MLPs Minting Gains Amid Shale Revival
The US energy industry has undergone a monumental shift over the past decade. Ten years ago production of natural gas and oil alike was thought to be in terminal decline in the US, and for good reason. It had been declining for decades, for both commodities.
After reaching a level of 11.3 million barrels per day (bpd) in 1970, US oil production fell to 9.7 million bpd by 1976. The opening of the Trans-Alaska Pipeline System in 1977 enabled production to once again reach 10.6 million bpd by 1985, but shortly after oil production in Alaska peaked and US oil production resumed its decline over the following 23 years. By 2008, US oil production had fallen to 6.8 million bpd, a level last seen in the 1940s.
The decline in US natural gas production wasn’t as dramatic, but following an all-time high in 1973, gas production would decline about 25% by the mid 1980s. Natural gas production would then rise and fall over the next two decades, but by 2010 had never again reached the 1973 high. That was about to change.
Hydraulic fracturing, or “fracking,” a technology developed in the late 1940s, has boosted output from oil and gas wells across traditional production regions like Texas and Oklahoma. By now, fracking has been used to stimulate oil and gas production in more than 1 million wells in the US.
Fracking involves pumping water, chemicals and a proppant (usually sand) into an oil or gas well under high pressure to break open channels (fractures) in the reservoir rock trapping the deposit. Oil and gas do not travel freely in some deposits, but certain formations respond well to being fractured. The proppant is designed to hold the fractures open, allowing the oil (or natural gas) to flow to the well bore.
But if fracking has been around for 60 years, why has the so-called fracking revolution only taken off in the past decade? Primarily because of a fairly recent development of combining fracking with another common technique used in the oil and gas industry — horizontal drilling.
Like fracking, horizontal drilling was invented decades ago, and has been widely used in the oil and gas industry since the 1980s. As its name implies, horizontal drilling involves drilling down to an oil or gas deposit and then turning the drill horizontal to the formation to access a greater fraction of the deposit. These horizontal laterals can be up to 10,000 feet in length, and therefore cover a much greater area below ground than a conventional vertical well. These techniques have been especially effective in unlocking previously uneconomical oil and gas deposits in the many shale formations across the US. (Thus, the boom is also frequently called the “shale boom.”)
While there are potential environmental implications associated with fracking, those are beyond the scope of this article. The purpose here is to examine the ways that the fracking revolution has changed the US energy picture. After hitting a low point of 6.8 million barrels per day in 2008, oil production would reverse course and increase at the fastest pace in US history:
The natural gas industry started experimenting with horizontal drilling and fracking in gas fields a bit earlier than the oil industry, and subsequently saw gas production turn upward in 2005. And although oil production hasn’t yet eclipsed the peak set in the 1970s, in 2011 US natural gas production reached new all-time highs.
The fracking revolution has created enormous opportunities for Master Limited Partnerships (MLPs) across the oil and gas industry. Upstream MLPs like BreitBurn Energy Partners (NASDAQ: BBEP) and Legacy Reserves (NASDAQ: LGCY) produced the oil and gas. There was a huge new requirement for sand in the fracking operations, and this encouraged new MLPs like Emerge Energy Services (NYSE: EMES) and Hi-Crush Partners (NYSE:HCLP) — both of which have more than doubled in price over the past 12 months. Fracking also requires large volumes of water, which Cypress Energy Partners (NYSE: CELP) provides.
But much of this newfound oil and gas production is taking place in regions that haven’t been traditional producers of oil and gas. This has created strong demand for midstream providers to build the gathering systems, pipelines and storage tanks required to move oil and gas from fields in North Dakota and Pennsylvania to customers on the Gulf Coast and in the Northeast. This profited such midstream MLP giants as Kinder Morgan Energy Partners (NYSE: KMP), Enterprise Products Partners (NYSE: EPD), and Plains All American Pipeline (NYSE: PAA).
But the fracking boom will inevitably begin to slow. How soon could US oil and gas production once more begin to decline? How will the various MLPs fare then?
The shale boom still has plenty of life left. Not all shale plays will decline at the same time, and there are still many drilling locations to be developed. There will be future winners, even in a declining production scenario. They will be determined in part based on the various MLPs’ focus, as well as geography. New opportunities will emerge, such as the upcoming surge of liquefied natural gas (LNG) exports. Join us at MLP Profits as we uncover more winners from the fracking boom.