US Govt. Energy Forecast
Adam Hamilton December 16, 2005 3351 Words
Wall Street seems to have a pathological aversion to acknowledging the long-term secular bull market in commodities unfolding today. This is unfortunate since big Wall Street firms have such great influence over the information that ultimately reaches mainstream investors.
The primary facet of this Great Commodities Bull is energy, the crucial fuels that make all global commerce possible. Rising energy prices herald wondrous opportunities for investors, but Wall Street has largely chosen the head-in-the-sand approach. It wants to ignore rising energy prices since their bull markets will ultimately weigh on the market-darling sectors like technology.
The higher energy prices rise, the more consumer disposable income is diverted to paying for energy. When consumers have less to spend, they buy fewer products made by the big American publicly traded corporations. Lower sales mean lower corporate profits. And lower profits make current valuations far too high so stock prices must correct to reflect the new fundamental realities. Thus, Wall Street is no friend of energy.
But as investors, our mission is to seek to maximize our returns while minimizing our risks. Today there are probably no other sectors on the planet that better reflect this higher-potential lower-risk ideal than the various energy sectors. Today energy stocks generally have low valuations, they are cheap relative to their profits, and the energy prices that drive these profits are likely to rise for many years to come, driving profits even higher.
Investors owe it to themselves to bypass the de facto Wall Street embargo on energy information and learn why the opportunities in energy today are so awesome. A fascinating report just released by the US government this week, its new 25-year forecast for the energy industry, does a wonderful job explaining why energy fundamentals remain so phenomenally bullish. Everyone who manages money, from individual investors to professional fund managers, needs to read this report.
It is called the Annual Energy Outlook 2006 (Early Release), henceforth AEO. It is available at www.eia.doe.gov/oiaf/aeo/index.html . As this web address indicates, the AEO is published by the Energy Information Administration (EIA), the statistical branch of the US Department of Energy (DoE) that compiles all of the official energy statistics for the US federal government. This is the official position of the government of the United States of America on energy trends.
I think you will agree with me that rising energy prices are politically incorrect. Remember Congress having hearings about gasoline and oil prices in recent months? Americans hate paying more for energy, so they whine whenever prices rise, and Congress responds by parading CEOs in front of cameras and hammering them with ridiculously naïve questions. Thus, the EIA has every incentive to lowball its estimates to keep its political masters happy. So we can probably safely assume that information out of the AEO is conservative.
This latest AEO captured my attention this week because the EIA radically departed from its previous energy stance. Prior to a few days ago, the official DoE oil price projection was around $33 per barrel in 2025 in today’s dollars. This week its projections were raised by 2/3rds to $54 in 2025 in today’s dollars. If the 2.7% average annual CPI inflation rate of the last 5 years is applied to the next 25 years, the DoE is officially forecasting $112 oil in 2030!
This is a financial bombshell. I cannot count the number of times I have heard or read Wall Street analysts justifying their belief that $30 oil was right around the corner by citing official US government predictions. With these very predictions now forecasting oil to conservatively rise to $112 nominal in the next 25 years, much of the intellectual foundation under the $30 oil fantasy has been shattered. Investors and money managers have to realize that we have entered a new fundamental energy paradigm.
The US government now believes oil supplies will remain tight for decades to come. The AEO says, “The United States and emerging Asia - notably, China - are expected to lead the increase in demand for world oil supplies, keeping pressure on prices through 2030.” The US government now expects that world oil demand is going to rise from 82m barrels per day in 2004 to 111m bpd in 2025, a 35% increase.
This is a staggering amount of additional global demand, equivalent to the output of 29 new Alaska oil pipelines coming online (assuming current Alaska pipeline throughput)! The US will account for about 1/5th of this global demand growth. In the US alone the DoE predicts domestic demand growth of 25%, from 20.8m bpd to 26.1m bpd.
