By Simon Lack
It should be no surprise that government policy is of great consequence to investment returns. As a result of the credit crisis, this is perhaps more true than at any time since the Great Depression in the 1930s. Federal tax and spending policies always figure prominently, but today’s highly expansionary fiscal policy, the pace of its withdrawal and ultra low interest rates are all major factors governing the economic outlook and investment returns.
Regular readers will be familiar with our investment in the natural gas sector, and I won’t list each reason in detail here; simply put, natural gas is cleaner than other fossil-based fuels; cheaper on an energy-equivalent basis than crude oil derived sources; and it’s here, in the U.S. The T Boone Pickens Plan to convert trucks from diesel to natural gas mitigates many challenges facing the U.S. It reduces our reliance on an unstable region where we’ve fought three wars in the last twenty years; it reduces our trade deficit; it provides a “bridge” to renewable energy sources which are many years’ of development and investment away from providing a meaningful alternative to fossil fuels. It’s so obviously in the best interests of the U.S. to promote the use of domestic natural gas that the current failure to do so begs examination.
The chart shows our relatively steady annual consumption alongside growing proven reserves thanks to recent advances in shale drilling technology. The U.S. Energy Information Administration (EIA) estimates that ultimately recoverable reserves are 2.1 quadrillion cubic feet (7-8 times proved reserves, or about 90 years of consumption at current levels).
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I was in Texas in December visiting with a number of energy companies, and more recently attended a lunch sponsored by the American Gas Association (AGA), both of which offered rich insight into the political impediments to smart energy policy. Start with the coal industry, which is heavily unionized (and therefore politically organized), and a generous supporter of like-minded politicians. At least coal exists in abundance domestically, although the phrase “clean coal” is most appropriate as a comparison with “old coal” rather than alternatives.
In any case, global warming took a backseat to more immediate economic concerns when Lehman failed in 2008, and weekly snowstorms in the north-east U.S. are not drawing adherents to Al Gore no matter how tenuous the relationship between seasonal weather fluctuations and global ocean temperatures. “Big Oil” is of course, well, bigger in Washington, DC than the fragmented natural gas industry. Chesapeake Energy (CHK), the largest independent natural gas E&P name, has a market cap of $18BN, versus $398BN for Exxon Mobil (XOM), so no matter how telegenic its CEO Aubrey McClendon, XOM and its peers have a substantially greater impact on jobs, taxes and (presumably) Congress. Lastly, the auto companies were lukewarm on alternatives to gasoline until high oil and their own government bailout changed minds.
Dave Parker is retiring as President and CEO of the AGA. He provided a political update at the lunch I recently attended, and I had an opportunity to chat with him afterwards. The Environmental Protection Agency (EPA) is contemplating stricter emission rules that will force older coal burning power plants to invest in expensive “scrubbers” or close if the required expenditure is uneconomic. If these standards are implemented it will increase natural gas demand and reduce the use of coal. The Administration is in favor of improved emission standards through regulation (the legislative route having failed) and House Republicans are against. Dave’s view on how this will resolve itself was fascinating to one like me who spends much more time looking at financial numbers than opinion polls.
To summarize the outgoing AGA President and CEO: President Obama will govern from the center so as to win re-election, delaying more liberal elements of his agenda until that time. Of the 33 senators up for re-election in 2012, 21 are Democrats (and two are independents) including Senators Brown (Ohio), Casey (Pennsylvania) and Rockefeller (West Virginia), all of coal-rich states. Dave’s analysis begins, as he says, with the electoral college. Many will respond with a shake of their heads at the process through which policies are made. Sausage making is not pretty.
But really, senate elections in coal-mining states whose outcome is determined in part by each candidate’s degree of support from coal miners seems more democratic than any plausible alternatives.
For our part, we’ve combined an assessment of what should suit America with an analysis of the operating performance of relevant companies, and as a result are invested in companies with low operating and acquisition costs combined with large potential reserves, such as Range Resources (RRC) , Comstock Resources (CRK) and Southwestern Energy (SWN). These stocks have generally outperformed their peers in recent months. However, our investment thesis is certainly more balanced and better informed through the political realism of people like Dave Rogers.