This is the fourth article in a series of articles covering and summarizing different investment themes/thesis. These themes are usually very powerful and answer for the moves of stocks, entire sectors or even the entire market. The relevance of themes for specific stocks, sectors and even the entire market is explained in the first article in the series (linked below).
The previous articles on this series (by the order they were published) can be found here:
This article will be the fourth on a series of articles summarizing themes which are moving specific sectors or markets today. Knowing these themes can help when selecting securities. I'll continue with the following three themes:
The shale revolution;
The electric vehicle revolution.
The shale revolution
The shale revolution is easy to explain. It has been known for many years that significant quantities of oil, condensates and natural gas were available in shale deposits. However, up until rather recently the technology to explore those deposits efficiently had not come together.
With horizontal drilling and fracking techniques, such technology fell in place. The end result was a significant expansion of production from shale deposits. First this production was focused on natural gas, driving that market down to its April 2012 lows below $1.90. Then, with the deteriorating natural gas economics, the focus shifted towards liquids and oil, resulting in the present expansion of U.S. crude production. The two charts below show this effect (Source: EIA, red circle shows where the shale revolution increased production)
First a clarification - I will be classifying as a "positive impact" something which might make a given product or service more expensive. This "positive impact" might well be a negative societal impact. For instance, fracking uses a lot of water, and there are many places where fresh water is in short supply. Thus, fracking might lead to an increased water cost. This can be positive for companies providing fresh water, such as Consolidated Water Co. (NASDAQ:CWCO) and others.
Fracking also uses a lot of sand and other supplies. However, these being cheap commodities whose supply can be readily increased can lead to quick cycles where the initial impact - which we've already seen - quickly fades away.
The potentially lowered costs for natural gas and crude can also mean a positive impact for industries where it works as a feedstock. This is particularly important in industries whose end-product is priced on a worldwide market, because the lower feedstock costs are presently limited to the U.S. for a variety of reasons. Natural gas is much cheaper in the U.S. than in either Europe or Asia. The same goes for crude. This has had a huge impact in refineries such as Valero (NYSE:VLO) or Tesoro Corporation (NYSE:TSO). It should however be said that this impact should be temporary - WTIC crude will probably regain parity with other benchmarks, so it would be risky to buy refiners after they've been priced on the temporarily wider margins. Natural gas should take longer to normalize, so it might be possible to buy fertilizer/chemical makers which benefit from it.
The main negative implication of the shale revolution is regarding prices for the products produced. Natural gas already had a rude awakening, and it seems possible that crude might go through the same process. Indeed, the large spread between WTIC crude and other worldwide benchmarks like Brent is already due to this impact, together with infrastructure limitations and settlement technicalities.
Another possible negative impact can happen in companies catering to offshore exploration and production. If the shale revolution leads to enough new inshore cheaper production, it might at the same time impact the more expensive offshore exploration and production. This has already happened to natural gas, and might yet happen to crude. Companies which could be severely impacted would include Transocean (NYSE:RIG), Ensco (NYSE:ESV), Ocean Rig UDW (NASDAQ:ORIG) and others with large exposure to offshore drilling.
Natural gas is used to produce electricity in direct competition with coal. This has meant lower coal prices and thus worse prospects for the entire coal industry (NYSEARCA:KOL) as well as for specific producers like James River Coal (JRCC), Arch Coal (NYSE:ACI) and others.
The Peak Oil theory has its genesis in the behavior of a single oil well. After a oil well is drilled and starts producing, its production quickly hits its peak and starts declining as the reservoir loses pressure from the production. The same goes for a group of oil wells, and even for an entire field, or for an entire country - at some point the natural decline on existing wells overwhelms the drilling of new wells and produces a peak in overall production.
M.King Hubbert was the first proponent of this theory and correctly predicted the peak in U.S. crude production back in the 70s. At some point, the entire world will go through this same process, so it will forcibly have to rely on other energy sources, especially for transportation where crude use is the most intense. The chart below illustrates the phenomenon (Source: ASPO, Peakoil.net)
Here, a small aside. The shale revolution has brought about a delay in peak oil by exploring reservoirs that up until recently were well-known but not economically viable to produce.
Peak oil, or even the prospect of it, leads to a flurry of innovation in alternative energy sources. Both renewables and alternative fuels thus see much more investment. Companies in those fields end up gaining, and entire industries can be born or re-born due to this. Electric vehicles are one example. Eolic energy is another. Still solar is yet another.
The prospect of diminished crude production also led to significantly more investment in non-conventional crude and natural gas sources. The shale revolution was a child of that investment, as was deep offshore drilling and now even the talked about artic drilling. This has been very positive for many oil services companies, but as explained above, right now offshore drillers might be somewhat threatened by the lower costs of inshore shale fracking.
The switch to different energy sources is not pacific. Fossil fuel, for all its defects, is still very cheap and energy-dense. The alternatives are sometimes not ready for prime-time and can lead to significant losses, as was the case with solar energy. Even things like electric vehicles, as shown by Tesla (NASDAQ:TSLA), still raise significant doubts due to the battery's cost and life.
The electric vehicle revolution
As crude and crude-derived fuels like gasoline and diesel get more expensive both due to emerging market demand and supply constraints (peak oil), alternative modes of transportation are sought. One of these modes, known for more than a hundred years, is the use of electricity to power vehicles.
Fuel costs have been rising at the same time technology and battery costs have been plunging. Battery capacities have been getting larger, and their lives longer. At some point, the two lines cross and EVs become competitive.
New companies crop up trying to field competitive EVs. Here the standout is Tesla, on course to deliver more than 20000 high-priced EVs in a single year. It's possible that suppliers to this industry will also benefit significantly if the trend catches on. Panasonic (OTCPK:PCRFY), as a supplier to Tesla, would be an example.
If batteries get good and cheap enough so that electric vehicles pose a problem for traditional combustion-engine vehicles, then the impact will be far reaching. While today's vendors of traditional vehicles can probably adapt, their suppliers would probably face significant difficulties. It's still early in this game to predict losers as for now EVs are still confined to a niche, but the possibility exists and needs to be taken into account. Were EVs to expand quickly and anyone connected to make gas engines, transmissions, etc, would suffer deeply. Dana Holding Corporation (NYSE:DAN), for instance, seems to have significant exposure. But again, it's too early.