Roosevelt’s Energy Arbitrage theme, our largest and one of our oldest, has demonstrated its persistence and secular characteristics over time. The theme continues to expand its reach to many parts of the US economy and even beyond. Our initial premise was that the disparity in the price of oil versus natural gas, out of all proportions to these commodities’ energy value, would create opportunity. This remains as true now as it was when we initiated the theme. However, one potential threat to this picture has been the lack of infrastructure to extract, process, and transport these products. We believe the need for such infrastructure represents a growth opportunity, and with this in mind, have now embarked on an important sub-theme within Energy Arbitrage, Midstream Infrastructure. We have invested in this aspect of the theme previously, but our current view suggests that it deserves greater emphasis.
This emerging sub-theme will seek to invest in companies directly involved in the creation and build out of the necessary infrastructure, ranging from the first step after the wells are put into production, the gathering of oil and natural gas, to its processing, division into various energy components, storing, and transporting whether by pipeline, rail, truck or ship. Because of tax reporting complexities, we will avoid direct investment into the Master Limited Partnerships (MLPs) that dominate this space and concentrate on the General Partners and other entities that are also organized to avoid MLP tax issues. General Partnerships profit through their incentive rights in those limited partnerships, often along with their direct ownership of partnership units.
Historically, oil and gas deposits have been discovered in prolific quantities in extremely inhospitable or distant locations from their end markets, such as deserts, jungles, and below 10,000 feet ocean depths. However, the U.S. shale revolution has reversed that tradition, discovering and developing major energy resources in far friendlier settings and closer to end markets. This has caused more social than engineering complexity in building the necessary facilities to get these products to market. The permitting process to build a natural gas pipeline into New York City is infinitely more complex, costly, and time consuming than a similar process in Russia, for example. But we believe the rewards of a ready and nearby market with substantial unmet demand are more attractive.
For example, the Utica formation, mostly located in Ohio, is a good example of one of the newest shale successes, and we think the following statement from the Ohio Department of Natural Resources illustrates the point quite well:
The production growth depends heavily on the development of the midstream infrastructure needed to transfer the resources to market. In a little more than 24 months, a new industry developed, including 11 processing facilities and miles of new pipelines. Companies have spent or have committed more than $6 billion on midstream infrastructure. “Companies are investing billions of dollars and creating jobs for Ohioans, proving the value and importance of the Utica shale play,” said JobsOhio Senior Managing Director David Mustine.
Similarly, North Dakota’s Williston Basin has seen production escalate ten-fold over the past decade to over a million barrels of oil a day. However, the lack of midstream infrastructure has restricted growth and forced substantial flaring of natural gas, a process which burns off (rather than captures) associated gas produced when extracting oil. Flaring is a considerable source of carbon dioxide emissions, and state authorities are now mandating that this process be significantly reduced and eventually stopped:
"The overarching goal of everything is to reduce the number of wells flaring and the volume of gas flared in North Dakota over time," Lynn Helms, the NDIC’s director of natural resources, said. "This is the enforcement mechanism behind gas capture plans."
Overall, per our Energy Arbitrage theme, we believe advances in drilling and producing shale oil and gas deposits continue to reduce the country’s dependence on foreign energy sources. We think these gains are creating a potential industrial renaissance in this country, and both manufacturers and infrastructure participants could be major beneficiaries. The development of midstream infrastructure is a large part of this story, and we believe we are well positioned to capitalize on these industry changes.
Submitted by: Robert L. Meyer, CFA
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.