Will Trump's "drill baby drill" mantra create or destroy opportunity for energy investors
Likely good for natural gas, possibly less so for oil
As part of his platform, Donald J. Trump promises to reduce inflation by increasing energy supply, and he is right. Flooding the world market will oil will reduce the costs of pretty well everything as the costs of petrochemicals, asphalt, JP4, bunker fuel, gasoline and diesel fuel fall from current levels to a level that takes the pressure off inflation. Since this may coincide with a fairly rapid decline in interest rates already underway, moribund housing markets will come back to life and stock market will cheer.
OIL MARKETS
Well, not all stock markets, depending on how low the price of oil falls in the face of global surpluses led by increasing U.S. output. The question is just far will oil prices fall.
Recent data from Rystad point to a break-even oil price in the mid US$54 to $58 range. Even with less regulation and a less hostile administration, major producers won’t keep throwing capital away by drilling at prices where they lose money. Producer discipline may be the watchword.
In my opinion, West Texas Intermediate will probably trade in the US$60 to $65 range for an extended period of time, and U.S. output will put a lid on world oil prices even in OPEC tries to lean against the price decline by witholding output. The U.S. is a bigger producer than OPEC today and will have the driver’s seat on supply-demand balances going forward. OPEC producers need prices even higher than the U.S. break-even level to sustain their own economies.
No doubt there will be wide swings and periods of very low oil prices followed by sharp upticks when supply falls below demand. This volatility has been characteristic of oil markets since oil first became a key energy source, and won’t go away. Wise investors will buy energy names when the oil price falls well below the cost of production and rely on the old adage “the best cure for low oil prices is low oil prices”.
For Canadan producers, given sufficient pipeline capacity and access to deep water ports (something Pierre Poilievre has promised to deliver if he can oust Trudeau, which I see as highly likely), a price of US$60 with a narrow US$10 to US$12 differential will see Western Canada Selection (WCS) and Edmonton Par (light oil) settle out somewhere around CDN$65 and CDN$75 respectively. At those prices, Canadian producers are nicely profitable.
I have no doubt the volatility created by a change in U.S. energy policies will see energy stocks in weak hands sold and trading prices fall, perhaps even sharply, but I see that outcome as opportunity rather than risk.
NATURAL GAS MARKETS
Natural gas is another kettle of fish.
Growth in data centers alone is putting pressure on electrical grids in most jurisdictions and, fueled by Artificial Intelligence applications, is on a strong growth trajectory. To get enough power to support the number of data centers most contemplate, natural gas powered co-generation is the most reliable and in my view the most likely beneficiary.
At the same time, Europe wants to diversify away from Russian gas and India and Asia are short gas. I think gas markets will be reasonably robust and, for Canadian producers, growth of LNG in Canada and the United States is a strong tailwind, but somewhat offset by the growth in supply from so-called “associated gas” which is a normal by-product of oil production. Nonetheless, I see a bull market for natural gas producers emerging over the next decade as demand for energy grows worldwide and the arbitrage between oil costing about CDN$12 a gigajoule and natural gas today at about CDN$2 a gigajoule will see increased use of natural gas to supply the power needed for economic growth in the AI world.
For physics wonks who read this article, it takes about 7.4 cubic feet of natural gas to produce 1 kilowatt hour of power and at CDN$2 per thousand cubic feet, electricity can be generated at a cost of $2.00 divided by (1000/7.4) = $0.0148 per KwH. Since electricity at the wholesale level in jurisdictions where there is a surplus (e.g. Manitoba has a surplus of hydroelectric power) is about $0.09 per KwH although after a base load incremental power for industrial users can be as low as $0.045 per KwH. In any event, matching the price for that surplus power would be possible with natural gas at CDN$6.00 a gigajoule and Canadian natural gas producers like Peyto, Birchcliff, NuVista, ARC Resources, Pinecliff Energy and Tourmaline are very profitable at CDN$6.00 gas.
Natural gas is a local market, not a global market (despite LNG) and natural gas prices reflect the alternatives available to energy users in each local market. It is the absence of a large and integrated system of pipelines in North America that makes gas a “local market” and arbitrage between local markets depends on transportation costs, just as access to offshore LNG markets reflects the cost of liquifying gas, shipping it to another destination by sea, and connecting it to a distribution system. LNG prices in Europe and Asia today are about ten times higher than local prices for natural gas in Alberta, for example.
I have ignored wind, solar, biomass and nuclear sources of power for two reasons. First, despite pronouncements of support for nuclear, it will be well beyond my lifetime before the next large nuclear reactor is built anywhere on Earth in my opinion. People have irrational fears about nuclear and the permitting process takes decades. The capital costs are enormous and the price of energy from nuclear (while reliable) is not as low as from fossil fuels. Wind, solar, and biomass are bad jokes - they are unreliable, costly, depend on taxpayer subsidies, and have little value in a world that is waking up to the reality that CO2 emissions are unrelated to climate change. Before many more years go by, wind and solar farms will be stranded assets or local museums. Once voters elect leaders with enough common sense to abandon the “climate” rhetoric the left relies on the scare voters into electing Democrats, Liberals or Labour parties in western democracies, the whole charade will collapse under its own weight.
I hope you’re right!