The U.S. energy industry is undergoing a renaissance. As I explain in my new Market Perspectives (PDF) paper, the proliferation of shale gas and unconventional oil production techniques are leading to a surge in domestic energy production that is likely to continue in coming years.
For investors wondering how to play this boom, here are two ideas to consider, one perhaps obvious and one not.
1. Overweight U.S. Energy Companies. This one may be obvious. All else being equal, higher domestic energy production should give U.S. energy companies a greater share of the global energy market. In addition, even with rising U.S. production, oil prices have remained stable thanks to production declines in other parts of the world and ongoing unrest in the Middle East. Thus, increased domestic production should translate into higher earnings for U.S. energy producers. One way to access U.S. energy companies is the iShares Dow Jones U.S. Energy Sector Index Fund (IYE).
2. Consider U.S. Manufacturing and Materials Companies. The implications of the U.S. energy boom, however, go far beyond the energy sector. Increased domestic shale production has helped bring down the cost of natural gas. And this represents a competitive edge for U.S. manufacturing and materials companies dependent on natural gas. In fact, U.S. natural gas costs are now a fraction of those in Europe or Asia. The chemicals industry, in particular, is arguably the biggest beneficiary of the U.S. energy revolution given that natural gas is a key ingredient in manufacturing a variety of chemicals and plastics. In addition, it looks as if the benefits of the shale revolution may not yet be fully factored into the prices of chemical company stocks.
Based on the historical relationship between natural gas prices and chemical company valuations, with natural gas in the $4 range, the chemicals industry should be trading at around a 15% premium to the broader market. As of mid-June, however, the premium was around 9%. This means that if natural gas prices remain at current levels, U.S. chemical companies' multiples potentially have some room for expansion vs. the broader market. One way to access these companies is the iShares Dow Jones U.S. Basic Materials Index Fund (IYM).
To be sure, there's always the chance that other countries may ramp up their energy production or at least keep levels stable, eliminating some of the potential benefits to U.S. firms. However, while other countries have the potential for similar shale gas deposits, so far no other country or region has been able to exploit this opportunity to the same degree as the United States.
Sources: BlackRock Investment Strategy Group research, "July 2013 Market Perspectives, Drilling Down: What the U.S. Energy Boom Means for the Economy and Investors"
Disclaimer: In addition to the normal risks associated with investing, narrowly focused investments typically exhibit higher volatility. The energy sector is cyclical and highly dependent on commodities prices. Companies in this sector may face civil liability from accidents and a risk of loss from terrorism and natural disasters. Profitability of companies in the oil industry is related to worldwide energy prices, exploration and production spending. Such companies may be adversely affected by changes in exchange rates, government regulation, world events, economic conditions and environmental damage claims. Oil and gas exploration and production can be affected by natural disasters and changes in interest rates. Oil equipment and services companies may be adversely affected by increased competition and depletion of resources.