Where will all this oil come from? The US expects OPEC nations to grow their production by 42%, from 31m bpd today to 44m bpd in 2025. The rest of the world will have to grow its production from 52m bpd today to 67m bpd in 2025, a 29% increase. Actual US oil production is expected to grow modestly from 5.4m bpd today to 5.9m bpd in 2014 at its next interim peak, and then taper off to 4.6m bpd by 2030.
60% of US oil is still expected to be imported in 2025, and OPEC will shoulder much of the burden. This is interesting in light of the growing number of analysts who believe Saudi Arabia has already or will soon hit its peak production. If Saudi production peaks soon, it’s unlikely that OPEC will be able to grow its production by 42%.
If these new DoE forecasts prove even remotely correct, the opportunities these secular trends present to investors today are staggering. Globally most of the easy oil to find has already been found. It is getting more and more difficult to find new oilfields, and giant elephant field discoveries have become extinct. Even the elite oil companies of the XOI only have sufficient reserves today to cover 11 more years of production. The best of the companies that own oil reserves and sell oil are going to become immensely valuable.
In the current issue of our Zeal Intelligence newsletter I did a study on oil-stock valuations. The elite XOI oil stocks are trading under 11x earnings on average. Compare this to 31x average earnings for the market-darling NASDAQ 100 tech stocks. Why pay $31 for a dollar of tech-stock profits when you can pay $11 for an identical dollar of oil-stock profits?
Oil stocks are cheap today fundamentally, their product is getting more scarce by the day, and it is extraordinarily difficult for new companies to enter the industry since so much capital is necessary. What a phenomenal investment opportunity!
Wall Street’s irrational fear of a secular bull market in oil and antipathy towards companies that produce it as reflected in their low valuations is just plain dumb. The best investors are sector-neutral, they don’t care in which industry they invest as long as it is going to be wildly profitable. The new AEO offers a great deal of fundamental predictions suggesting oil-stock investors are likely to reap fortunes in the years ahead. We are currently deploying into the most promising oil stocks in our newsletters to ride this wave.
High oil prices create interesting peripheral investing opportunities as well. For example, global peak production of light-sweet crude has probably already been reached, so the proportion of world oil that has high sulfur content (sour) will only grow. Sour crude is less expensive since it can’t command light-sweet’s premium price. Refineries that specialize in this difficult-to-refine sour crude are likely to soar. We are researching sour-crude refining and have already started layering in trades in our Zeal Speculator alert service.
The AEO also addressed natural gas, probably the second most-important source of energy today after crude oil. It expects real natural gas prices to decline gradually from today’s high levels but it is still forecasting $12 nominal natural gas prices in 2030. The DoE is forecasting gas consumption to grow 21% to 27t cubic feet in 2025. But domestic US production is only expected to run 21t cf then leaving a massive 6t cf shortfall that must be made up by other means.
Part of this core 21t cf of US gas production in 2025 will come from a new Alaska natural gas pipeline that the US government expects to be completed and online by 2015. It will help Alaska expand its gas production an awesome 450% from current levels, but total Alaskan production will still only run at 2.2t cf. Thus the DoE already accounted for a surge in natural gas from Alaska when forecasting its 6t cf domestic gas shortfall in 2025.
The only way to close this structural gas deficit is via natural gas imports. The AEO only expects 1.2t cf of natural gas to be imported from Canada and Mexico by 2030, less than a quarter of the projected US domestic shortfall. On an interesting sidenote, the report even mentions the decline in gas production in Alberta. The little known fact that Albertan natural gas reserves are being depleted has huge implications for the oil sands industry there. Without natural gas to fuel the difficult extraction of oil from oil sands, the entire oil sands industry would grind to a halt. Natural gas may prove to be the key to the future of the oil sands.
So where will America get its gas that we so desperately need to heat our homes and generate 20% of our electricity? The DoE says, “Growth in LNG imports is projected to meet much of the increased demand for natural gas.” LNG is liquefied natural gas. The gas is supercooled to -260°F to shrink its volume by 600x so it can be loaded in LNG tankers to be shipped across the world’s seas. The LNG industry is going to explode.
