Energy Independence: Financial Fact or Political Fiction?
With a background in mathematics, Marin Katusa left teaching post-secondary mathematics to pursue portfolio management within the resource sector. He is regularly interviewed on national and local television channels in North America, including the Business News Network (BNN) and other radio and newspaper outlets. Katusa is the chief investment strategist for the energy division of Casey Research. He is the editor of the Casey Energy Report, Casey Energy Confidential and Casey Energy Dividends newsletters. A regular part of his due diligence process for Casey Research includes property tours, which has resulted in his visits to hundreds of mining and energy producing and exploration projects all around the world.
Porter Stansberry founded Stansberry & Associates Investment Research, a private publishing company based in Baltimore, Maryland, in 1999. His monthly newsletter, Stansberry's Investment Advisory, deals with safe-value investments poised to give subscribers years of exceptional returns. Stansberry oversees a staff of investment analysts whose expertise ranges from value investing to insider trading to short selling. Together, Stansberry and his research team do exhaustive amounts of real-world independent research. They've visited more than 200 companies to find the best low-risk investments. Prior to launching Stansberry & Associates Investment Research, Stansberry was the first American editor of the Fleet Street Letter, the oldest English-language financial newsletter.
The Energy Report: In light of the conflict in Ukraine and Iraq, is U.S. energy independence more important than ever?
Porter Stansberry: Energy self-sufficiency is a political issue, not an economic one. There is no particular advantage to being energy "independent." Yes, it is important to have enough production capacity to sustain our economy in the event of a global or trade war, but that's also true for many other products, such as food. What really matters for the wealth of our country and for our standard of living is that we maximize our competitive advantage in trade with other countries. If there are other places that can produce energy more efficiently (and thus, more cheaply) than we can produce it here, then we should maximize that advantage through trade.
Going forward, I believe the U.S. will be the clear leader in producing, refining and transporting natural gas around the world. We have the world's largest natural gas pipeline system and the world's largest functional reserves of natural gas. Given this comparative advantage, we should seek to maximize gas production by gaining access to world markets. That is happening with the huge, ongoing liquefied natural gas (LNG) build-out, and that is why Targa Resources Corp. (TRGP:NYSE), a stock I pitched not too long ago, has done so incredibly well.
Given that we consume around 18 million barrels per day (18 MMbbl/d) of crude oil in the U.S., and our domestic production is only around 8 MMbbl/d, it will be years before we will become energy independent in terms of oil. On the other hand, if you count coal exports, you could argue that we are already energy independent. In any case, even though we don't yet produce enough crude oil to meet all of our domestic consumption needs, I do think you'll soon see the U.S. begin to lift restrictions on crude oil exports. And I think that's a very important move for us to make.
"Decline rates are a concern, but we have 15 or 20 years of drilling left in the shale fields, so we don't have to worry about that. We just need to get out of the way of the people and the technology, and let the markets dictate how fast they can drill it." —Cactus Schroeder
Why would I want to see us exporting crude if we're not making enough to satisfy our own demand for crude? Again, you have to understand how wealth is built through trade, and the idea of competitive advantage. We can't use all of the light sweet crude we're currently producing in Texas because we don't have the right kind of refineries. It would be far better for our country to sell oil to the highest global bidder than to consume it in less optimal ways. The higher profits could be reinvested in more production and new refineries here in the U.S.
Crude exports would also have important benefits for our overall economy. They're the only likely way to solve our chronic current account deficits. Given that the U.S. Department of the Interior is an unwelcome partner in lots of oil production in the U.S., it's good for our government's deficit problem too.
Marin Katusa: The best thing the U.S. can do is lift the crude export ban. That will result in lower gas prices for the average American. Refineries in the U.S. have spent billions to modify those refineries to be able to treat the heavier crudes. The fracking revolution has unlocked the light oil, but that oil is trading at a discount because the pipelines are not in place to move it to play the arbitrage. Rail has picked up some of the slack, but the North American sector still needs to invest in its infrastructure. It will happen, but it will take longer than we want it to.
The U.S. will not be energy independent by the media tag line of 2020. It is still a major importer of oil. But the potential is there for the U.S. to become a major exporter of LNG and oil. Unfortunately, the government will not do what it needs to do during this administration to make that happen.
Chris Martenson: First, let's define what we mean by energy independence. Since various types of energy—coal, gas, oil—perform very different functions in our economy, there's no point in lumping them together and counting their BTUs as one big pile of energy. That obscures reality, rather than illuminating anything useful. Rather, we should explore the question of independence of each type of energy individually: oil, coal, nuclear and natural gas.
If the question is: Will the U.S. ever achieve petroleum independence?, the answer is currently no. Today, the U.S. produces a bit more than 8 MMbbl/d of crude oil, and imports an additional 7 MMbbl/d. Under even the most optimistic scenarios, shale oil peaks out in 2021 while adding another 4 MMbbl/d to current production. That still leaves a gap of 3 MMbbl/d and at that point the gap only grows wider, forever, as the shale oil fields enter terminal decline.
