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Your Three Most Pressing Energy Questions – Answered

by | published February 19th, 2016

Given the action that has taken place in the energy sector over the past several months, I haven’t had the opportunity to sit down and answer your many questions.

So let’s do that today.

Your questions have focused mostly on three issues, and I’ve put them all together and answered them.

First, many of you have asked about the status of liquefied natural gas (LNG) exports from the U.S., and how that will impact the global market.

One promising company in particular has drawn your interest…

Q 1: How Will U.S. LNG Exports Affect the Global Market?

Cheniere Energy Inc. (NYSE MKT:LNG) was to have begun exports in the fourth quarter of last year from the Sabine Pass facility on the Gulf of Mexico, but that has now been delayed until the first quarter of 2016. The company has secured five major twenty-year contracts with some of the largest European and Asian LNG importers in the world.

In addition, the U.S. government has approved several other terminals and company export applications. With the acceleration of LNG trade worldwide, U.S. exports are expected to account for 6% or more of total volume before 2020 (from 0 now).

However, it will take some time for LNG sales to establish sufficient hold in some markets. That’s because the initial delivery price will exceed that for natural gas coming via traditional pipeline.

Nonetheless, LNG will be one of the most important changes in the energy sector over the next decade.

This importance comes from the ability to establish spot markets in every location where regular volume is delivered. This ability to trade locally in short-term contracts will undermine the position (and price) of long-term pipeline delivery contracts.

As with just about anything else, increasing trade and guarantee of delivery will lower the export price and improve the predictability of local market transactions. And that will have a primary ripple effect across energy usage in entire economies.

Q 2: What Are ETFs and ETNs, and How Should I Use Them?

Second, many of you have been asking questions about whether exchange traded funds (ETFs) and exchange traded notes (ETNs) trade like any other stock on the secondary market…

Now, while these instruments look similar, there is an important difference.

When you invest in an ETF, you are investing into a fund that holds the asset it tracks. That asset may be stocks, bonds, gold or other commodities, or futures contracts. On the other hand, an ETN acts like a fixed instrument (a bond). It’s an unsecured debt note issued by an institution.

Just like with a bond, an ETN can be held to maturity, or bought or sold at will. But if the underwriter (usually a bank) goes belly up, the investor would risk a total default.

Both have been popular as a way to tap into wide areas of the energy sector. Remember, an ETF or ETN will have management fees. While they usually track a particular index and attempt to reflect the movement of the underlying assets, the actual return to the investor results from how well the ETF or ETN actually tracks the underlying assets and how big the fees are.

Using an ETF or ETN does allow you to “track” a large market segment without committing significant investment exposure. That may be useful in the current continuing volatility in energy, especially in oil.

Some of you have also asked about “bear” and “bull” ETFs and ETNs. These attempt to magnify the return, with the more liquid providing two (“2X”) or three (“3X”) times the actual movement of underlying assets. A “bear” ETF or ETN gives positive returns when the underlying value goes down, while a “bull” does the opposite.

If the instrument in question is a direct play on a commodity value – the price of oil being the most popular these days – a significant return can be had in a short period of time during intense price movements…

Provided you get the direction correct.

If not, remember this. Your loss from one of these will amount to two or three times the movement of the underlying asset (depending on the specific ETF or ETN). So, if you are betting on a decline in oil prices and the price actually rises, your loss will be about 200-300% of the rise in oil.

In other words, it is very important to note the much higher risk involved with using these leveraged or “multiplier” ETFs or ETNs.

Q 3: What Will Happen with America’s Smaller Oil Companies?

Finally, the question asked more than any other is how smaller oil and natural gas producers in the U.S. are likely to fare in the current climate.

Not well, is the short version of the answer.

Sustainable per barrel prices of at least $10 higher than what is now in the market are required if most of these small guys are going to survive much longer. They are almost all heavily indebted, and their only access to additional credit is now experiencing a significant deterioration in interest rates. At levels approaching (or surpassing) 18%, the cost is too prohibitive.

