Yesterday the folks at RBC Capital Markets issued an excellent research piece titled “Cross-Sector Implications of North America Energy Supply Chain Evolution.” It is a look at the shale revolution from the perspective of a supply chain – the linkages between interconnected businesses involved in the development, extraction and production of liquid and gas hydrocarbon energy. The 31 page report makes some great points about the fundamentals of today’s hydrocarbon markets and recommends stocks that are expected to benefit from these developments. I thought it would be useful to summarize the high points of their investment thesis here. You’ll need to contact RBC if you want to see the report and its investment strategies.
RBC segments the energy supply chain into five sectors: (1) equipment manufacturers (hardware need to develop, produce and transport hydrocarbons), (2) getting equipment materials to the lease needed for drilling (rail and barge companies), (3) oilfield services at the lease (drilling, pressure pumping, fluid tank systems), (4) development of resources (E&P companies), (5) processing and transportation of the products (gas processing, truck, rail, barge, pipelines – mostly MLPs).
RBC looks at the investment opportunities in these sectors in three stages.
Near term. In the near term, the biggest beneficiary is the transportation sector. On the front end of the chain, there has been a “material uptick” in demand for transportation and logistics services to handle the movement of raw materials into drilling sites for development and extraction. This includes water (clean & dirty), frac sand, pipe, frac pumps, drill cuttings, etc. On the back end, it means truck, rail and pipeline facilities to get the product to market. One of the biggest beneficiaries is rail, showing a 25% increase in petroleum-based carloads in just the past 12 month period. A great example is a recent CP announcement that it will provide rail service from the US Development terminal in Van Hook, ND to St. James, LA with capacity to handle 30 unit trains per month --104 cars each, 650 bbls per car – or about 70,000 b/d. Growth in the demand for railcars and tank trailers is off the scale. Tank trailers that were running $60-80k last year are going for $150k today.
Intermediate term. RBC sees Midstream as the big winner in the intermediate term. A 9% rig count growth rate (crude and wet gas) in 2012 is projected, with a continued shift toward horizontal drilling. The resulting production growth drives the need for significant infrastructure projects in the crude, natural gas and NGL sectors across all transportation “modalities”. Translated, that means more trucks, railcars, barges and pipelines. RBC particularly likes pipeline MLPs needed to transport all these hydrocarbons to market. In addition, it also means more gas processing plants. Finally is also good news for petchems at the end of the supply chain, who will see cheap feedstock costs for years to come.
Long Term. The long term trend looks positive for all sectors along the supply chain. In the past three years the E&P sector has proved it can move very quickly – tripling the oil rig count to nearly 1,300 today. With oil prices expected to remain high, there is every reason to believe that high rates of growth will continue, resulting in substantial supply chain opportunities. In the service sector side, the shift to horizontal drilling creates a higher “service intensity model” for oil services and equipment companies. It takes a lot of equipment, materials and people to deploy all of these drilling and fracing technologies.
There is an interesting wrinkle to pipeline transportation. As always, transportation by pipe is the cheapest way to move product to market. For example, getting Bakken crude to the gulf is about $5/bbl via pipe versus $10-11 via rail. But the industry can’t build new pipelines nearly fast enough to keep up with the pace of drilling/development. Also, in some areas pipelines are simply not economically viable due to distances, terrain and resource development patterns. For these reasons, rail, truck and barge facilities (and the terminals necessary to handle loading/unloading) are becoming increasingly important in the energy transportation mix, not only as “stopgap” and staging investments but as permanent components of the energy transportation infrastructure.
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