Under less rosy scenarios, the shale plays peak out in 2018, while adding only 2–3 MMbbl/d, leaving a much wider gap of 4–5 MMbbl/d to be filled by foreign imports.
For natural gas the situation is different. Fracking has a real chance to deliver natural gas independence. . .for a while. The U.S. will remain a net importer of natural gas for a few more years, and then be in a position to either meet 100% of its own needs for 20–30 years or export natural gas to the world in the form of LNG, and cut that window of independence down to 15–20 years.
"We have the world's largest natural gas pipeline system and the world's largest functional reserves of natural gas. Given this comparative advantage, we should seek to maximize gas production by gaining access to world markets." —Porter Stansberry
As with the shale oil plays, the shale gas plays require extremely intensive drilling to keep production growing. The minute the last well is finished, production begins to decline. Our choice with natural gas is either to use it to deliver the energy that drives the refashioning of our domestic energy infrastructure for the day that it, too, runs out, or to export the gas to drive up the current profits of energy companies.
Our view at Peak Prosperity is that we should not export LNG for two reasons. First, it costs 25% of the embodied energy in natural gas to compress it, power that is forever lost to humanity in the service of creating a liquid out of a gas. That's just energetically stupid. Second, we desperately need that gas for domestic purposes, as we face the largest-ever build-out of our energy infrastructure, to move toward whatever combination of resources we decide will replace dwindling fossil fuels.
Bill Powers: The U.S. is a mature oil-producing region. Some of the shale fields, like the Piceance Basin in Colorado, are already in severe decline. One of the best, the Marcellus Shale, is already slowing its rate of growth, and is within two years of peaking. Technology has increased oil and gas production in recent years, but there is a limit to what technology can do. The laws of physics and geology will always win out.
TER: In a recent interview, T. Boone Pickens predicted an energy renaissance in the U.S.—if the government gets out of the way. What are he, and other industry experts, getting wrong about U.S. production estimates?
BP: They don't understand the decline rates. These wells don't last multiple decades. The average is seven years, many less than that. Refracturing can work, but it is expensive. In the end, the price has to go up. That is an opportunity for juniors with a weighting toward gas and low valuations. That includes Pine Cliff Energy Ltd. (PNE:TSX.V), which has substantial upside opportunity and low cost of operations.
Advantage Oil and Gas Ltd. (AAV:TSX; AAV:NYSE) is also a low-cost operator with a great opportunity. Bellatrix Exploration Ltd. (BXE:TSX) has significant gas resources waiting to be unlocked. And Arsenal Energy Inc. (AEI:TSX) has significant acreage coming on.
Everyone in North America should be aware we are in a structural rising gas price environment that will result in tremendous opportunities from an investment position. This also means individuals may want to find a way to use less gas.
TER: Based on the amount of energy required to pull a barrel of energy out of the ground today, is fracking sustainable?
PS: It seems very clear to me, based on the economic outcomes, that fracking produces far more energy than it consumes. Most new wells produce large volumes of energy, far more than what was required to stimulate the well. Some of them, of course, don't. Others are bona fide gushers.
One extreme example is a gas well in the Niobrara Shale that WPX Energy Inc. (WPX:NYSE) drilled in January 2013. It's already produced 2.5 billion cubic feet of natural gas. At $3 per million cubic feet, that's $7 million worth of gas. That's a lot of energy from one well.
Another way of answering this question is to look at the financial results of the best frackers. Clearly the market leader is EOG Resources Inc. (EOG:NYSE). Over the last three years the company has spent roughly $5 billion ($5B) drilling and fracking wells. It has produced over $35B in oil and gas revenue. That's 7 to 1. Seems sustainable to me. . .
CM: A number of costs associated with fracking are either being subsidized by current taxpayers or will be absorbed by future taxpayers. We know that the taxes collected from the fracking and production companies are insufficient to fully repair the road and bridge damage their operations cause. In Texas in 2012, the state received $3.6B in severance taxes from oil producers, but the Texas Department of Transportation estimated $4B in damage to roads. Arkansas has taken in less than half the amount of the damage to its roads by oil trucks.
In the future, it's entirely unclear who will pay to cap all the abandoned wells—probably numbering in the millions when all is said and done. But if the recent experiences of Wyoming and Pennsylvania are any indication, that cost will be handed to taxpayers.
"Fracking has a real chance to deliver natural gas independence. . .for a while."—Chris Martenson
But the most obviously unsustainable part of the fracking story centers on the producers themselves. The largest and theoretically best positioned of them have all been turning in negative free cash flows (FCF). Consider Chesapeake Energy Corp. (CHK:NYSE), which had negative FCFs of $8.5B in 2011, $11.9B in 2012 and $3B in 2013. This means, at current prices, the company is spending more on capital than it is making in revenue, by a very wide margin.
The shale story is already a mature story. The best areas in the best plays have been intensively drilled for several years now. So it's worth asking, where's the positive FCF? Isn't that the point of all this, to make money?
