The U.S. oil and gas boom largely underpinned the country’s economic recovery, but this is only the beginning. Don’t underestimate what cheap oil and natural gas means for the U.S. economy, or how long this advantage could last.
Horizontal drilling and hydraulic fracturing have unlocked the vast potential of shale formations in several U.S. regions, making oil — and especially natural gas — much cheaper relative to the rest of the world. The benefits from cheap natural gas, a key input cost for a number of manufacturers, are only beginning to flow through the U.S. economy.
Ripple effects from cheap gas will be felt strongest in the chemical industry, where the U.S. has repositioned itself as one of the lowest-cost producers of key ingredients in the production of everything from plastics, textiles, roofing tiles, cosmetics, furniture, appliances, computers to a number of other products. We expect companies to spend more than $100 billion over the latter half of the decade to increase capacity along the chemical product supply chain. Increased production is leading to labor shortages and wage pressure. Executives at chemical companies say welder wages have jumped by $5 an hour this year.
The chemical industry is not the only beneficiary. Natural gas represents roughly 70% of the cost of nitrogen production, one of the biggest costs for fertilizer companies. U.S. oil refiners also stand to gain. Refiners benefit from both cheaper U.S. oil, and cheaper natural gas feedstock, which is used to heat oil and turn it into refined products. The refined products can be exported and are sold based on Brent oil prices, which are higher than U.S. prices.
With shale oil production greatly exceeding pipeline capacity, the $78 billion U.S. railroad industry is picking up the slack. At Union Pacific, for instance, crude oil carloads jumped 107% from the first quarter of 2012 to the first quarter this year.
But while cheap natural gas is a game changer for refiners, chemical firms and transport companies, in many cases, this competitive advantage is not fully reflected in their stock prices, creating exciting investment opportunities, in our view. There are several reasons the natural gas advantage is underappreciated. The performance of many industrial companies is tied closely to the economy, which is improving but still slow. Investors have overlooked long-term benefits of cheap natural gas, focusing instead on short-term economic concerns.
We also believe the market does not recognize how long cheap natural gas prices will stick around in the U.S. Many investors use assessments from the Energy Information Administration (EIA) to gauge the potential of oil and natural gas reserves. In our view, those assessments greatly underestimate how much oil and gas can be pulled from shale.
As part of our research, we have had extensive conversations with laboratories that use X-ray technology to analyze the size of pores in these rock formations. (Bigger pores mean more oil and natural gas can be extracted.) Analysis from those labs gives us confidence a lot more gas can be extracted from U.S. shale formations than the EIA estimates. We also think the market is underestimating how new technologies will improve recovery rates of natural gas from some of these formations.
Some believe the window for the U.S. to enjoy cheaper natural gas prices is somewhat limited if the U.S. starts exporting liquid natural gas (LNG). We think these fears are overblown. Only two liquefaction plants have received some level of governmental approval to export LNG, and those licenses limit the plants to exporting a combined total of 3.6 billion cubic feet (BCF) per day. When these plants come on line in 2016 and 2018, respectively, we don’t expect their export volumes to push up domestic prices. With U.S. natural gas consumption around 70 BCF per day, the exported product represents only 5% of demand.
Even if shipping a fraction of U.S. gas overseas caused an uptick in prices, the higher prices could encourage a wave of new natural gas drilling in U.S. formations that are unprofitable at current gas prices but still profitable well below prices in Europe or Asia.
Given the vast reserve potential in U.S. shale formations, improving technologies for extracting natural gas, and a minimal threat of natural gas price increases when LNG hits the export market, we think low natural gas prices are an advantage U.S. companies could enjoy for some time to come.
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