imaginima
Co-authored with Philip Mause.
There are macroeconomic forces at play in energy that have influenced our stock selection in the sector. There has been a shift for the U.S. from being a net consumer of energy to a net producer. This means opportunities for income investors like us!
We’ve already benefited greatly from a pickup in merger & acquisition activity in the sector with Magellan Midstream Partners (MMP) and Crestwood Equity Partners (CEQP) being acquired. There will be more similar opportunities in the future. For now, let’s take a look at the macro tailwinds driving the U.S. energy sector.
The Massive Increase in U.S. Energy Production and Its Consequences for Investors (Part 1)
In the past 15 years, U.S. energy production has skyrocketed. Since 2007, we have gone from being a massive oil importer to becoming an oil exporter. We have increased natural gas production by more than 50 percent and now export large quantities of LNG. We have also substantially increased solar and wind production. In the 1970s and 1980s, when we were obsessed with reducing oil imports, these developments would have been headline news.
But today – we don’t hear much about this from politicians or in the media. It may be that, with today’s political alignment, the Democrats are probably embarrassed by the fact that fossil fuel production grew enormously during the Obama and Biden administrations – and, for other reasons, the Republicans may not be interested in calling attention to that fact.
This article deals with the general effects of this development. Subsequent articles in this series will deal with a more detailed analysis of these topics:
- Part 2 – natural gas,
- Part 3 – oil, and
- Part 4 – renewables.
The Numbers
The table below compares energy production in the United States in 2007 and 2022. Nuclear and hydro have been left out because they have not varied significantly over this time period.
| 2007 | 2022 | Change | |
|---|---|---|---|
| Oil (Million Barrels per day) | 6.86 | 17.79 | 159% |
| Natural Gas (Trillion cu. ft./yr) | 24.66 | 43.39 | 76% |
| Wind (Trillions of BTUs/yr) | 341 | 3,845 | 1,027% |
| Solar (Trillions of BTUs/yr) | 65 | 1,870 | 2,777% |
| Coal (million tons/yr) | 1,147 | 594 | – 48% |
There has been a major decline in coal production, but it has been more than offset by the increases in other energy sources. On a Quadrillion BTU basis, the decline in coal production has been roughly 11.458; while the increases in petroleum, natural gas, solar, and wind production have been respectively 13.969, 17.320, 3.504, and 1.814 for a total net increase of 25.149 Quadrillion BTUs or roughly one-fourth of our total annual energy consumption. Source: EIA
This has not been a demand-driven increase in production. During these same 15 years, the annual energy consumption in the U.S. has stayed roughly equal, actually declining slightly from 100.9 Quads to 100.3 Quads. There has been a major shift in the electricity industry from coal to natural gas and renewables. But an equally important shift has been that the U.S. is no longer an energy importer and, in fact, exports petroleum (on a net basis), natural gas, and coal.
Balance of Payments
Back in 2007, the massive U.S. oil imports were adding to our trade deficit which, in turn, was heavily impacted by increases in oil prices. Heading into the Panic of 2008, oil prices briefly reached $145 a barrel and were projected by some pundits to reach $200 a barrel. When you are importing more than 10 million barrels a day, $200 a barrel means more than $700 billion per year in the balance of payments deficits. This has all sorts of potential effects on exchange rates, confidence in our economy, and economic growth.
The Business Cycle
There is a debate as to the impact of higher oil prices on the economy. Some economists suggest that higher oil prices operated as a kind of “choke chain” on the economy so that economic growth led to increased demand for oil, which in turn produced higher prices leading to inflation and thus inducing the Federal Reserve to increase interest rates which, in turn, produced a recession. An argument can be made that the recessions of 1973, 1979, 1990, and even 2008 all seemed to appear in the wake of sharp oil price increases. There is no doubt that higher oil prices had the effect of taking money out of the pockets of middle-income (and other) Americans who had to pay more money for gasoline.