The bottom line is that the price of oil needs to be higher. By my estimate, it needs to be $130 a barrel ($130/bbl) or higher, with $10/bbl of that higher price flowing to public trusts to be cash-flow and social-cost neutral.
TER: Is $150/bbl oil the likely outcome of the global problems in the Middle East and Ukraine?
CM: The situation in Ukraine has less bearing on oil costs, because there's no production directly at risk. Indirectly, that would change if some form of overt hostility between Russia and the West caused Russian oil exports to falter. I consider that highly unlikely at this stage.
However, the Middle East is another matter entirely. Even a slight reduction in Middle East exports will see the prompt return of $150/bbl oil. Recalling the $150/bbl oil we saw in July 2008, the correct explanation for that event lies in the observation that in five of the six preceding quarters, global demand for oil exceeded supply. Not by a lot, but it does not take much tightness in the oil market to create higher prices.
TER: Germany is Europe's biggest consumer of gas, with 80 billion cubic meters consumed in 2012. About a third of that comes from Russia. Can fracking in Germany end that dependency?
MK: Fracking has been occurring in Europe since the 1950s; it is not a new phenomenon, even though the media tries to make it so. Germany has been increasing its natural gas and oil imports from Russia over the last two decades. Horizontal fracking will help change that, but it is not an overnight solution. The sudden success of the U.S. shale sector took almost 15 years to mature, and it will take as long, if not longer, in Europe. However, it will happen, as Germany needs it to happen. Investors who expose themselves to the shale revolution in Germany will make a fortune.
"If you're a contrarian and have patience, nuclear will reward those who are exposed to the sector." —Marin Katusa
The Russians have been using modern technology to enhance oil and gas production, something Europe is late to the game to do. But the United Kingdom, Germany, the Netherlands and Albania are moving in the right direction. France is going the wrong way, in every way possible, when it comes to energy policy.
To answer your question specifically, fracking, along with other technologies, will help revitalize and increase domestic production within Germany, which has one of the highest netbacks in the world. It is still very early days in the European energy renaissance, but it has started.
TER: Will the violence in Iraq make Europe's transition away from Russia more difficult?
MK: The disturbance in Iraq has increased Brent crude pricing, and will continue to do so. The situation in the Middle East will get worse before it gets better, so expect higher Brent crude pricing.
TER: What role will nuclear and alternative energy play in European energy independence?
MK: Green energy does have a role to play, but it is still not primary base load. Furthermore, without government subsidies, green energy will not be as economic as coal and natural gas. Look at Germany, for example. Electricity costs for the average person increased by 25% each year over the last two years. Expect the same this year and next. Going green has taken the green out of the economy.
The most hated energy right now is nuclear, but it is real and is here to stay. Eventually, Japan will bring back its nukes, and so will Germany. It is too expensive for them not to. Nuclear energy is very misunderstood. But if you're a contrarian and have patience, nuclear will reward those who are exposed to the sector.
TER: What can investors do to protect themselves?
CM: The biggest risk is the extreme complacency that has built up in the equity and bond markets of the industrialized nations. Complacency leads to risk being mispriced, and we are at extreme levels of complacency at the moment.
An oil price spike would be a less-than-perfect event and could lead to very large speculative losses. We advise people to invest with an understanding of the risks involved and to potentially forgo additional gains in favor of protecting wealth. In times like these, cash is always a good place to be. If an investor wants to remain in equities, then using options to protect positions is sensible at this time.
TER: Thank you all for your time.
Bill Powers is an independent analyst, private investor and author of the book Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth. Powers is the former editor of the Powers Energy Investor, Canadian Energy Viewpoint and U.S. Energy Investor. He has published investment research on the oil and gas industry since 2002 and sits on the board of directors of Calgary-based Arsenal Energy Inc. An active investor for over 25 years, Powers has devoted the last 15 years to studying and analyzing the energy sector, driven by his desire to uncover superior investment opportunities. Follow him on Twitter for ongoing updates.
Cactus Schroeder has been drilling for oil in Texas for more than 30 years. He owns his own oil exploration company, Chisholm Exploration Inc. Chisholm focuses on the Permian Basin around Abilene, Texas, and averages 2,000 barrels of production per day. Schroeder was featured on a Discovery Channel show called "Wildcatters," which followed three people searching for oil and gas in areas other than oil fields.
Chris Martenson is a scientist, writer and financial and economic analyst. He earned his master's degree in business administration from Cornell University, and a Ph.D. from Duke University. As one of the early econobloggers who forecast the housing market collapse and stock market correction years in advance, he launched a video seminar and later published a book entitled The Crash Course. To learn more about Martenson and to view the Accelerated Crash Course, go to chrismartenson.com.
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1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
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3) Porter Stansberry: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Bill Powers: I own, or my family owns, shares of the following companies mentioned in this interview: Arsenal Energy Inc. I am a director of Arsenal Energy Inc. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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