It's 2014 and we are in the midst of the shale oil revolution. Thanks to a host of new drilling technology, drillers are now able to access oil from the source rock, where as in the past drillers were restricted to drilling in oil-rich basins only.
However, an increasing number of credible voices are beginning to see how growth in shale oil production will slow or perhaps even stop, and the reason is not technical but political. Most shale oil produced in the U.S. is light and sweet. Production of light, sweet crude has grown so much that the U.S. will, within two or three years, satisfy its own domestic demand for light sweet crude from existing production.
Yet, if the last few years are any indication, it's doubtful that production of light, sweet crude would peak on its own at such an early date. Unfortunately there is a congressional ban on crude oil exports, and that ban is, for various reasons, not likely to be lifted. While refined crude products, such as gasoline, may be exported, refineries would have to greatly increase capacity in order to process and export all future light, sweet crude produced in the U.S.
Therefore, the majority of shale oil produced will have to be consumed within the U.S. And to make matters worse for producers, U.S. demand for oil is flat to declining. All this points to two possibilities for the future, neither of them great for producers: Decelerating production growth (a likely scenario if no other big shale plays are developed) or a glut in light, sweet crude (likely to happen if the newer shale plays end up as good as the Bakken or Eagle Ford).
Look ahead to dry gas
While oil will likely provide higher returns than will gas for the next three years, dry gas has a brighter future, at least domestically. Because shale gas is relatively cheap and abundant, demand for dry gas has steadily grown over the years and shows no sign of stopping.
The above chart shows just how much consumption growth we will see in the next few years: Demand from power generation will more than triple. Exports to Mexico will increase by 50%. LNG exports will double despite infrastructure constraints. Industrial petrochemical demand will grow by almost 50%.
Unlike the situation with oil, the best returns may not be with the upstream players. After all, gas is much more abundant than oil is. The biggest challenge, and hence the greatest returns, will likely come from transporting that gas, which often comes from new supply sources with little transportation infrastructure in place, to where it needs to be.
In other words, the greatest returns will likely be in midstream gas names. The most obvious choice is Kinder Morgan Energy Partners (NYSE: KMP ) and its general partner, Kinder Morgan Inc (NYSE: KMI ) . Kinder Morgan is easily the largest mover of dry gas in the country, and nearly half of all revenue in the colossal midstream business comes from dry gas.
Richard Kinder, the visionary CEO of Kinder Morgan, saw the inevitable rise of natural gas about a decade ago and has been acting accordingly, hence the business' huge exposure to natural gas. Between now and 2017, Kinder Morgan will spend $4.1 billion in natural gas growth prospects. These projects include LNG export facility expansion, midstream infrastructure in the Eagle Ford, and work on a pipeline that will deliver Marcellus shale gas to the Gulf Coast refinery complex. Few other midstream business are spending as much on natural gas as Kinder Morgan is.
Natural gas consumption will increase for the long term. Oil consumption in the U.S., on the other hand, is already stagnant. While oil fetches higher returns today than does gas, the long-term future may favor natural gas. Kinder Morgan is a fine way to profit from this long-term trend.
The best investments in the shale revolution
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