By Amine Bouchentouf
As an investor in commodities, you always need to keep track of the big picture that's impacting not just the macro factors, but also the granular details in each market you're investing in. As discussed in my last column, commodities are facing a particularly strong headwind that's a direct result of a slowdown in global economic activity. The structural problems facing Europe are beginning to have a detrimental effect on activity in other key regions of the globe, namely Asia and China. China has been one of the locomotives behind the spectacular demand in natural resources over the last decade, for everything from soybeans to coal to copper. However, as Chinese economic activity begins to decline so has its demand for natural resources, which has pushed prices of commodities to decade lows.
Within this broad macroeconomic scenario, there is an equally potent subcurrent that is having a major influence on an important commodity subasset class: energy. The energy complex, along with the metals and agricultural complexes, has experienced weakness this year. This weakness is not only a result of the big-picture macro issues facing global economic activity, but it's also a result of a direct issue that's particular to the energy asset class: increased supply as a result of technological improvements stemming from hydraulic fracking and access to shale oil.
Specifically, will the shale boom that began in the United States herald a new era in the global energy supply dynamics?
Shale Oil: The Beginning of a New Era
It is very hard to ignore the revolutionary impact that certain technologies have had on the commodities industry over the decades and the centuries. Technological improvements such as the development of the steam engine, electric transmission through copper wiring, and gasoline-powered automobiles have changed entire industries. The advent of hydraulic fracturing and horizontal drilling may also end up having a revolutionary impact on the energy industry.
This technological development, which began in the United States, has pretty much turned the whole energy picture on its head in North America. Previously untapped and unrecoverable reserves are now being exploited at a commercial and industrial level. For example, oil production in the U.S. has increased by over 20% year over year. A decade ago, the recoverable reserves in the Bakken formation located in North Dakota and Montana (which is at the heart of this shale oil revolution) stood at 150 million barrels of recoverable oil; that number has now jumped to 7.5 billion barrels, representing an increase by a multiple of 50. This technological improvement has had such a dramatic impact on the American oil landscape that the United States may not only achieve that elusive goal of being "energy independent," but may very well become a net crude oil exporter to the world's other large consumer markets.
This year's crude oil exports from the United States reached a 13-year high, according to the Department of Energy, and this trend will only accelerate. This scenario was unthinkable just five years ago when politicians were running on platforms that promised to wean the U.S. off of foreign oil. That is now likely to become the case, but not because of any political action -- instead because of drastic technological improvements in reserve-recovery techniques.
Thriving in a New Energy World
The technological revolution that began in the United States will soon make its way to the most remote places of the world. Already, countries such as Estonia and Lebanon are exploring ways to access previously commercially unrecoverable reserves. And traditional energy powerhouses such as Saudi Arabia and Russia are beginning to invest heavily in the technologies that will allow them to tap their own shale oil reserves.
As this technology upends the global energy landscape, are the world's petro-nations in a race to the bottom? Investors in crude oil have enjoyed strong earnings over the last decade, as the demand for oil remained high while supplies remained limited. However, as vast reserves of crude are tapped around the world and demand remains anemic, will we be seeing oil back to previous levels of $70 or even $50 per barrel? In this current environment, that is not out of the realm of possibility.
The smart investor will develop an investment plan that is able to withstand the cycles that are inherent in the oil business. We recommend sticking with large companies that have global reach, that are active throughout the oil supply chain, and that have experienced weather supply shocks and other severe market dislocations. Two companies that fit this profile are Exxon Mobil (XOM) and BP (BP).
Exxon's footprint in the global energy landscape is second to none, and it is one of the technological leaders behind the shale oil boom. It also boasts a diversified revenue stream across products and regions that allow it to withstand market dislocations in the long term. BP is a slightly more unconventional play because of the recent issues it faced in the Gulf of Mexico and Russia. However, it survived both episodes where many oil companies would have gone belly up. It is experienced in crisis and has a defensible economic moat across regions and products that allow it to survive and thrive in any energy environment.
The energy complex is very dynamic, and investors need to go with nimble yet large companies that can provide value throughout the energy life cycle. And Exxon and BP fit that bill.
Disclosure: The author doesn't have any positions in the stocks mentioned.