Why energy exploration in North America has its own political risks
Leading non-integrated oil and gas producer Apache Corporation found itself in the spotlight in recent weeks, as the latest company to grapple with the question of how big a commitment to make to North America’s shale gas and tight oil revolution. Jana Partners LLC, a leading investor in Apache, published a letter to investors July 21 urging the company to exit its international investments and focus on exploring US shale formations such as the Permian Basin in Texas and New Mexico. Just last Friday, Apache announced plans reflecting this advice, as they intend to divest completely from two liquefied natural gas (LNG) projects in Western Australia and Canada in an effort to reduce international assets.
Jana’s letter highlights a recent trend — driven by the technological innovations that have reversed decades-long declines in U.S. oil and gas production — in which traditionally globally-oriented oil and gas producers are “onshoring” back to their roots in North America.
Investors should be cautious of this trend, which trades one form of political risk for another. Instead of fears of sanctions, armed conflicts, or forced nationalization of the oil and gas industry, oil and gas producers may face opposition from local communities and others on environmental grounds. They’ll also have to contend with a growing risk of saturated domestic markets for light oil and natural gas, and the need to receive politically-sensitive regulatory approval in order to export overseas. While North America is safer for workers, and companies can launch public policy campaigns to address these challenges, investors should not underestimate the complexity of doing business in the region.
Since 2009, top oil and gas producers like Hess, Devon Energy, EnCana, ConocoPhillips, Husky Energy, Occidental and EOG Resources have increased the proportion of their exploration and production budget that they devote to North American interests. While EOG Resources and Hess devoted less than half their exploration and production budget to the region in 2009, in 2013 they devoted 94 percent and 62 percent, respectively. Following a similar strategy, Pioneer Natural Resources sold off its last international operation in 2012.
As the Jana letter suggests, one apparent benefit of this North America-centric approach is the ability to shift away from the challenges — political and otherwise — of working in energy-rich developing markets. Anyone looking at headlines from the Middle East or Russia can see the potential appeal of such an approach.
Yet while they may no longer be spooked by political turmoil in Egypt — as they have been since the 2011 revolution — investors in Apache and other companies might be wary of new restrictions on flaring in North Dakota’s massive Bakken oil fields, or of growing restrictions on the companies’ ability to transport crude oil by rail. In addition, the flip side of surging domestic oil and gas production is the need to develop offshore markets — since domestic supply has been outpacing demand. But energy companies are struggling to get Commerce Department approval to export domestic crude oil, which has been restricted under a longstanding ban put in place in the 1970s.
Stockpiles of crude oil along the Gulf Coast have reached record levels this year. Companies are struggling to export liquefied natural gas because of the Department of Energy’s lengthy approval process for export terminals.
The uncertainty of being able to export crude oil and liquefied natural gas means that energy companies that already focus on North America are taking on more commodity price risk. Restrictions on exports are creating a market access bottleneck that keeps West Texas Intermediate (WTI) and Henry Hub natural gas prices artificially low compared to oil and gas prices abroad.
Investors should also be wary of the complicated restructurings that will be necessary to pursue a North America-only strategy. In order to free up cash flow for North American exploration activities, companies will have to put a price tag on international assets that are difficult to value — such as properties with probable, but not proven oil reserves — and then find buyers for those assets.
Lastly, the onshoring phenomenon will motivate oil- and gas-producing developing countries to improve their investment climate by offering better terms. As companies like Apache Energy exit emerging markets overseas, they will increase the trend toward “reverse resource nationalism”: when governments in these countries offer increasingly favorable terms to retain the companies’ investment. Mexico’s current sweeping energy reform is a great example of this practice. International companies, which previously could not compete with Mexico’s state oil company, can now compete for access to the country’s oil and gas resources.
Despite the popularity of onshoring among energy companies and their investors, the strategy should be viewed with caution. A tradeoff of political risks, increased commodity price risks, and complicated restructurings — when coupled with the “ripple effect” of governments of developing markets offering better terms for investment — could reduce future payoff for companies and investors flocking to the North American shale formations.
PHOTO: A pumpjack brings oil to the surface in the Monterey Shale, California, April 29, 2013. REUTERS/Lucy Nicholson