The announcement that Mexico will open up its oil market to private companies is expected to flood a North American market that's already producing oil at a level that is choking the available refining capacity. With Congress wielding tight control over crude exports, industry analysts expect oil prices could fall as much as 20% by 2017. At the same time, natural gas demand is only expected to increase as several large LNG export terminals go online starting in 2015. The increased demand for natural gas, both domestically and for export, will likely push NG prices higher.
For companies like ExxonMobil (XOM -0.09%) and Royal Dutch Shell (RDS.A) that are engaged in oil and gas production, access to Mexican oil fields and higher natural gas prices are both positives. But for companies like Power Solutions International (PSIX -2.71%), Westport Innovations (WPRT -0.61%) and Clean Energy Fuels (CLNE -2.18%), which depend on natural gas prices remaining cheap relative to diesel, this sounds like terrible news. What should investors do? Let's take a closer look.
Just how big is this?
Source: Wikipedia
Estimates put Mexico's current oil production at 2.5 million barrels per day (mmbd), and this number could double within a few years, based on estimates. The EIA is projecting domestic production of 9.5 mmbd by 2019, a sharp increase from current production of 6.5 million barrels. Added together, today's combined production (not even including Canada) of 8.5 million barrels could increase as much as 50% by 2019, to 14.5 mmbd, even as the demand for crude oil continues to decline.
Put a different way, the expected growth in production in Mexico and the U.S. alone over the next few years is equal to nearly all of North America's 5.6 mmbd of oil imported in 2012. This doesn't even factor in Canada's substantial (and growing) output.
Pressure on the spread?
On the surface, this looks like it will put tremendous pressure on Clean Energy Fuels, Power Solutions, and Westport -- all of which are reliant to a large extent on cheap natural gas in relation to the price of diesel. However, it's not that simple: While the commodity cost of diesel is heavily tied to the price of crude oil, natural gas (both CNG and LNG) prices for transportation are more a factor of the cost to transport, store, and either pressurize or liquefy the commodity.
Think about it this way: Each 42-gallon barrel of oil produces about 10 gallons of diesel and a lot of other things at the same time, so it's not simple to determine how much the cost of oil moving up or down will affect diesel costs. Over the past five years, oil has gone up more than 160%, while diesel has gone up about 70%.
Natural gas, however, is a little simpler as it requires no refining and is used directly for one thing or another. Each "mcf" of natural gas makes about 7 diesel gallon-equivalents, so at today's spot-price of ~$4.21/mcf, we know that the commodity cost is around 60 cents per gallon-equivalent for natural gas.
If natural gas prices were to double overnight to $8/mcf, the commodity itself would cost $1.20 per gallon. Earlier this year, Clean Energy Fuels' Andrew Littlefair said that it costs the company "about a buck, a buck-ten" per gallon-equivalent to get LNG to the pump. Simply put, natural gas prices could explode, and natural gas would still be less than diesel, with room for for Clean Energy Fuels to make a tidy profit.
Engine makers and a larger opportunity
For Westport, the opportunity is much larger than just the domestic scene. While the company's JV with Cummins is primed for a massive 2014, based on the early success of the ISX12 G engine for heavy-duty trucking, the company's just-announced HDPI 2.0 (and the seven OEM applications that are in the works) could lead to massive growth in the next year and beyond. Add in the company's JV in China, which is rapidly expanding its use of natural gas for transportation, and the North American market won't be the only source of growth for Westport.
Clean Energy Fuels isn't missing out on the Chinese opportunity either. Subsidiary IMW announced a significant deal earlier this year to supply equipment for as many as 310 stations for China Gas. This deal alone is worth as much as $175 million over three years, nearly half of Clean Energy's total sales this year.
Oil rig flaring off natural gas.Source: Wikipedia
For Power Solutions International, its success so far has been largely a product of remaining focused on niche markets like forklifts and generators, and recently one area really stands out. Power Solutions CEO Gary Winemaster, from the Q3 earnings release:
We continue to benefit from strong momentum in oil and gas applications, where our heavy-duty power systems can use wellhead gas. This results in a rapid payback for the customer, using a cleaner-burning fuel. Sales of these systems almost doubled in the third quarter from last year. We are in the early stages of an exciting new market opportunity.
Wellhead gas is typically flared off, so this is essentially free fuel. The massive expansion of oil production in Mexico (and all of N. America) should lead to continued demand for Power Solutions' generators, even if natural gas prices rise and oil prices fall.
Final thoughts: Growing international demand offers massive upside
The IEA estimates that North America will import 2 mmbd from Africa and the Middle East, and 1.3 million from South America in 2018, a 39% decline from 2012 levels. These estimates were from before the opening up of Mexico, meaning that another 3+ million imported barrels per day could be replaced with Mexican or American oil.
With continued growing demand for oil in much of Asia and a large import market in Europe, there's little reason to anticipate expanded oil production causing any serious harm to Clean Energy, Power Solutions International, or Westport. To the contrary, global demand for natural gas, and engines that can burn this cleaner alternative to diesel, is only set to grow.
