Why invest in North American energy, and why now?

North American energy revolution continues to help our economy and provide compelling investment opportunities

Feb 11, 2014 @ 12:01 am

By Brian Kessens

As 2014 opens, the North American energy revolution continues to help our economy and provide compelling investment opportunities across the energy value chain.

North American crude oil production topped 8 million barrels per day (bbl/d) in 2013 and production is on pace to reach 9.3 bbl/d by 2015, the highest level in 43 years. At the same time, the U.S. is now producing enough natural gas to meet its needs independent of imports. This results in improving business fundamentals for companies spanning the energy value chain — from the exploration and productions companies producing these valuable resources to the pipeline and related infrastructure companies that transport oil and gas to the end users.

Increased production drives investment opportunity

Thanks to advancements in drilling and completion technologies, oil and gas production companies are now able to tap vast domestic shale resources that previously were uneconomic. Specifically, three separate onshore fields now each produce more than 1 million bbl/d. The Bakken shale in North Dakota surpassed 1 million bbl/d in December, while the Eagle Ford shale in South Texas achieved the feat in May, and now produces more than 1.2 million bbl/d. The Permian basin in Texas and New Mexico, with current production at 1.3 million bbl/d, has the highest growth expectation. In 2013, these three fields led production growth in the lower 48 states, and are expected to continue to lead.

Several investment strategies stand to benefit due to this production increase. Exploration and production companies operating in the most productive basins with the best production growth should benefit as they develop their vast resource plays. Those with many years of well inventory and strong balance sheets to find the capital investment should earn attractive returns on capital.

In the midstream sector, the need for additional pipeline takeaway capacity creates opportunity. One midstream investment strategy focuses on high-quality master limited partnerships — publicly traded partnerships that earn cash flow from fee-based sources and operate long-haul pipelines that enjoy long-term contracts. These companies offer tax-advantaged, attractive yields and distribution growth that we expect will equal 6%-8% in 2014.

The average MLP yield in 2013 was 6%, helping midstream MLPs outperform other yield-oriented asset classes, including real estate investment trusts and utilities. The other yield-oriented investments were partly restrained by interest rate uncertainty and an uptick in rates, while MLPs fared better due to their potential for higher distribution growth. If rates move higher due to inflation, liquids and pipeline companies can pass through the inflation due to a tariff escalator tied to the production price index. This ability to grow in a rising rate environment is another reason we believe MLPs are a compelling long-term investment across market cycles.

There also are attractive investment opportunities in the downstream sector. We think oil refineries, petrochemical facilities and natural-gas-fired power generation will benefit from feedstocks that are domestically abundant and inexpensive compared to global prices. Plants in the U.S. simply are more competitive versus the rest of the world, due to the changing North American energy market.

Why now?

We are still in the early innings of a crude oil production growth story that may see the U.S. surpass 10 million bbl/d of production by the end of the decade. This directly benefits the producers and is driving the immediate need for additional pipeline infrastructure. Over the next three years, we project more than $100 billion in pipeline and related growth projects.

We expect these projects to drive midstream distribution growth and facilitate the transport of inexpensive, abundant supplies of hydrocarbons to refineries (offsetting higher-cost crude oil imports), new petrochemical facilities and natural-gas-fired power generators. We think these dynamics will result in higher cash flows across the energy industry, leading to attractive stock price returns. At Tortoise, we think the future of North American energy — and for those investing in it — is bright.

Brian Kessens is portfolio manager and senior investment analyst at Tortoise Capital Advisors

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