While the Panic of 2008 was caused by the failure of unconventional mortgages and the securities that were based upon them, the fact that its timing was coincident with a spike in oil prices may not be accidental. Higher gasoline prices would hit middle and lower-middle-income Americans especially hard. Many of the troublesome mortgages were issued based on real estate in the outskirts of major metropolitan areas, and residents of those areas would be expected to have longer than average commutes and spend higher than average amounts of take-home pay on gasoline. The drain created by gasoline price increases may have increased the number of residents who defaulted on the mortgages that backed the securities whose failure led to the Panic.
Now that we are no longer major importers of oil, it is still possible for world oil prices to increase and for that to increase U.S. gasoline prices. But there is an important difference. In 2007, the money being spent to buy more expensive imported oil was going overseas and, in some cases, was not easily recycled into the U.S. economy. If we had a major price increase today (as we had in 2022), the money would stay in the U.S. economy and go to higher royalty payments, higher tax collections in oil-producing states and localities, increased CAPEX by oil producers, and increased dividend payments to owners of U.S. oil companies. This immediate recycling of funds within the U.S. economy may have the effect of reducing the negative impact of higher oil prices on growth and reducing the danger of a deep recession. This may be a factor (although certainly not the only factor) in the surprising resilience of the U.S. economy in the current cycle.
It should be noted that the U.S. economy can still be impacted by a cutoff in oil imports or a massive increase in the world oil price. While we are net exporters, the petroleum market is complex, and we still import crude and export refined products. Refineries are generally set up to refine certain types of crude, and transportation economics often leads to imports in one part of the country and exports in another part. Due to this complexity, an abrupt cessation of oil imports would be disruptive, and it would take time and expense to adjust. But the degree of disruption would pale in comparison with the impact we would have suffered in 2007.
The Dollar
Now that the U.S. is actually a net exporter of energy rather than an importer, an increase in energy prices will tend to reduce the U.S. trade deficit rather than increase it. This would tend to strengthen the dollar. Most of our trading partners are actually net importers, so their currencies may be negatively impacted by higher oil prices. The net effect in the long term may be a stronger dollar which tends to reduce inflationary pressures.
The fact that the dollar is not likely to be negatively affected by the rollercoaster of oil prices, although competing major currencies (the euro or the yuan) may suffer negative effects, is likely to cement the dollar in place as the global reserve currency.
National Security
The fact that we are no longer dependent upon oil imports will likely enhance our national security. In the 20th century, oil was a major factor in the cause and the course of World War 2. Our oil independence may give us more leverage in confronting various oil-exporting countries (including Russia). The Strategic Petroleum Reserve – originally set up to ensure that our military would have access to oil in the event of a cutoff of imports – now does not really need to serve that purpose. Instead, it can be used to cushion the market from price fluctuations and also to generate profits simply by buying at low prices and selling at high prices. The Biden Administration seems to have adopted this policy.
As noted above, the petroleum market is complex, and we should take measures to protect ourselves against the disruption that an abrupt cut-off would entail. It is also the case that many of our allies are net importers, and we would try to help cushion the impact upon them by increasing our exports if their imports were disrupted. But – again – the impact of an import disruption upon us from a national security perspective today would be sharply reduced from the impact we would have suffered in 2007.
Investors
The above factors lead to certain conclusions from the perspective of investment. They definitely make investment in the U.S. more attractive than investment in markets which would be subject to severe impact from higher oil prices or an oil import disruption. The enhanced resilience of the dollar makes investment in dollar-denominated assets comparatively attractive.
The U.S. energy sector also becomes more interesting because of its ability to serve as a source of exports to our allies; especially in the natural gas-oriented sector, certain names should command investor attention. These companies include Antero Midstream (AM) with a yield of 7.6%, Cheniere Energy (LNG) with a yield of 1%, and Enterprise Products Partners (EPD) with a yield of 7.4%.