A rise in bankruptcies, along with a new round of mergers and acquisitions, is inevitable. Some smaller companies may survive by selling selected assets, but such cherry picking will help only a few.

Some of you have asked whether Congress lifting the ban on oil exports will help these smaller companies.

Unfortunately, the rise in U.S. exports will not come quickly enough, nor at an adequate price, to be of help here. And while the recently announced oil production “freeze” will likely establish a floor for oil prices, the bounce will not happen quickly enough to be of much difference.

Make no mistake. Oil prices will be rising. My estimate remains $42-$45 per barrel by June.

But this is not going to stem the coming tide of “creative destruction” in the oil and gas sector.

When the dust settles, you will have some choice plays. But in the interim, keep your powder dry.

Please Note: Kent cannot respond to your comments and questions directly. But he can address them in future alerts... so keep an eye on your inbox. If you have a question about your subscription, please email us directly at customerservice@oilandenergyinvestor.com

  1. Dasmithjones
    February 19th, 2016 at 13:37 | #1

    I would like to know what your prediction for future liquid natural gas prices will be

  2. Raphael Kolb
    February 19th, 2016 at 14:00 | #2

    I enjoy and learn a lot from your reports – thank you very much.
    The Canadian dollar is a direct function of oil prices and has reached a point of over 45% on the exchange rate (currently slightly improved – around 37%)
    What – if any – oil ETFs in the Canadian market would you recommend?

    Thanks and all the best

    Raphael

  3. Michael
    February 19th, 2016 at 16:21 | #3

    What is the best play for the rebound in oil prices?

  4. Henry Arthur
    February 19th, 2016 at 18:42 | #4

    Thanks!!

  5. Allen Novotny
    February 19th, 2016 at 23:13 | #5

    Now that the price of energy is so low, how much lower is LNG compared with what Cheniere thought a couple of years ago?

  6. gorham blythe
    February 23rd, 2016 at 11:33 | #6

    Kent, I noticed that you are bullish on oil.
    But I disagree because I’ve observed that some places in Canada and even in some Bakken boom towns, they are giving oil away for free due to over supply, all in the hope that bankers will reconsider their loans in the promise that by yer end it will stabilize around $50 -$60.

  7. February 24th, 2016 at 19:06 | #7

    If oil is on it’s way to $50, how can we best position ourselves to profit the ride up?

  8. ROBERT
    February 25th, 2016 at 00:15 | #8

    Kent, according to you and others, solar energy is the energy of the future. What does this new energy picture do to things such as; exploration of the Artic. What about the CHEVRONS AND EXXONS. I assume there will still be a need for some refining if for no other reasons than to make jet fuel, chemicals, resids ,etc.
    In other words can you paint an overall view of the energy world we are approaching.

  9. richard malmed
    February 25th, 2016 at 12:38 | #9

    Has anyone factored into the enrgy market an increase in solar power. Suppose 25% of all roofs in CA,AZ,NM,TX,LA,MI,AL,and Fl were covered with solar panels and that thosepanels showed at least a 5% return on investment p.a.over and above amortization of expense of panels over 10 years. what effect would that have on the oil markets. I believe it would far exceed the effect of shale and bust the cost of oil well down below where it is today. If this is forseeable by lets say 2020, it hAS huge implications globally, destroys the terrorist networks. Has anyone done such a projection? Is it a realistic possibility?

  10. Jeffrey J Hiser
    May 18th, 2016 at 09:28 | #10

    I’ve traded two of the leveraged ETF’s (both long and short WTI from time to time – symbols UCO and SCO) over the past 8-9 months. Question – why would both be down significantly in % terms over the past six months (or from any given period of time??). I just overlaid a six month chart with both and it’s around 19% and 23% respectively – seems odd to me. There must be a rational explanation – if so please provide. Thanks much in advance.

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