September 24, 2019
The recent drone attacks on Saudi Arabia’s oil fields caught the world’s energy market off guard in that these 18 drones and 7 cruise missiles took half of Saudi Arabia’s production capacity – and 5% of the world’s daily oil production offline – with relative ease. Flying under the radar to release widespread damage clearly revealed how alarmingly vulnerable global oil production is to smart weapon technology.
The well-coordinated attacks hit 19 targets in pin-point fashion with separation towers as the primary hits. Whoever programmed the GPS coordinates on the bomb-laden drones and missiles did so with high-level precision. Saudi Arabia on Friday revealed extensive damage from the strikes on their state giant Aramco’s facilities in Khurais and the world’s largest oil processing facility at Abqaiq. As of this writing, the evidence points to Iran, which led to a further tightening of sanctions.
According to BBC, oil prices spiked by nearly 15%, the biggest daily jump in 30 years. The price of WTI crude shot up from $55 to $62.80 per barrel in reaction to the attack. But when compared to other oil shocks, the move came from modest levels and thus didn’t have the economic impact if this attack would have happened in late 2014 when crude was trading above $93. However, another series of major attacks on oil producing assets could wreak havoc in global energy markets and push the global economy into recession.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
This latest attack once again illustrates the fragile nature of geopolitical stability in the Middle East, even with all the hundreds of billions of dollars of firepower the U.S. has sold and installed in Saudi Arabia. WTI crude settled back and closed at $58 last Friday after the Saudis stated they would be back at full production by the end of September, but I suspect rising tensions with Iran will keep oil prices elevated.
With Saudi Arabia now looking to take Aramco public, the secrecy surrounding its production and reserves has been made public – claiming about 3.8 million barrels per day (BPD) of production. By comparison, the Permian Basin located in western Texas is producing over 4.2 billion bpd, making it the world’s most productive single oil field. The Permian Basin covers more than 86,000 square miles.
As of 2018, and according Dallas new.com the Permian Basin production accounts for 30% of U.S. crude oil production and 7% of U.S. dry natural gas production. While production was thought to have peaked in the early 1970s, new oil extraction technologies, such as hydraulic fracturing and horizontal drilling, have increased production dramatically. It is forecasted that production from the Permian will exceed 8 million bpd by 2024.
The U.S. Geological Survey estimates that over 46 billion barrels of oil, 280 trillion cubic feet of gas, and 20 billion barrels of natural gas liquids are trapped in these low-permeability shale formations. These are the totals for both proven and unproven reserves, but what is interesting is that the deeper drillers dig, the greater the proven reserve data grows. The world consumes approximately 100 million barrels of oil and 0.36 trillion cubic feet of natural gas per day, so this represents potential centuries of supply.
Time to Revisit Energy Infrastructure Stocks
Source: Energy Infrastructure Administration (EIA)
According to CNBC, production in the Permian Basin is booming. Both ExxonMobil and Chevron will each be producing one million barrels per day by 2023. And while there is no shortage of oil and gas, there is a shortage of pipeline capacity to carry that oil and gas from the field to the refineries and export terminals.
(Navellier & Associates owns CHV in some managed but does not own XOM. Bryan Perry does not own XOM or CHV in personal accounts.)
To remedy the transport situation, three new major pipelines are just beginning to deliver product that will support the transfer of more than two million barrels per day. They include the 900,000 bpd EPIC pipeline, the 670,000 bpd Cactus II pipeline, and the 800,000 bpd Grey Oak pipeline.
The obvious winners in the acceleration of the pipeline buildout in the Permian are many of the midstream companies structured as Master Limited Partnerships or MLPs that issue widely unpopular K-1 tax statements that can make for some accounting headaches and higher tax preparation expenses. However, some energy infrastructure ETFs exist that convert all the K-1 related income, depreciation, and depletion allowances into 1099 income that is reported as common dividends.
ETFs that replace K-1 income with a nice neat 1099 are the way to go for income investors seeking to get in on the U.S. energy boom. A few of the most widely traded are the Alerian MLP ETF (AMLP) with a 8.17% yield, Global X MLP ETF (MLPA) that pays 8.43%, and Kayne Anderson MLP/Midstream Investment (KYN) that sports a yield of 9.66%. In fact, there are roughly 35 ETFs and closed-end funds (CEFs) that offer hefty yields and take care of converting K-1 distributions into 1099 qualified dividends.
Leave no doubt: The energy infrastructure sector has sorely lagged the S&P 500 and other income producing sectors like utilities and REITs for the past five years. And yet the fundamentals of the domestic oil market have improved to where most of the leading energy infrastructure companies are seeing their distribution coverage climb to levels approaching 2x of payouts.
At some point, these fat yields and improving balance sheets in my opinion make for a much more attractive investment theme, one that might be developing sooner rather than later.