MLP investors are well aware that energy infrastructure securities move with crude oil, until that relationship inconveniently broke down during the summer. Although we move and process far more natural gas (on an energy equivalent basis) than oil, investor sentiment causes the link. Because the economic link is weaker than sometimes implied by moves in the sector, the two can part company with little warning.
Some relationship makes sense, because pipelines and related infrastructure are typically built in anticipation of future demand. Commencing pipeline operations at 100% capacity is of course the best case, but more common is a steady ramp-up of utilization. The rate at which capacity gets used up can depend on production levels in the supplying region, and production is sensitive to price.
Before the Shale Revolution, U.S. crude oil production was heading steadily lower. Today, any forecast of U.S. output must be based in part on commodity prices. The correlation between the two is sometimes higher than it should be, but it’s no longer a commodity-insensitive business.
A recent report from the National Bureau of Economic Research (The Unconventional Oil Supply Boom: Aggregate Price Response From MicroData) seeks to measure the sensitivity of U.S. oil production to price. Among their conclusions is that unconventional drilling is up to six times more responsive to prices than conventional. This is because shale projects are “short-cycle”; the payback time is far shorter. Shale drillers can hedge enough of their expected output to ensure an adequate return, not just because upfront expenses are comparatively low but also because initial production rates are high, relative to conventional wells (see Why Shale Upends Conventional Thinking). Exxon Mobil’s CEO Darren Woods commented earlier this year that a third of their capex budget was dedicated to short-cycle opportunities. It’s because they’re less risky. Conventional projects have far longer payback periods, exposing them to the vicissitudes of prices.