This year’s top 10 stories included a peek into AustralianSuper’s international equities build out in London, AMP’s move to slash employee benefits, and plenty of hard-hitting analysis of the issues that matter in institutional investment. But the real story is how readers helped shape all of that coverage.
Orbis’ Stuart Place is riding from Melbourne to the Moon and Back to fund a treatment for the “monster of a disease” that his youngest son was born with. The investment industry is rallying behind him.
Fracking in the USA – an investor perspective
(pictured: Bill Miller and Ben Blanchett)
by Patrick Liddy*
The US fracking revolution has transformed the economics of oil and gas production globally. The US has become a bigger producer than Saudi Arabia and again becoming energy independent.
These dynamics lower energy prices for the end user worldwide while driving a robust US economy. The geopolitical and macro-economic impacts of fracking and the resulting US investment opportunities are now being played out.
US shale oil and gas is privately owned, while most of the world’s oil reserves (over 70 per cent) are in state hands. In a world dominated by state-owned companies and publicly owned reserves, US shale is a new frontier for private operators in the search for robust profits. And interestingly enough, US natural gas currently provides a chance for greater profit than oil.
New and improved technology (horizontal drilling and fracking), high oil and gas prices and plentiful cheap credit encouraged a boom in oil and gas shale activity starting in the early 2000s. The number of working drilling rigs increased 265 per cent and several hundred thousand shale wells were drilled. Some US$200 billion has been borrowed to invest in fracking. Oil and gas prices and production ramped up. Investors gambled on continuing high oil and gas prices making their investments profitable for years to come. Alas, this was not the case as prices began to slump in 2014.
The slump in prices destroyed the assumption that high prices were here to stay. From a mid-year high of $115 per barrel of oil, by the end of 2014 the price per barrel had fallen by more than 40 per cent (and today by more than 60 per cent). Natural gas prices have fallen even more, from as high as $13 per thousand cubic feet (Mcf) in mid 2008 to an average of $5.50 per Mcf in 2014, and to an inflation-adjusted historic low of $1.49 per Mcf on March 4, 2016 (currently $2.70 per Mcf). Working drilling rigs have fallen from 2,000 at the beginning of 2012 to 400 today. Virtually all drilling for natural gas has ceased and natural gas production is now declining for the first time in 10 years.
But in the meantime, the rapid development of huge new sources of natural gas from shale ignited an unprecedented $150+ billion investment surge in new U.S. plant by chemical, LNG, electric generating and pipeline companies. These investments are just now beginning to come on stream and will require unprecedented increases in gas purchases during the next five to seven years – right when drilling and gas production are falling during this historic period of financial distress in the U.S. oil and gas industry.
This severe financial stress combined with the impeding rapid growth in the demand for natural gas has created a rare opportunity for an experienced team that is not hobbled by legacy problems from the boom.
One of these groups (and there are only a few of them left) taking advantage of this opportunity is long-term industry and energy investment partners Miller Thomson (E&P) and its affiliate, Westgate Energy Partners (oil and gas private equity). Their game is part opportunistic fund, part vertical integration and part industry smarts. The founders of this group are experts in both the energy business and at profiting in counter cyclical plays. Their plan has been pretty simple: buy up distressed producing natural gas fields with large, undeveloped gas reserves at attractive valuations in today’s distressed financial world, secure gas distribution, and have the long-term gas buying clients signed up already. The future is, by definition, “true uncertainty,” but this purchase and sales model decreases risk.
As successful investor and industry veteran Roderick Thomson points out – “the US also has the following attributes –
- Existing robust infrastructure
- It is the biggest market for energy
- It is politically stable
- Strategically located – Mexico is the fastest growing purchaser of natural gas in the world (from de-minimus demand to more that 10 per cent of total US production in the next 10 years). And Mexico must rely exclusively on US shale supplies
- Strong intellectual and private property rights”
This makes exploitation easier on the environment, quicker to bring to market and economically more viable. Thomson has some insight into profitable growth opportunities, having seeded, among other things, both Skype and Baidu.
His energy partner of 35 years, Bill Miller, who is managing director and chairman, and CEO Ben Blanchett, agree. Miller says: “These opportunities rarely come along in oil and gas, perhaps once every 50 years. It’s almost the perfect storm – distressed assets, a strong growing customers base and an excellent transport system – the pipes and infrastructure already exist. And we have experience in every element required to implement our plan.”
Thomson and Miller and their long-term investment partner and co-founder of Westgate, James Jeffs, have been working together for 30 years. With their long term operating partners (geology, engineering, production, drilling, gas marketing, financial and investments), they collectively have almost 300 year’s of operating and investment experience.
The fracking revolution has fundamentally changed the structure and pricing of world energy. The US is now the major player in this market and is still in the early stages of growing into the largest source of energy in history. The US has the most mature infrastructure. The US is the largest consumer of natural gas and demand for natural gas is growing rapidly. The market is now in severe financial stress. Because of that stress, gas production is falling. There exists a huge opportunity for counter cyclical investors.
*Patrick Liddy is chief executive of the consultancy MSI Group. This is the first in a series of articles following a study tour in California earlier this month organized by the private equity manager Trimantium Capital.
