For many years one of the principal long term challenges to the American economy has been ensuring a continued supply of energy. The global supply of fossil fuels was thought to be dwindling fast. Much of it was in the hands of hostile regimes in unstable parts of the world. In the last several years, however, vast deposits of natural gas have been discovered across the United States. The gas is relatively easily available due to new drilling techniques. The natural gas boom has already had a major impact on the energy industry. Now as the implications of having a huge, cheap, domestic supply of energy continue to unfold, we are seeing increasing benefits across other sectors of the economy. A recent piece in the Financial Times argues that natural gas could potentially transform the U.S. economy in the way the tech boom did in the 90s:
Ten years from today, the CEA and Federal Reserve chairman will again celebrate a decade of unexpected strong growth. This time the credit will go to countrywide gains from the very low energy prices found only in the US. Low-cost energy will have spawned an export surge in all sorts of goods, from chemicals to tyres. Fracking and the other technologies that gave us low natural gas prices will have added more than 1 per cent a year to US growth, repeating the 2000 surprise. Today, few realise that the US stands on the cusp of significant economic gains stimulated by low energy costs. … As a result of these circumstances, the benefits of low-cost energy supplies will spread throughout the US economy, stimulating exports of goods and services and creating millions of jobs.
Another piece in the New York Times tells a similar story and details how the gas boom is revitalizing U.S. manufacturing:
The rapid development of shale gas technology has helped reduce energy imports and, in some cases, encouraged companies producing petrochemicals, steel, fertilizers and other products to return to the United States after relocating overseas. Natural gas exports are growing and terminals built to hold imported supplies are being repurposed for international sales. The American petrochemical industry, for example, uses natural gas as both its primary raw material, in the form of liquid ethane, and as an energy fuel. And cheaper prices have led to a major expansion of capacity in the United States.
While these developments are highly encouraging, it poses difficult investment questions. A major shift like the shale gas drilling boom is easy to identify, but it is more difficult to participate in it as an investor. This is because the drilling boom has created a supply glut that has driven down the price of natural gas. The low price of the gas has taken its toll on the profit of the very companies driving the boom, the natural gas producers. It’s also a long term process. Factories and vehicles cannot switch fuels over night. New pipelines and fueling stations must be built and factories and vehicles refitted.
Despite the fact that natural gas prices have dropped 80% in the last four years, there have been other ways to participate in the boom than investing in natural gas producers. One way in has been natural gas drilling services companies that have profited from the increase in drilling activity without being hurt as much by the drop in prices. Another has been investing in gas pipeline companies that get paid based on the volume of gas that goes through the pipelines and not on the price of the commodity.
We’ve also seen the benefits of natural gas spread to other sectors as the above articles mention. One small cap company we follow was primarily involved in servicing water and sewer pipes. They are now expanding their business by working to maintain the increasing number of pipelines being built to transport natural gas. Another company that makes nutritional supplements found that one of the chemicals it was already producing could be used in “fracking”, part of the natural gas extraction process. This provided a new, unexpected source of revenue.
The sudden, unexpected rise of shale gas drilling is an exciting development. It shows that the conventional wisdom about the economy—such as the impending threat of “peak oil”—is often wrong. It also shows the hazards of acting (and investing) on the basis of long-term forecasts. Things happen, and sometimes they are so big that they change everything. One thinks of the collapse of the Soviet Union in the political sphere. In the economic sphere such a development appears to be the sudden and unexpected rise of natural gas. Alas the cost of wealth is always vigilance. That never changes.