For the U.S. energy market, there is finally light at the end of the tunnel: U.S. energy usage is beginning to recover from the sharp contraction experienced during the financial crisis and global recession.
All signs point to continual but gradual increases as the national economy stabilizes. According to BP’s annual Statistical Review of World Energy, published in June, U.S. primary energy usage (commercially traded fuels including modern renewable) rose 3.7% in 2010. Worldwide, 2010 numbers are even more impressive. Global energy consumption was up 5.6% from 2009, an increase not seen since 1973.
For investors seeking opportunities in the energy sector, this will require them to be selective and think globally, not necessarily locally.
As demand for energy amplifies in the coming years, the U.S. will continue to rely both on its own domestic supply of fuel and imports to meet its needs.
New technology has helped to slightly increase U.S. crude oil production, even with restrictions on drilling. Some of this same technology is putting additional supplies of domestic natural gas within reach.
The outlook for other energy sources is not as clear. Although coal remains a vital source of the nation’s energy needs, its domestic use could be subject to future environmental policies. Nuclear power expansion in the U.S. will depend on whether funding is available to build costly new plants.
Crude oil consumption slid as a result of job losses during the recession. Put simply, fewer people were driving to work and consuming products, says Northern Trust Senior Investment Research Analyst Jackson Hockley, adding that 97% of crude oil is used for transportation of all kinds.
That changed as the economy began to stabilize. “As the U.S. economy found a bottom, you saw a rapid uptick in demand for crude oil,” he adds.
At the same time, domestic crude oil production has declined steadily since peaking at 9.6 million barrels in 1970. It 2009, output was just 5.31 million barrels, according to the Energy Information Administration, an arm of the U.S Department of Energy.
However, technological improvements are starting to reverse the output decline – and without drilling more wells, Hockley points out. Crude oil producers today can take an existing traditional vertical well and drill horizontally, which provides access across a deposit, rather than through the initial small section reached vertically. This allows producers to reach more oil out of one production area, reducing the need to drill additional wells in the same area. The technology, already in use at the Bakken formation in North Dakota, has resulted in a small increase in U.S. production over the past 12 to 18 months.
Bakken aside, there is little movement to expand crude oil production here via traditional methods, Hockley notes. Deep-water drilling is largely off limits following last year’s Deepwater Horizon oil spill in the Gulf of Mexico, which heightened awareness of the risks associated with this type of exploration and development. Alaska has significant potential on and offshore, but certain areas like the Arctic National Wildlife Refuge are again off limits.
What It Means for Investors: Even though domestic production is limited, investors should keep in mind that crude oil is a global commodity. That’s one reason it has investment potential. “We like the oil sector,” Hockley says.
Once an investor decides to include energy in his or her portfolio, Hockley suggests two different approaches based on risk tolerance. As a conservative option, consider only the major oil companies like Chevron and BP as portfolio additions.
For those who can withstand a little more volatility, he suggests spreading out investments across the subsectors of the energy field. That includes oil services sector companies, which provide equipment to crude oil companies and stand to do well when their equipment produces a find – Halliburton, National Oilwell Varco and Schlumberger, for example. Exploration and production companies such as Apache Corp. and Noble Energy also fit the bill here though they may be a bit riskier as not all explorations result in finds.
Crude oil production may be lagging, but natural gas output has risen sharply and supplies are likely to remain ample. The horizontal drilling technique that’s now being used in crude oil production was first implemented in the natural gas sector. In addition, multistage hydraulic fracturing has also enabled greater development of natural gas. “Fracking,” as hydraulic fracturing is sometimes called, works by pumping liquids – usually water – and a small amount of chemicals through a well to build up pressure and create fractures in the sedimentary rock. That allows the natural gas to be captured.
Advanced drilling, combined with fracking, has unlocked natural gas stores, particularly in shale‑gas – a natural gas deposit that comes from shale rock. From 2006-10, production of shale‑gas grew at an annual average rate of 48%, according to the EIA. In 2009, 16% of natural gas output came from shale‑gas, with total production of 21.0 trillion cubic feet.
High prices for natural gas in the mid-2000s, combined with the new technologies, made it economically feasible to produce shale‑gas. And as more supply became available, prices for natural gas tumbled to around $4 per million cubic feet (mcf) currently from as high as nearly $13 per mcf in 2008.
The bulk of natural gas demand comes from commercial and residential heating, but with improved efficiencies in building construction, growth there has been limited, Hockley says.
One area of potential growth for natural gas demand is as a companion fuel to solar and wind power, i.e., supplying energy when the sun isn’t shining or the wind isn’t blowing, he notes. In addition, because of low natural gas prices, the fuel is starting to be considered as an alternative to coal-fired power generation for electricity. Natural gas is considered “cleaner” than coal with regards to greenhouse gas emissions, a factor power-plant operators have not overlooked.
What It Means for Investors: In terms of investing in the natural gas sector, Hockley is less enthusiastic. Because of the substantial potential supplies of natural gas waiting to be tapped, prices are likely to be kept subdued.
Coal remains a major part of U.S. energy supply and demand. The U.S. has the world’s largest reserves, and coal production increased to 1,083.8 million tons in 2010 from 1,074.9 million in 2009.
