrel yesterday and the European benchmark Brent sold at $108.35. The US floor will make life very pleasant indeed for producers (the Middle East, for example) with lower costs.

But the rising tide of US production at these price levels is also going to call into question the investment logic of even higher cost sources, such as Brazil's deep-water pre-salt reserves in the South Atlantic. If the US oil export ban falls—and I'm pretty sure it will—oil producers in high cost and infrastructure challenged regions—the Russia off-shore Arctic and some of the undeveloped reserves in Siberia—could well find it very difficult to raise the necessary—and huge—amounts of investment capital they'll need. I think we're already seeing evidence that the more hard nosed number crunchers in the oil industry—such as Norway's Statoil ((STO) in New York and (STL:NO) in Oslo) are already rethinking investments in high cost projects, such as Mozambique and the Trans-Anatolian Natural Gas Pipeline, that would bring natural gas from the Caspian Sea to Europe. Statoil and Total (TOT) recently decided not to exercise options to acquire 12% and 5% of the pipeline, respectively. Projected construction costs have climbed to $12 billion from $7.5 billion. (Statoil is a member of my Jubak's Picks portfolio.)

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did own shares of Statoil as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund's portfolio here.

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