It’s been a tough year for energy. Excuse us, it’s been a tough three years.
Despite signs that the global oil markets are finally rebalancing, energy market sentiment remains in the doldrums and energy equities are trading at decade-low prices relative to the broader market. While we read articles postulating “lower for longer” or “the end of oil,” the reality is that the ongoing technological progress exhibited by the U.S. energy industry has created a new structural platform for potential growth.
In short, investors have yet to recognize that even at $50 per barrel (/bbl) there are growth opportunities across the upstream, midstream, downstream and services subsectors of the U.S. energy industry.
Energy Growth Will Span the Value Chain
Sure, every energy investor would love to have the tailwind of rising commodity prices. However, don’t lose sight of the fact that margin capture is the name of the game for producers. Part of the reason crude oil is having trouble breaking through $50/bbl is the prospect of restarting U.S. shale growth. And the adoption of “big data” technologies in the oil patch is expected to further lower U.S. shale break-evens.
However, we believe the market has yet to give much credit to the benefit of these efficiency improvements. For the highest-quality producers, the acceleration of drilling may lead to an inflection higher in corporate returns, even on a flat oil price. For some perspective on how much runway shale producers have for growth, analysts at Raymond James & Associates are modeling 200,000 “core” oil drilling locations in the U.S. – this equates to about 20 years of inventory at the current drilling pace.
Given that fear of U.S. volume growth appears to be the primary driver of negative crude oil price sentiment, the underperformance of the midstream sector is particularly shortsighted, in our view. Unfortunately, Plains companies’ (NYSE: PAA and NYSE:PAGP) troubled high-profile second-quarter update stole investor focus in recent weeks. Plains’ issues proved to be primarily Plains-focused, as most operators reported a healthy quarter and improved confidence on forward expectations as volumes continue to improve.
As detailed in our June blog, we continue to believe many investors are overlooking the improving outlook for logistics assets needed to support the U.S. volume growth story. Importantly, many of the big-ticket projects connecting shale basins to refineries and export outlets have already been paid for, with $140 billion of capital deployed over the last five years. As a result, we believe many midstream companies are on the cusp of an inflection in distributable cash flow, as higher volumes translate into increased utilization across existing pipelines/storage/processing assets.
Oil consumers have been the clearest beneficiaries of this lower oil-price world, as evidenced by U.S. vehicle miles traveled reaching all-time highs again this summer. While the adoption of electric vehicles (EVs) is an attention-grabbing, long-term theme, even the most aggressive EV sales forecasts, if realized, would create only a slow and marginal impact on worldwide oil demand over the next decade. Consumer preferences continue to favor traditional powertrain engines in higher-growth emerging markets. For example, the sale of cheaper, less fuel-efficient sport utility vehicles in China has increased five-fold in the past five years and now account for close to 40% of sales. This compares with a mere 1.3% market share for EVs.
All told, in our opinion, these trends point to a resiliency in global oil demand growth that is often underestimated by generalist investors. From the perspective of feedstock consumers, both U.S. refineries and petrochemical complexes sit near the low end of the global cost curve, which provides an opportunity for increasing exports of gasoline/diesel and/or plastics.
We believe certain oilfield services companies can do just fine in the current price environment as well. Much of the new oilfield technology is focused on optimizing the completion of a well or, eventually, a dozen-plus horizontal wells across several vertical horizons that optimally drain oil and gas from an entire acreage block. The industry will have to spend more service dollars as it moves towards new cutting-edge completion designs, and oilfield pricing needs to move higher to support the necessary equipment-rebuild cycle.
Shale to Drive U.S. Energy Sector Growth
While the equity markets have seemingly left energy stocks for dead, we believe that the U.S. has positioned itself to emerge as one of the few growth areas in a lower oil-price world. Specifically, U.S. shale is poised to steadily gain market share over the coming decade as it benefits from both competitive break-evens and a much shorter lead-time from investment to production. Therefore, even in a $50/bbl oil environment, we see these structural growth tailwinds benefitting the entire energy value chain.
We believe the SteelPath Panoramic Fund, which invests across these energy subsectors, as well as our core midstream-focused funds, are well positioned to benefit from these dynamics.
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As of June 30, 2017, 0.00% of Oppenheimer SteelPath Fund’s holdings were in Plains All American Pipeline and Plains GP Holdings LP.
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