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Trends in Oil & Gas

We have written fairly extensively on oil, but gas is becoming increasingly important in the energy space as improving technology, relatively less carbon footprint and abundance of the resource push gas away from its historical use for power generation more into petrochemicals and as an alternative fuel to gasoline (even indirectly as gas-fired power plants can charge electric vehicles/EVs).

Some commentators have opined that Big Oil (Exxon, BP) will transition to Big Gas companies as infrastructure grows and EV adoption rises.

Should EV adoption come sooner than anticipated and renewable energy continue to ramp up at the same pace today – especially if there is a push from Chinese infrastructure planning in developing nations, there is a risk that transport will become decarbonized too quickly, which would be excellent for society as a whole but troublesome for energy companies who have invested billions into building long-life gas assets such as liquefaction and regasification terminals.

All in all, gas will be an interesting space to watch for the next while.

Trends in Gas

North American gas demand is expected to increase as per the EIA because of growing power, residential, and industrial demand as well as exports to Mexico via pipeline (for electricity/power generation) and exports overseas over Liquefied Natural Gas (LNG).

Much of the incremental gas supply for this demand will be from the Gulf Coast (there is an abundance of cheap shale gas that is now available both from gas plays as well as associated gas from tight oil basins), so Canadian companies will need to invest in infrastructure or contract with midstream partners to get their gas to high demand markets. The Gulf Coast (PADD III) is where sentiment is most favorable and pro-energy and where large liquefaction facilities have been constructed or are planned.

Meanwhile, low cost basin supply in Canada and the US continues to grow (the Montney in particular), so ensuring takeaway capacity for gas continues to be a key objective. Costs are continuing to decline and the output that producers can glean from one rig continues to rise.

Liquefied Natural Gas

Gas is cheaper than oil from an energy equivalency basis (gas is $3/mcf and has 1/6 of the energy content of a barrel of oil, so on an equivalency basis oil should be $18/bbl, which of course it is not) but has been historically difficult to transport across the ocean like oil (which is a liquid and is put on tankers, whereas gas takes up an enormous amount of space and cannot be released into the air so needs to be transported in pipeline or compressed container at all times) keeping it a regional commodity.

Cooling natural gas to extremely low temperatures liquefies the gas, making the volume requirement 1/400th of that of gas in atmospheric pressure. As such, transporting gas across the ocean to high demand areas that do not produce their own large quantities of gas can be lucrative.

Qatar (which has been in the news lately for various reasons) is the richest country in the world by GDP per capita primarily due to its large gas resource which is heavily exported via LNG and gas-to-liquids (GTL) infrastructure.

Since then, Australia and Russia have looked to become LNG players, but the biggest story has been in the USA. Before the shale revolution, natural gas production in the US was declining as domestic resources would not be able to meet power generation and petrochemical demand. The US began building LNG regasification terminals on the coasts to purchase LNG from overseas.

The shale revolution multiplied US gas reserves, ensuring energy independence and that the US had more cheap gas than it could do with. The regasification terminals have all been undergoing processes to be converted to liquefaction terminals and firms such as Cheniere Energy have become leaders in LNG export.

Compressed Natural Gas

Gas’s viability as an alternative transport fuel to gasoline has seen a lot of equity research focused on compressed natural gas fleets (PepsiCo and a few other firms adopt multiple CNG trucks).

Gas is much cheaper on an energy equivalent basis versus oil and much cleaner, so as a direct comparison to a gasoline fleet, should natural gas’ limitations as a fuel be addressed, the idea makes sense.

Gas takes much more volume than gasoline, so compressing the gas (or even liquefying it) should the costs of compression plus the fuel be less than that of gasoline, substantial costs can be saved for many corporates that depend on moving goods around.

Unfortunately, CNG may become a forgotten idea because of the chicken egg problem of widespread adoption and required infrastructure. Required infrastructure will require substantial government support – private sector funds will not fund CNG infrastructure unless there is widespread adoption. Widespread adoption will not come about without the required infrastructure. Infrastructure means CNG stations across the country.

Fortunately, the rise of EVs and renewables renders this a moot conversation.

LNG and CNG for Ships

Despite the rise of EVs and batteries for displacing combustion engine cars, large tankers for seaborne traffic may not yet be as readily replaced. CNG and LNG already make for good fuels for massive ships due to the relative cheapness for the same energy efficiency compared to hydrocarbon liquids.

Trends in Oil

Energy demand continues to grow as more of the developing world industrializes, but not at the pace of China during the boom period between 2007 and 2013 (unsustainable boom). Interestingly, much of the industrialization of the developing world is driven by China as they fund the infrastructure and the growth model for African nations.

Broad Trends in Fuel Efficiency, Renewables and Urbanization

However, in the developed world, the energy demand outlook is less certain as 1) fuel efficiency improves – engines can traverse longer distances with the same amount of fuel; 2) substitutes become cheaper and more desired by society (for instance renewable energy such as wind, solar and biomass); 3) Trend towards urbanization and scale – population density will increase in cities and ease of access through efficient public transport will become a regular feature in the city of tomorrow.

Oil and Gas Greenfield Deferrals

In a lower cost environment, we are seeing greenfield projects being cancelled or deferred while brownfield expansions (Canadian example: MEG Energy) that would be less profitable under a high oil price environment are undertaken. There is ample consolidation and asset portfolio rationalization as non-core assets are shed and private equity firms take over leverage friendly producing assets that may not meet major oil company return hurdles.

Asset Rationalization via Gas Station and Petrochemical Spin Offs

We have noticed that oil and gas companies, including integrated oil companies, have been offloading their petrochemical and retail marketing businesses (gas station networks). This is a corporate finance decision as well as a simplification of operations to focus on core competencies, and the market rewards them in terms of valuation as operations are seen to be more transparent.

Petrochemical and lubricants divisions are happily snapped up by companies further downstream as they benefit from economies of scale and product specialization. Gas stations have also been sold off en masse as gasoline retail specialists can achieve efficiency by sourcing food and other periphery items that make more money than the gasoline itself. Also, these companies may have very different credit and leverage focuses compared to the primary E&P business. A large E&P can reinvest disposition proceeds into higher returning plays.

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