For the past five years, the energy sector has slightly underperformed the overall stock market as measured by the S&P 500 Index (17.54% to 19.61%). This has led to the question, "Is now the time to invest in energy for the long term?" As with many issues, the answer requires some digging. While most Wall Street analysts project stable to declining energy prices in the short-term, there remains considerable reason to invest in energy companies for long term rewards.
1. Long-Term Global Demand for Energy Is Robust
British Petroleum projects that the industrialized (OECD) nations' consumption rates will remain relatively stable or decline, while non-OECD nations' demand for energy will escalate more than 2.3% annually well into the future. For example, China is projected to almost double its energy use by 2030 before giving way to India, with both countries replacing the United States as the world's largest consumer of energy.
Energy demand is driven by a variety of factors, including:
- Population Growth. The global population, according to World Population Prospects, is expected to add 1.5 billion people by 2030, with the highest rates in Africa, India, and the United States. Simply stated, as the population increases, energy demand expands.
- Economic Growth. As third-world countries transition into industrialized economies, the demand for energy escalates. In 1820, energy consumption worldwide per capita was approximately 20 million Btu (MBtu), primarily in biofuels (wood and peat). By the year 2011, energy use had risen to almost 75 MBtu per capita. Worldwide total energy use was 510.5 quadrillion Btu, with the U.S. accounting for 19.2% of the total. Demand is estimated to grow an estimated 1.6% per year to 694.2 quadrillion Btu by 2030.
- Per Capita Energy Use Increase. In 2011, per capita consumption of energy in the United States was 289.7 Mbtu compared to China's 71.4 Mbtu and India's 23.8 Mbtu. The combination of higher population growth, increased industrialization, and expansion of the middle class will drive per capita energy use upward, especially electricity. Monday Morning chief investment strategist Keith Fitz-Gerald projected on November 1, 2013 that the world would spend between $15 and $17 trillion on energy needs, an amount equal to the U.S. total national debt. Fitz-Gerald went on to say, "There is not a government in the world that can't afford to keep the lights on. This spending is absolutely at the top of the priority list."
2. Continued Global Economic Recovery Is Driving Energy Needs
Global GDP growth for 2010 and 2011 was less than projected by the International Monetary Fund (IMF) in 2010: 5.3% in 2010, and 3.9% in 2011, with China meeting its growth projection. According to The Conference Board's Global Economic Outlook 2014, advanced countries, such as the Eurozone and the U.S., will eliminate many of their regulations regarding investment, increasing their rates of GDP growth respectively - 2.4% for the U.S. and 1.2% for the Eurozone from 2014 to 2019.
After that, growth is projected to moderate slightly for the U.S. to 1.7%, while the Eurozone remains unchanged. Countries like China, Brazil, India, and Mexico are expected to transition from investment to domestic consumption for the benefit of their populations, reducing exports while imports increase. The result is projected growth of 4.3% for the next five years, and 3.2% for the five years following.
3. Energy Prices Are Generally Upward and Stable
The discovery and exploitation of shale oil and natural gas has substantially expanded world reserves. The United States could eliminate dependence on foreign oil while becoming the world's largest oil producer by 2017, exporting more oil and gas than it imports by 2025, and achieving full energy self-sufficiency by 2030.
Though some analysts project the increased supply could reduce oil prices by as much as 35% to 40%, they haven't considered that price reductions:
- Ignore the Increased Cost of Drilling and Transporting Costs. For example, the average cost to bring a new well on line has doubled in the last decade, reflecting the need to drill deeper with new technology in hostile environments.
- Do Not Consider That a Growing Number of Oil Fields Are Out of Production. Many are in disrepair, while others are out of production due to terrorist and military actions. To get them back online, they'd need millions of dollars of new capital investment.
- Would Threaten Existing Governments in the Volatile Middle East and Russia. These governments are heavily dependent on oil revenues.
- Assume Reserve Estimates Are Correct. The Institute for Energy Research, a conservative trade group, reports that in the United States alone, total recoverable oil exceeds 1.4 trillion barrels - an amount more than the world has used in the last 150 years, six times the reserves of Saudi Arabia, and enough to fuel America for roughly 250 years. There are also estimated natural gas reserves sufficient to fuel America for 175 years. Conversely, the U.S. Energy Information Agency estimates recoverable reserves at 33 billion barrels - about 20% of the Institute for Energy Research's estimate - with daily production of 1.2 million BOPD by 2035, or about 12% of projected U.S. production at that time. Industry observers have always recognized that reserve estimates are notoriously inaccurate, especially the definition of "recoverable."
- Overstate the Industry's Capability of Finding and Developing New Reserves. To meet anticipated energy demand, analysts in 2011 projected a requirement of 7,300 active rigs by 2015, with half of the demand coming from outside the United States. However, according to the Baker Hughes Worldwide Rig count, there were fewer than 3,200 rigs active globally at the end of April 2013, with about 1,750 in the United States. Furthermore, the average rig is more than 20 years old, and there is a severe shortage of trained, experienced work crews and specialists who are familiar with horizontal drilling and hydraulic fracturing.
Rather than reduce oil prices, America is far more likely to use its newly-found energy reserves to stabilize energy prices, moderating global price fluctuations, and reaping the benefits of being a net energy exporter, rather than importer.
4. U.S. Government Restrictions on Energy Will Relax
Whenever the environment conflicts with economy, the economy invariably wins. Adding national security to the equation makes the contest almost unfair for those who seek even minor restrictions on the energy industry. In a March 30, 2009 article in The New Yorker, David Owen best described the conflict between the environment and the economy, "Our best intentions regarding conservation and carbon reduction inevitably run up against the realities of foreclosure and bankruptcy and unemployment. How do we persuade people to drive less - an environmental necessity - while also encouraging them to revive our staggering economy by buying new cars?"
A 2013 Gallup Poll illustrates the difficulty that environmentalists must overcome when seeking new regulations, especially after the 2008 recession and subsequent loss of jobs. Only young people between the ages of 18 to 29 favored environmental protection over economic growth (49% to 45%). Since the President and Congress are elected by the people, who are in turn influenced by large corporate donors, it is unlikely that new stringent regulations on energy exploration or transportation will be imposed, and that regulations under attack by the industry will be ameliorated. This is already occurring. Peter Lehner, executive director of National Resources Defense Council (NRDC), recognized in an article on May 18, 2013, that regulations and standards on energy efficiency were "not as strong as they should have been," and that the Department of Energy's investments in clean energy have been subject to a "flurry of Republican attacks."
Final Thoughts
The energy industry consists of various sectors (extraction, production, refinement, and distribution), as well as sub-sectors within sectors (oil, natural gas, coal, and biofuels). There are hundreds of companies under the umbrella of the "energy industry," any of which could be affected disparately by events. Despite the negative perception of some analysts, investors should remember that there is little likelihood that the world's energy needs can be met with existing technology at an acceptable environmental cost over the next twenty years. To the contrary, there are fundamental reasons to suspect that energy supply will always be less than demand, thereby providing financial opportunities in energy-specific Exchange Traded Funds (ETFs) and carefully selected securities.
Have you considered long-term energy investments? Why or why not?
