Consider Investing in America’s Energy Real Estate in 2023

The primary drivers of the world’s oil and gas supply can be broken down into three categories:

1. U.S. Shale – while U.S. shale growing by almost 11.6 million barrels per day, it is no longer keeping pace with demand growth, which necessitates the production of closer to 13 million barrels per day.

The reason for this is that the old shale model is based on being able to access the debt and equity markets which allowed suppliers to outspend their cash flow every year. For example, a supplier that brought in $1 billion in cash flow might spend $1.5 billion on its infrastructure and production capacity given the cheap debt available to them. Today, the debt markets are much more stringent with lenders increasingly focused on ESG investing and achieving their own net-zero benchmarks.

Meanwhile, production is constrained by shale equity investors who question the necessity to continue growing amid depressed share prices. They want shale companies to keep production flat while maximizing free cash flow (cash flow that can then be returned to investors in the form of dividends and share buy-backs).

Lastly, the nation’s best shale acreage is already almost fully developed. In order for shale companies to continue drilling, they must move to Tier 2 and Tier 3 assets that yield less oil. This will effectively limit shale production in the years to come. Those who own assets in the more productive Tier 1 areas will likely hold off on subsequent drilling while the overall lack of supply boosts the value of those assets.

2. OPEC – OPEC, as a group, has had to deal with insufficient oil prices for the past six or seven years, in some cases, well below the fiscal break-even point. OPEC members have been pressured to divest, increase their borrowing, etc. At the same time, they have not been given the latitude to invest in new productive capacity. Some countries are now underproducing their quota, forsaking billions of dollars in the process.

Therefore, while OPEC countries do have a spare capacity of about two or three million barrels per day (in the context of a 100 million barrel per day market), in practice, they are bringing in much less than that capacity which will continue to hinder global supply.

3. Global “Super Majors” – these are major oil and gas companies, most of which are based in Europe. The Global Super Majors include Shell and BP, among others. These companies have been insufficiently investing in production since 2014 when oil prices crashed and today, face pressure from shareholders who want them to simultaneously increase dividends, do buybacks, and reach net-zero by 2050. As a result, they are not investing in new oil production. They are instead investing in renewables like offshore wind.

OIL AND GAS DEMAND

There has been a lot of debate as to when the world will reach “peak oil” demand. This is an important conversation to have because while most discuss this topic with good intentions, it results in what experts have dubbed “energy ignorance” – which is essentially (a) the lack of knowledge of how oil is used; (b) what are the alternatives to oil; and (c) what is a reasonable, rational timeline for those alternatives to displace oil consumption.

Many people, for example, assume that the primary driver of oil demand is gasoline needed to fuel our cars. As more companies move to hybrid and all-electric vehicles, someone might reasonably expect demand for oil to plummet.

Yet, when you delve into how exactly oil is used, you will find that approximately 60% of oil is used for transportation and the remaining 40% is not. Of the 60% used for transportation, only about 27% of demand is for cars – not an insignificant number, but a number worth putting in context. As further context: globally last year, there were approximately 6.5 million electric vehicles sold. There are approximately 1.2 to 1.3 billion internal combustion engine cars still on the roads to displace. Even as the share of EV cars continues to increase, energy experts believe that it will take at least two decades to reach the tipping point where it will truly erode incremental oil demand from cars. It will likely take until at least 2040 for another alternative, hydrogen for heavy hauling trucks, to become more pervasive. Renewable jet fuel is expected to lag even further behind.

The remaining 40% of oil demand comes from things like petrochemicals, lubricants, plastics, cement, and agriculture. The primary driver of this 40% is population growth. Despite best efforts to reach net-zero by 2050, the global population is expected to grow by 32% between now and then – an increase that will keep demand for oil at all-time highs.