The US government now expects US LNG imports to soar a staggering 583% to 4.1t cf in 2025. It will make up over 2/3rds of the shortfall between US gas demand and domestic production. Amazingly the US only has four existing onshore LNG terminals today. The DoE only expects another eight or so to be built. In the current issue of Zeal Intelligence we just purchased a company that is building four of these desperately needed new LNG terminals. LNG has to be offloaded into the US somewhere and investors can profit from it by investing in the handful of companies that are involved in this LNG buildout.
It is not just the LNG industry that will thrive though. Domestic US gas producers are finding and pumping a scarce product already in high demand that is only going to grow. We’ve been researching trading natural-gas stocks and are now layering in a campaign of the best of the elite US gas producers. Like oil, barriers to entry in the gas industry are very high so new gas companies cannot just be wished into existence with no capital like the dot-coms of yore.
Natural gas offers little-known peripheral opportunities too. For example, gas is often found with oil. When oil is pumped out of the deep sea or in remote locations where no gas pipelines exist, the gas is considered stranded. Oil companies have no alternative today other than burning off this valuable gas in great flares, wasting it. Today there are companies working on converting stranded gas into synthetic oil on site at remote wellhead locations so it can be pumped out with the rest of the oil. We just bought one of these companies in our alert service.
The DoE’s AEO report goes on to discuss coal, a commodity that flies much lower on investors’ radars than oil or even gas. US coal prices are expected to gradually decline in real terms and total US coal production is expected to grow 36% by 2025. Interestingly the DoE believes nearly 2/3rds of US coal in 2030 will originate from Western states. It even singles out the low-cost coal from Wyoming’s Powder River Basin as an example. Investors can certainly ride this shift to cheaper coal from the west.
But the greatest coal opportunities may lie in coal-to-liquids (CTL) technologies. The AEO expects coal use in CTL plants to soar to 190m tons by 2030, 1/9th of US coal production. CTL heats coal into a gas in a contained reaction that requires no external energy. This coal gas is then cleaned of sulfur, mercury, arsenic, and other toxins. It is then distilled into a synthetic form of crude oil that can be refined on site to produce gasoline, diesel, and jet fuel. These ultra-clean synthetic fuels burn in conventional engines with no modifications.
While this sounds like science fiction, it is not. In the 1940s Germany powered most of its war effort using coal-based synthetic diesel. The US government started exploring synfuels in 1925 and Congress passed an act in the 1940s funding synfuel research and production. But as cheap oil was later discovered in the US, synfuels fell out of favor. It costs about $35 a barrel to produce synthetic oil so high oil prices are essential for this innovative industry.
Obviously in light of the DoE’s projection of continuing high real oil prices in the coming decades, synfuels are once again attractive. While they can be produced from coal or natural gas, the coal angle is much more attractive due to the price differential between coal and gas. And the US is believed to have over a quarter of the world’s recoverable coal reserves, it is known as the Saudi Arabia of coal. Wide-scale CTL to use this coal and reduce crude oil imports is a match made in heaven. Has your Wall Street broker talked with you about CTL yet?
The AEO also addressed nuclear power. The US government believes US nuclear generating capacity is going to grow to 109gw in 2019, up 9% from today. Nuclear power is expected to produce 10% of the electricity consumed in the US by then. What is “burned” to generate nuclear power? Uranium! Investors can profit tremendously here too. Back in August we took a long-term stake in the world’s largest uranium miner and we are already up 28%.
While this multi-decade bull market in energy is great for prudent investors who understand this new paradigm of energy demand growth outstripping supply growth globally, it is not as exciting for consumers. Some folks think higher energy prices will sink the economy and destroy general growth. Interestingly the DoE addressed this very point and does not share this opinion.
The AEO says, “Despite the higher forecast for energy prices, gross domestic product (GDP) is projected to grow at an average annual rate of 3.0 percent from 2004 to 2030 ... The ratio of final energy expenditures to GDP has generally fallen over time and was only about 0.07 in 2004, down from a high of 0.14 during the 1970s. It is projected to fall to about 0.05 in 2030 as a result of continued declines in energy use per unit of output and growth in other areas of the economy.”
