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The Power of Petroleum

October 13, 2018

Petroleum still powers the world’s economies, and overall demand continues to climb. Over just the last six years, global oil demand per day has jumped by 10.14% according to the International Energy Agency (IEA).

In just the past year, that demand per day has risen by 2.54%. This might seem modest, but note that it has come as many of the globe’s higher-growth economies, including China, have experienced subdued economic expansion.

The bad news is that global oil production continues to fall behind demand. The result is that the glut of oil that briefly sent crude oil prices lower in 2014 has been cleared out. This glut manifested thanks to members of the Organization of Petroleum Exporting Countries (OPEC) who sought to limit the production gains of the US shale and fracking operations by driving down crude prices to make field investment unprofitable.

But what it did instead was to drive US producers to turn to better field management and better production technology to drive production to more profitable levels, even with crude prices under $40.00 a barrel.

As a result, one of the primary oil fields, the Permian Basin, found mostly in Western Texas and extending into New Mexico, has become a powerhouse of oil production. Over just the past three years, production in the Permian Basin has gushed higher by 98.89%, and in just the last year production has soared by 33%.

Meanwhile, OPEC’s contribution to global supply is now slipping down a steep slope, with the past two years seeing monthly supply of crude dropping by 3.87%.

This supply and demand shift is driving crude oil prices higher even as demand continues to outstrip supplies and thus contributes to higher US production. Both the global standard of Brent crude and US West Texas Intermediate (WTI) have been climbing significantly over the past year, with Brent up over the past 12 months by 43.73% and WTI up by 41.41%.

And it may well get worse for the globe’s petrol consumers. Saudi Arabia has been the go-to nation within OPEC for additional crude supply. But according to the EIA, the largest field in Saudi Arabia, the Ghawar Field, is capped at production of 5.8 million barrels per day (MBPD). And there have been estimates that the field is post-peak production, with a rate of decline in available daily supply of 8% per year.

But at the same time, the EIA is estimating that, just given known production capabilities in the Permian Basin, the region’s daily production of 3.67 MBPD should advance beyond 4 MBPD in just four years or less.

More interesting is that the EIA also calculates that if the Permian alone were a member of OPEC, it would be the fourth-largest producer in the cartel.

And the Permian is just one of the major success stories in the US petrol patches, with additional fields in operation and expanding in Oklahoma, South Dakota, California and, of course, Alaska, in addition to off-shore platforms.

Production Vs. Takeaway

One of the limitations in the Permian as well as other US production locations is the ability to take the crude and natural gas away to refiners and shippers. This is why the US WTI prices continue to trade at a discount to Brent.

In the Permian specifically, pipeline capacity is limited to 3.1 MBPD, according to Bloomberg Analytics. That leaves a lot in storage and limits productivity. But this is being addressed with eased pipeline expansion approvals. The capacity to take away Permian crude is on track to increase by 2.1 MBPD by the end of 2019 thanks to pipeline projects underway by Andeavor (ANDV). This Incredible Dividend Machine holding will soon be part of Marathon Petroleum (MPC), and the pipeline is likely to be dropped down to Andeavor Logistics (ANDX), found in the Niche Investments.

Further, additional projects are in the process of receiving approval, which would enhance takeaway capacity by another 2.2 MBPD by 2020–2021.

How This Plays Out

The oil and gas markets are firmly on the ascent. And as the US is the central economic growth story here, any global economic advancement or recovery should only further demand, which in turn should support higher prices.

This means that one of the bigger growth and income plays for our model portfolios should continue to be in US petroleum.

Let’s start with Viper Energy (VNOM), which was detailed in the August issue. This Permian Basin company owns vast acreages of oil and gas-producing properties that it leases out to producers and for which it receives royalty payments. Little capital is required for this cash machine. Make this your highest priority buy in this space.

Next is our broad play on the petrol market, the Energy Select Sector SPDR ETF (XLE). This ETF provides exposure to up- and downstream petroleum companies and midstream pipelines, including many of our holdings.

Providing the technological support for Permian and other fields continues to be the mission and objective of global field services leader Schlumberger (SLB). This company suffered during the crude oil slump noted above a few years ago, but with the petrol market now on the climb, it represents a value under $70.00.

Then we have the pipelines, the Toll-Takers of the Total Return Portfolio. They offer the needed pipes for oil and gas throughout the US and North America including the marine terminals for crude shipments and exports.

They include Buckeye Partners (BPL), Enterprise Products Partners (EPD) and Plains GP Holdings (PAGP). These should all be bought in taxable accounts to gain the tax-shielded advantages of passthrough securities.

Then buy Kinder Morgan Inc. (KMI) and Pembina Pipeline (PBA). These can be bought in tax-free accounts. Pembina’s Canadian revenues may be subject to tax reporting, but for now they are exempt from withholding for US tax-free accounts.

Last up is Dominion Energy (D) in the Incredible Dividend Machine. This utility has been ramping up its pipelines for US natural gas and is set to become one of the leaders for liquefied natural gas for export.