United States

Energy trends to watch in 2018

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Absent major geopolitical shocks, oil and gas prices are expected to remain range-bound in 2018. Increased U.S. oil production is hampering OPEC’s efforts to eliminate the supply glut and restraining the upward price trajectory of late 2017. Technological innovations and operational efficiencies in the United States have helped to stabilize margins at lower prices, but these gains are expected to plateau in the future. Cash flow will continue to be a primary focus, but investment will shift toward opportunities in other basins.

The shift toward lower-carbon generation will continue to lead to myriad investment opportunities in the United States and abroad, regardless of the policies of the Trump administration. Amid stagnant electricity demand and rising costs, power and utility companies will seek opportunities to bundle services and increase margins.  

Following are highlights of some trends to watch in 2018 and beyond: 

Technology

Oil and gas
Technological innovation fueled the U.S. shale revolution and enabled the United States to remain resilient in the subsequent lower-price environment. Innovations in drilling technology have resulted in considerable improvements to initial production rates and estimated ultimate recoveries. Although optimization opportunities regarding spacing and laterals remain, the gains attributable to innovations in technology may be hitting a plateau. The days of double-digit increases in recovery are likely ending, and the widespread use of advanced drilling and completion technologies levels the playing field. Nonetheless, the United States will continue its march to be the largest oil and gas producer in the world.

Power and utility
Technological innovations for renewable sources such as solar and wind have reduced their levelized cost of electricity (LCOE), making renewable energy much more competitive than it once was. In fact, since 2010, costs of new solar photovoltaics have declined by 70 percent, wind by 25 percent and battery costs by 40 percent.1

Looking ahead, technology that enables more efficient energy storage and management will benefit both utilities and consumers. As the smart grid transition continues, these innovations will reduce operating and consumption costs. Unfortunately, much of the existing infrastructure in the United States is quite dated, and will need to be upgraded or replaced to accommodate newer technologies. This will require considerable political and industrial will, accompanied by capital investment from companies and governments.

Pricing and margins

Oil and gas
As discussed above, wells are being drilled and operated more efficiently than they once were, resulting in lower breakevens and improved profitability. But the industry has continued to experience a range-bound, lower-price environment. This is unlikely to change in the near future, as evidenced by the backwardation of oil futures contracts as of late 2017. The United States is now considered by many to be the swing producer and its ability to ramp up production creates a check on advancing prices.

In late November, OPEC agreed to extend production cuts through 2018. These production cuts, which have been in place for over a year, finally appear to be working. But even if a relatively high compliance rate is sustained, many are doubtful that global inventories will diminish substantially until 2019. Still, it is expected that the extended production cuts will provide continued price stability well over $50 per barrel, absent any major geopolitical shocks.

Continued price stability, in turn, is expected to push U.S. crude production to a record-breaking 10 million-barrels-per-day mark in 2018. The United States is already the world’s largest producer of natural gas and oil products, and it will soon become the world’s largest producer of crude oil.2 Looking at 2018 and beyond, U.S. oil and gas exports will continue to grow―especially if the spread between the Brent and West Texas Intermediate crude oil price remains anywhere near as high as it has been throughout the fourth quarter of 2017. The United States is now a net exporter of natural gas and its liquefied natural gas export capacity is rapidly expanding.

Power and utility
For regulated utilities, price increases are subject to rate case approvals by state utilities commissions. This often means benchmarking discount rates against rates of return of other public companies with similar assets. However, arguments for asset or location-specific risk premiums are being made by utilities with rate bases that may be subject to greater risk, for example in certain rural areas.

Efficiencies gained through technological improvements and energy conservation ultimately contribute to declines in energy demand. Despite population increases, energy usage is decreasing, and rising costs will drive utilities towards higher-margin opportunities. Consequently, these companies will seek to bundle energy management, security, and other home- and utility-related services for the consumer.

Learn more about pricing and margins in this brief video interview with Steve Sprenger, principal and energy valuation leader at RSM US LLP.


Regulatory environment

In June 2017, the Trump administration announced the United States’ withdrawal from the Paris Climate Accord, in part because it claimed that the Paris pact unfairly restricted coal production by the United States while allowing other countries to increase coal production. In October 2017, EPA Administrator Scott Pruitt issued a proposal to repeal the U.S. Clean Power Plan, which would have made it difficult to open a new coal plant in the United States.3 Despite this, many coal plants are shutting down and will continue to do so, and few are being proposed to replace them.

Regardless of the Trump administration’s position, state renewable portfolio standards, a global movement away from carbon and declining LCOEs for renewables will continue to drive investment in the alternative energy sector. Early last year, natural gas supplanted coal as the predominant fuel for U.S. electricity generation for the first time. There are a number of reasons for this change: Natural gas and renewable energy costs make it difficult for coal to compete. Furthermore, there are 29 states with portfolio standards that require an increasingly higher percentage of total electricity generated within the state to be through renewable resources.4

On the same day of the administration’s announcement, three major coal plants—two in New Jersey and one in Massachusetts—announced they were shutting down.5 While it is not clear if regulations played a part in the decision to close these plants, competition from natural gas and renewable energy resources made them economically impracticable. As the number of developed countries staying with the Paris Accord will attest, global markets continue to push for clean-burning energy.

Learn more about the regulatory environment in this brief video interview with Steve Sprenger, principal and energy valuation leader at RSM US LLP.


Financing

Private equity investment in oil and gas companies has increased substantially in recent years. Struggling upstream and oilfield services companies, as well as some midstream companies, required infusions to continue operations and restructure debt. But with the influx of capital comes more input from, if not control by, investors as well as added pressure for near-term cash flow and returns. This focus is not unique to private equity-backed companies; most exploration and production (E&P) companies are in a similar position. This could mean, however, that short-term profits come at some expense of longer-term innovation and resource discovery.

Equity raising by U.S. E&P companies slowed in 2017 and, under a range-bound environment, this is expected to continue. More opportunities for debt issuances are expected, however, as these firms continue to stabilize their profitability and balance sheets.

After a tremendous amount of investment in the Permian Basin in recent years, its attractiveness appears to be waning, as many are experiencing what has been coined “Permian fatigue.” Inflated valuation multiples for Permian assets have pushed many of the smaller players out and companies have started the time-consuming process of drilling in more difficult rocks.6

There is still considerable interest in the opportunities found in the Woodford SCOOP, or South Central Oklahoma Oil Province, liquids-rich play. Similarly, the STACK, or Sooner Trend Anadarko Basin Canadian and Kingfisher Counties play (also, as both names suggest, in Oklahoma) is providing lower breakeven-point opportunities. Look for investment in these plays and related midstream infrastructure to increase in the coming year.

1International Energy Association. https://www.iea.org.
2Global Energy Statistical Yearbook 2017. https://yearbook.enerdata.net.
3“What is the Clean Power Plan, and how can Trump repeal it?” (Oct. 10, 2017) The New York Times.
4J. Durkey, “State renewable portfolio standards and goals” (Aug. 1, 2017) National Conference of State Legislators.
5B. Demick, “As Trump touts coal while ditching the Paris accord, three more coal-fired plants shut” (June 1, 2017) The Los Angeles Times.
6E. Crooks, J.S. Kao, “In Charts: Has the US Shale Drilling Revolution Peaked?” (Oct. 18, 2017) Oil and Gas Investor.


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