In The Road Ahead: Investment Perspectives Part I, we explained how the United States, as well as much of the developed world, will soon contend with far-reaching systemic issues.
Economic and financial headwinds in the form of demographic trends and unsustainable government policies will force a reckoning throughout the global economic system.
Regardless, there are specific areas within the global market place that will provide dynamic opportunities for intelligent, forward-looking investors.
The next four Weekly Market Reviews will cover some of these themes and opportunities.
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"No real social change has ever been brought about without a revolution... Revolution is but thought carried into action." -Emma Goldman
In the 1970s, geoscientist Marion King Hubbert developed his Peak Oil Theory. His premise? The world would soon reach the apex of its oil production, after which the global economy's increasing energy appetites would compete for an ever-shrinking supply.
Texas oilman George Phydias Mitchell (here), however, had another idea.
A wildcatter and the founder of Mitchell Energy & Development Corp., Mitchell had long believed that there were large gas reserves buried in Texas's Barnett Shale. Unfortunately, the depth, location and rock formations made the oil impossible to retrieve.
Yet, Mitchell was not concerned with the impossible.
In 1981, he challenged his technical experts to determine a means of cracking the shale code. By 1999, the problem was solved.
Companies had long experimented with horizontal drilling technologies. This enabled wells to drill down and then sideways, opening large areas within the shale deposits. This was followed by the advent of hydraulic fracturing technology, or "fracking," which enabled producers to inject a mixture of water and sand at high pressure to create fractures in the shale bed, liberating the trapped gas therein.
Eventually, horizontal drilling and fracking were wedded, enabling the release of natural gas reserves from vast shale formations. The result? Today's natural gas revolution.
In the 1970s, the American public was held hostage by mercenary OPEC nations seeking to punish the U.S. for its relationship with Israel. Gas costs skyrocketed. Long lines formed at filling stations. Public morale ran low.
That was then. This is now.
U.S. oil production has reversed its 30-plus year decline. Imports from OPEC producers have fallen more than 20 percent in the last three years. Natural gas reserves and production have risen significantly while prices have dropped 75 percent the last five years. The International Energy Agency (IEA) forecasts that the U.S. could become the world's largest oil producer by 2020. Further, the IEA predicts that the U.S. may be energy independent by 2035.
A domestic energy renaissance is at hand. A game changer for international politics and economies.
Developing technologies could change the axiom "resource scarcity" into "resource abundance." Turn the U.S. into an energy exporter while unlocking hidden reserves in other nations.
Traditional energy barons like Russia, Venezuela and Saudi Arabia may find themselves in serious trouble. Better balances between supply and demand will help the global energy sector to function like a normal market, no longer dominated by a few select producers.
As U.S. dependence on foreign oil declines, Washington will be less inclined to risk lives and capital on the defense of foreign despots. Ensuring the free flow of oil and gas in far-away lands will not be a priority.
The major players have taken heed.
Saudi Prince Alwaleed recently went so far as to refer to North America's shale gas revolution as "an inevitable threat" to Saudi Arabia's oil-based economy.
Another transpiring dynamic rests in the geographic locations of the major shale formations. The most productive deposits are located within the very areas in which their most needed: the Rust Belt. And as the nineties technology revolution reshaped the landscape in what is today referred to as Silicon Valley, the natural gas revolution stands to reshape the economies of North Dakota, Texas, Ohio, Louisiana, Pennsylvania, Michigan, Oklahoma, Colorado, Arkansas and Alabama.
From our vantage point, this saga brings opportunity.
Regardless of what transpires within the global economy over the next decade, the facts remain: the U.S. shale and liquid natural gas revolution will provide investors with a massive opportunity. It is equivalent to buying Ford stock before most of the nation owned a car.
Never-heard-of regions like Eagle Ford, the Permian Basin and the Cline Shale are so flush with natural gas that they are rewriting the future of the domestic energy sector. The Eagle Ford shale alone is on track to provide a million barrels per day (bpd) by this time next year.
According to PIRA Energy Group, U.S. oil and natural gas production increased by 3.2 million barrels per day since 2009. Total output is expected to hit 12.1 million bpd by year's end. This marks the second fastest expansion in history, just behind Saudi Arabia's 1970s boom.
Currently, the U.S. produces roughly 300,000 bpd more than Saudi Arabia and 1.6 million bpd more than Russia. In fact, the 2013 U.S. supply growth is greater than the sum of the next nine fastest growing countries combined, covering most of the world's net demand the last two years.
PIRA reports that the U.S. position as the world's largest supplier appears secure for many years to come. At least through 2030.