Nearly all of the coal mined in the U.S. (90%) is used toward electricity, says Carol Raulston, senior vice president, communications, for the National Mining Association (NMA). In fact, 47% of all electrical generation in 2010 came from coal.
How much coal will continue to be part of U.S. energy supply depends on future regulations. According to the EIA, the Environmental Protection Agency (EPA) is expected to enact several key regulations in the coming decade that could impact the fleet of coal-fired power plants, especially where greenhouse gases are concerned.
While no new coal plants are likely to be built, coal is still the base-load fuel in the U.S. because it is the cheapest, says Ed Trafford, vice president, Northern Trust Global Investments.
The EPA’s decision to review all coal mining permit applications to construct fills, which are used to handle excess rock and dirt from mining operations, in Appalachia is another challenge. “Large construction projects of any kind – particularly in the rough terrain of Appalachia – require fill permits. The review process has resulted in a virtual moratorium on coal permits in the East,” Raulston says.
The industry is developing the next generation of “clean-coal” technology to further improve environmental performance at coal-based power plants, she adds. It has successfully tackled sulfur, nitrogen dioxides and particulate emissions, and now is looking to control greenhouse gas. Technology to capture, store or reuse carbon emissions is still small-scale. If successful, it will be about 15 years before the technology is commercially available to plants.
Trafford notes that “clean-coal” processes – usually a technique where power plants install scrubbers to remove carbon dioxide and sulfur – increase the cost of the power generated at these plants.
What It Means for Investors: Investors should start thinking about coal as a global fuel and not just a U.S. fuel, Trafford says. Demand growth in the U.S. is anemic compared with India and China, who import much of the coal to meet their sizable and growing needs. Much of the coal they import comes from Australia, but Trafford sees opportunities for the U.S. to export coal as additional port terminals are constructed. “The U.S. has fantastic resources of coal. There’s no reason not to take advantage of it,” he says.
U.S. nuclear energy supply has been on the rise, despite the fact that not a single new nuclear plant has been finished since 1973, with the last one going into service in 1996, says Paul Wilson, associate professor, engineering physics and chairman of the energy analysis and policy program at University of Wisconsin. According to the EIA, 19.6% of electricity generated in 2010 was via nuclear power, up from 19.4% in 2009.
The industry achieved increased capacity by “uprating” plants – either with new capital investments or by new capacity analysis of an existing plant using more precise calculations by nuclear physicists, Wilson notes. Uprates must be approved by the Nuclear Regulatory Commission before enacted. Over the past 20 years, the industry has added approximately 20 reactors in terms of capacity simply through uprates. As a result of these improvements, the average nuclear power plant today runs at 91.2% capacity, according to the Nuclear Energy Institute.
However, the industry is reaching its limits to expand power generation with uprates; further expansion will require new plants, Wilson says. In the long run, from a policy perspective, the future of nuclear power in the U.S. won’t be influenced by the damage done to the Fukushima nuclear plant in Japan as a result of the March earthquake and tsunami. Rather, constrained access to capital has a greater limiting effect, as new power plants can cost several billion dollars to build.
Bill Hurley, senior analyst at Northern Trust, agrees the accident in Japan won’t have a long-term effect, but says in the short-term it is an issue. “We are still separating fact from fiction for our investors. Nuclear energy is safe. There are many more deaths from coal and oil production, plus there’s the impact on the environment from those fuels,” he says.
Today, the industry waits to see if the Vogtle plant in Georgia, which is majority-owned by Georgia Power, will be granted a license for a new reactor. “We’ll see if that moves forward. If it does, it will be a real sea change, as it will be the first constructed plant in 30 to 40 years,” Wilson says.
Hurley, who has visited the Vogtle plant, is convinced it will be built. With the DOE likely forcing the retirement of some coal-powered plants, nuclear energy is the best alternative to handle that base-load power. Even with the Fukushima accident, there have been no signals by the U.S. government to limit nuclear power.
Trafford is less optimistic about nuclear taking over for coal and believes natural gas-fueled power plants may be an alternative to shuttered coal plants.
What It Means for Investors: Hurley notes there currently aren’t many investment opportunities in the market. Immediately following the Fukushima accident, there was a brief window to pick up stock in companies like Exelon and Entergy, but they no longer exist.
It will likely be a difficult environment for utilities during the next two to three years because these companies are locked into long-term forward contracts where they hedged output when power prices were lower. Thus, earnings growth will be limited. “It’s hard to get excited,” Hurley says.
In the short-term, some utility stocks could be bid up briefly, as investors sometimes seek out yield in the current low-interest rate environment. But these movements are short-lived and not likely to benefit investors.
The Road Ahead
The most significant growth in energy demand will come outside the U.S. as emerging markets like China and India develop their economies and build out power plants and infrastructure. Their increased consumption, however, likely will affect prices in the U.S.
More money likely will be spent on increasing energy production, whether it’s testing new ways to improve coal’s environment performance, building additional nuclear power plants or exploring for crude oil deposits.
“Globally, companies are spending more than ever before in an effort to keep up with demand growth,” Hockley says. “Can supply keep up? Price will be the arbiter.”