Thus, even though energy prices are expected to be high for decades, the total energy costs as a percentage of the US economy are still expected to decline in these coming decades. High energy prices today are very different from the high energy prices of the 1970s in the sense that it doesn’t take anywhere near as much energy today to produce a given output. The DoE calls this energy intensity and says it is projected to decline 1.8% per year to 2030.
This suggests high energy prices will not come close to triggering economic Armageddon. Investors can buy elite energy stocks, potentially earn fortunes, but the very products the companies they own produce are not going to sink the economy. Energy prices are simply rising up to a new higher norm reflecting global demand growth exceeding supply growth. This is the normal and expected free-market response to a structural deficit.
While I really feel strongly that you investors and money managers ought to go read the DoE report for yourselves, I want to share a few charts copied directly out of the report. There are additional interesting charts in the AEO, but these really capture the gist of the DoE’s research. The horizontal axes all run from 1980, to 2004 at the center lines, to 2030 on the right. The upper-left price chart is in constant real 2004 dollars.
These charts summarize the DoE’s latest official US government energy forecast rather nicely. In the upper left real oil and gas prices are expected to rise in the coming decades. Interestingly these are conservative long-term average prices, filtering out any potential geopolitical crises or other events that drive the tremendous oil and gas volatility that we have grown accustomed to in 2005.
In the upper right US energy consumption is expected to grow at a faster rate than domestic energy production, pushing up imports of energy in an absolute sense although as a percentage of consumption imports will remain fairly constant. Companies that can produce energy or facilitate its import from overseas are going to thrive in such a bullish fundamental environment.
In the lower left US fossil-fuel consumption is expected to grow at far faster rates than alternative energy including hydroelectric, non-hydroelectric renewables, and nuclear. While everyone wants the science-fiction future of unlimited clean energy, the reality of the coming decades will be the continuing dominance of oil, gas, and coal. The realm of exotic energies like hydrogen fusion remains decades away so investors should concentrate on the existing dominant energies today.
In the lower right US oil production is expected to decline, US gas production is expected to remain stable, and only coal production will grow dramatically. Nuclear and hydroelectric are largely expected to remain flat although non-hydroelectric renewables should grow. But even if the latter doubles, it will still only make up a small fraction of total US energy production by 2030. Once again the big money will be made in conventional energy in the next two decades.
As investors, we need to evaluate potential opportunities and deploy our capital accordingly. The official acknowledgement by the US government this week for the first time that $30 oil is nothing but a memory is very important as it signals the dawn of a new fundamental energy paradigm. Regardless of what Wall Street wants mainstream investors to believe, enormous fortunes should be won by energy investors in the coming years.
At Zeal we are now layering in elite oil, gas, and other energy trades in response to the recent oil correction. Our first round of Zeal Intelligence picks layered in a couple weeks ago is already thriving. Our new December ZI stock trades are up an average of 12% already while our energy-stock options trades have averaged 58% gains just this month alone. We are continuing to pour our time into researching the best oil and gas producer opportunities as well as peripheral areas like LNG and CTL.
Most investors do much reflecting this time of year, wondering what the most promising sectors will be in 2006 and beyond. If you are interested in learning about commodities-bull-related stock trades with tremendous potential on an ongoing basis, please subscribe today. If you are already honoring us with a subscription, consider gifting a friend with one. The energy journey in 2006 and beyond should be awesome.
The bottom line is this week’s release of the US government’s latest official forecast of secular energy trends is extremely important. It deftly guts the long-standing Wall Street fantasy that the return to a cheap-energy world is right around the corner. Love it or hate it, the new reality is higher energy prices while global production struggles to keep up with world demand growth.
Prudent investors and speculators who understand the times and deploy their capital accordingly ought to reap fortunes in this still very young energy bull. But the time to seize this rare opportunity is now. By the time Wall Street finally adores energy stocks more than techs or financials the greatest gains will have already been won.
Adam Hamilton, CPA December 16, 2005 Subscribe at www.zealllc.com/subscribe.htm