This revolution stems primarily from the increased output of U.S. shale formations. Only 10 years ago, the massive oil reserves therein were viewed as unrecoverable.
Obviously, fortunes will be made. But for whom?
Global oil companies are pouring resources into developing these fields. Accordingly, most individual investors, mutual funds and pension fund managers are focused on the usual suspects. The global energy behemoths. Chevron. BP. Chesapeake. Total S.A. RoyalDutch Shell. Devon Energy.
While those firms will make a fortune, they will not make you a fortune. They're too big. To diversified. Not sensitive enough to the huge incremental gains that can be had by smaller, more specialized firms.
Devon Energy (market cap: $27B) has made huge investments in natural gas production and exploration. Its shares are up 6.71 percent over the last year. Cheniere Energy (market cap: $9B) also also invested mightily in LNG. Its shares have jumped 49 percent.
Cheniere Energy Inc. (NYSE: LNG) has completed several contracts through which it will provide liquid natural gas to larger companies like Total S.A. from its Sabine Pass LNG terminal in Louisiana. Further, Cheniere will supply LNG to companies in India, South Korea and Spain.
Yet, Cheniere has already exploded. Shares are up 108 percent year to date. Rose 116 percent in 2012. 57 percent in 2011. A whopping 128 percent in 2010. That ship has sailed.
Remember, you'll never find winners by following the herd.
It will not be the mega producers that see their shares explode higher on the shale revolution. Their too big to see dramatic movements in the dial.
To win big, think small.
Fortunes will be made by small firms that take big chances, realizing the potential within those shale formations. Further, opportunities often exist on the margins. Forget about the producers. Who's making the picks and shovels?
It will be the transportation, infrastructure and engineering, manufacturers and suppliers that make fortunes from nothing.
Companies like Chicago Bridge & Iron Works (CBI) are creating the global infrastructure to store and transport liquid natural gas. Missed out on CBI's colossal recent runup? Consider its smaller, no less impressive peer, Kbr Inc. (KBR).
KBR receives 40 percent of its revenues from LNG projects. Following a recent pull back, the stock was a steal, trading at 10 times forward earnings. That's cheap for a stock in the midst of one of today's biggest growth trends.
These are leading global engineering, construction and services companies that can support the production, storage and transportation of liquefied natural gas from end to end. Upstream. Downstream. Private and public sector projects. They do it all.
What about the transportation companies that own and operate LNG carriers, like Golar LNG Ltd. (GLNG)? It pays a 4.86 percent dividend, and as U.S. LNG export capability flourishes, so shall it.
Another transportation play is Teekay LNG Partners (TGP). It pays a generous 6.51 percent dividend. Both TGP and GLNG stand to benefit as more LNG export terminals are approved. While they appear expensive from a P/E standpoint, the industry has high barriers to entry. It takes more than ambition to ship LNG. As such, there are not many fleets capable of doing so.
Some companies will profit by dent of staking their claims to the right geography.
In southwestern Texas, the Eagle Ford's oil reserves increased from 133 million bpd in 2009 to 1.1 million bpd in 2011. That growth will provide respectable returns for big producers like BHP Billiton, EOG Resources and Marathon. But what about the smaller producers?
Swift Energy Company (SFY) engages in the development, exploration, acquisition and operation of oil and gas properties throughout the nation. Yet, the primary focus of this half-a-billion concern lay in its onshore natural gas reserves in Texas and Louisiana. Swift has placed big bets on the Eagle Ford shale. As these bets begin to pay off, shareholders could benefit immensely.
Similarly, companies you've never heard of, like Laredo Petroleum (LPI) and Concho Resources (CXO) may also generate dynamic long-term profits on the backs of recent discoveries.
Should investors throw capital at every opportunity and pray for a couple of home runs? No. That is, unless rash decision making is part of your investment methodology.
Each of theses ideas, and the countless others we follow, have proper entry points. Valuations at which they are attractive, and at which they are not.
Only time, energy and analytical elbow grease will help to separate the wheat from the chaff.
As in every revolution, there will be winners and losers. The difference being that some of these winners could be game changers. For executives, consumers and shareholders alike.
Regardless of global economic growth, the U.S. natural gas industry offers substantial opportunities for those able to identify and commit.
In an interview with The Economist magazine last year, the late George P. Mitchell noted that, in the year 2000, shale gas represented just 1 percent of American natural gas supplies. Today, it's 30 percent and rising. We'll see where it goes."
Ever opportunistic, ever optimistic, Mitchell realized that the possibilities were endless. Who's fool enough to bet against him?