Dear Valued Clients and Friends,
The anniversary of a world-changing event passed last week that did not get nearly enough attention in the press. It clearly was a market-changing event, or I would not be writing about it. But I also mean exactly what I say – that it was a world-changing event as well. The geopolitical implications, environmental implications, and yes, market and economic implications, of the event I refer to are all nearly impossible to exaggerate. The event I refer to is the drilling of the first well which would use hydraulic fracturing to crack shale rock, thereby releasing the gas beneath the rock. Put differently, it was 20 years ago that “fracking” was born.
The company, Mitchell Energy, has since seen its founder, George Mitchell, pass on, and the company was sold to energy behemoth, Devon Energy, for many billions of dollars. The successful use of this profound energy exploration technique made Mr. Mitchell and his shareholders very wealthy, but it soon thereafter did the same for many other oil and gas businesses as well. And more importantly, it changed the entire dynamic of U.S. energy production, and through that change, the entire dynamic of global energy markets.
“Fracking” is the term we have applied in the culture to the combination of horizontal drilling (where the well is dug deep into the ground, often many thousands of feet deep), followed by hydraulic fracturing, where sand and water are pumped into the shale rock that exists many thousands of feet below the surface to “fracture” that rock, and allow the oil and gas embedded deep underground to be captured. The volumes of natural gas, natural gas liquids, and crude oil that this technique has uncovered all over the country have been unfathomable, and over the last decade alone has caused the United States to more than double their crude oil production on an absolute basis, and to surpass Russia and Saudi Arabia in production on a relative basis.
From the Barnett Shale to the Marcellus region in the Appalachians to the famous Bakken of North Dakota and of course the Permian Basin of west Texas, the geographical reach for shale producers has been vastly more than ever anticipated, and has left the United States with a century’s worth of exploration, drilling, and production capacity. Instantly, the national energy need to import expensive natural gas completely inverted, and we now stand ready to become the leading exporter of natural gas in the world.
Domestically, it also became the primary mechanism for electricity generation in the country, overhauling our country’s relationship with coal in less than a decade. This has had tremendous impact within our energy industry (causing coal to be a much less competitive commodity), but also environmentally, with the use of cleaner natural gas over coal leading to a dramatic reduction in carbon emissions. Thoughtful environmentalists have had to appreciate with awe and wonder what natural gas has meant to greenhouse emissions, which have been reduced nearly 15% since the shale revolution began, all the while increasing the underlying energy production many times over.
The obvious geopolitical impact is that the U.S. now sits in a position of leverage over the OPEC cartel, becoming crude oil’s actual marginal producer, and able to buffer against the supply/demand controls of Saudi Arabia. From late 2014 through early 2016 the world saw crude oil markets tumble as Saudi Arabia and other OPEC nations attempted to flood the world with oil supply, only to run into two laws of economics that foiled their plan, and caused them to be the great victim of their own attempt:
- Global demand proved far higher than they could have anticipated, offsetting the alleged “excess supply” they were generating, and
- The United States domestic production cost structure was cut in half, meaning, the U.S. producers became profitable in producing oil, even with oil prices reduced by 30-50%. Technological efficiencies and innovations outpowered supply manipulations.
Today the world awaits the catching up of the infrastructure support needed as a result of the fracking/shale innovation that began twenty years ago. Production capacity has exploded, but the ability to store and transport our new found liquid petroleum treasure has not exploded in tandem. The result is less environmentally friendly modes of transportation (truck and rail), and an inability to fully monetize our capacity (terminals to take away natural gas our not complete, not adequate, and not easy enough to build from a regulatory standpoint). Mexico stands ready to buy, as does much of Europe and Asia. It is a true global economic phenomenon – an entirely brand new market borne from the lab of innovation and entrepreneurial vision.
The next five years will see a build-out of the infrastructure needed to better support the next decade of oil and gas production, feeding our national energy needs, improving environmental quality exponentially, and creating the economic opportunity that billions of global customer prospects represent. As this extraordinary shift in the world’s energy complex continues to change, we will remember the well in the Barnett region of Texas that started it all twenty years ago this summer. Indeed, the whole world will remember.
David L. Bahnsen
Chief Investment Officer, Managing Partner