Investing in “Future Resources” like Unconventional Gas
In planning the Vontobel Fund – Future Resources, Sreejith Banerji, Fund Manager, recalls sitting down five years ago with a blank sheet of paper. Today, the Future Resources fund from Swiss Asset Manager Vontobel includes interests in unconventional oil and gas as well as agriculture and other related industries.
Petrochemicals, he explains, is one area included in the Fund.
“The industry can use natural gas liquids, compounds like methane ethane and propane, which are produced alongside natural gas in many shale reservoirs, and there’s been such a good supply of these materials that it’s been a real godsend for petrochemical companies in the US who can make materials like polyethylene, for example,” he says. “So the profit margins for these companies have skyrocketed because their costs have come down a lot - they work in a global market where they are competing against firms in Europe and Asia who are using crude oil-based raw materials whose prices have stayed high."
Mr. Banerji says players in the US with lower material costs enjoy a margin - companies like LyondellBasell - over their peers in other places where natural gas prices are much higher.
He adds that nitrogen-based fertilizers also typically use natural gas as a raw material.
“Again, US-based producers of these fertilizers have also benefited from having a very low cost structure, so you have to look everywhere basically where unconventional energy can have an impact: aside from producers you can look at companies providing the technology, services and equipment, but also the companies that are on the receiving end as well,” he says.
This focus on such ancillary businesses, according to Mr. Banerji, is because the shale gas revolution in North America has been a mixed blessing for a lot of gas producers, “because people have produced so much that you’ve seen natural gas prices fall to low levels in the US. Quite often buying into producers has not been a successful strategy.”
Because of this, Vontobel, he says, tries to look at the entire value chain, to see where/who could benefit from all the cheap gas.
He explains, “The results so far have allowed us to generate better returns than traditional resource funds. The fund has currently a 5 stars ranking with Morningstar in the category natural resources. And we’ll continue to be on the lookout for new opportunities, like in China where there’s a strong demand for gas, but they haven’t so much of it; they have a lot of coal, so there are a lot of projects happening to turn coal into gas, either to be used as gas or to convert further into other materials, chemicals. However we will have to look into the environmental impact of these projects before considering an investment."
He adds that Vontobel is continuously looking for companies to include in the Fund that could be positioned very strongly for the next decade, trying to stay ahead of the curve in terms of the resource technology side of things as exemplified by the shale gas revolution in North America.
Of course, many critics of the unconventional industry have contended that the entire shale gas revolution is just another bubble; Mr. Banerji offers his perspective:
“Certainly, especially on the shale oil side, there’s been some concerns that it’s not going to be particularly long lasting,” he explains. “Even bodies like the International Energy Agency (IEA) and the US Department of Energy have forecasts showing that there will be probably be a bit of a peak around 2020 or so and then a slight decline in production.
“You look at companies' operating results and what’s been happening and you see more efficiency, a firming up of reserve estimates from the application of new technologies. There’s the old adage, 'if you give an engineer time and money he’ll find a solution,' so it seems a lot of that could be done to prove up reserves for future production,” he says.
“There was a lot of skepticism with shale gas, but we’re in a situation where it is a massive contributor to overall US gas supplies, so I think those fears are misplaced.”
Of the biggest risks for investors, Mr. Banerji comments: “The risks are quite similar to those for traditional resources, things like the commodity price itself.”
Incidents like the deepwater spillage in the Gulf of Mexico a few years ago could be a similar risk, according to him.
“We take special efforts to invest in companies with good processes, a good safety track record, companies which employ all kinds of failsafe procedures to mitigate against the kind of risk that materialized three years ago with Macondo,” he explains.
The competitiveness argument, that other countries/economic areas could lose out if their unconventional hydrocarbons are not extracted, has been receiving a lot of mileage this year. Mr. Banerji offers his assessment of how much that argument will be a driver for other regions to adopt the North American unconventional oil and gas blueprint.
For one, he notes that in the UK Prime Minister David Cameron’s government is quite conscious of the phenomenon.
“Shale gas is having an effect in different kinds of areas, having an effect on the steel industry, for example. There’s a company in America called Nucor Corporation, who make a lot of steel using scrap as raw material. They’re building a facility that can use cheap natural gas to be used as a reductant in treating iron ore in the production of steel, a chemical reaction facilitated by this cheap natural gas. Again, that’s to kind of lower the cost structure of a company like Nucor,” he says.
As regards Europe in that context, Mr. Banerji comments: “The longer European governments say no to this cheap resource, the more uncompetitive that their own industries and companies become. There are a lot of European companies out there complaining about this: BASF, the German company, is one and there are several others. There’s a trend of steel plants in Europe getting closed down, so sooner or later there will probably be a desire from governments, from workers to take part in this kind of energy revolution.”
He admits he has no idea when that might happen. “It could take many years as such things tend to move ahead at a slower pace in Europe.”
Meanwhile, he notes that China is moving very swiftly to substitute natural gas for gasoline as a transportation fuel. In connection with China trying to utilize much more LNG as a transport fuel, Mr. Banerji names a company called Chart Industries that produces equipment to cool down and store natural gas.
“They’ve been getting a lot of contracts in China and also benefiting from the build-out of LNG export facilities in the US as well as they provide equipment to take part in the cooling and liquefaction of natural gas for export,” he reports.
As for offering a few handy tips for investors considering investing into unconventionals, Mr. Banerji’s first tip is to buy into the Vontobel Fund.
“In all seriousness,” he says, “it’s quite tricky if you’re not fully immersed in the subject to operate on your own. Buying into producers alone can be problematic, especially as the overproduction of gas from shales collapses the price.”
He also mentions that a problematic area has been companies that do pressure pumping, a service which he says is a key part of the shale production process.
“The market is strong for these kinds of services, but the fact is it’s quite easy to add supply if you get some from a supplier of such equipment, and then you’re in business. There are not a lot of barriers to get in on that game.
“So you have to try and pinpoint areas of the industry where there is some kind of technological know-how or certain other factors that keep too much competition out of the space to make some serious money in the area,” concludes Vontobel’s Sreejith Banerji.