In Russia Vs. Ukraine A Likely Winner Is North American Energy
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Reaching way back in the TV time machine there was a cold-war animated show called Rocky and Bullwinkle (yes, I spent too much time watching TV). Typically, the detestable Russian bad guy, Boris Badenov, would try to harm the lovable North American good guys played by a moose and a squirrel. One of Boris’ best lines to describe his constant failure was – I drop bomb on Moose and Squirrel, who gets blown up? – Me! Rearranging a bit for the current hideous conflagration is more like- I drop bomb on Ukraine- who gets blown up? Russia. Who wins? Secularly, the North American energy industry and associated infrastructure.

Following the Russian invasion of Ukraine, the West has begun its concerted efforts to wean itself off Russian oil & gas. Unfortunately, this comes a day late and a dollar short. Germany and other eastern European neighbors continue to supply Russia with hard currency in exchange for sanctioned Russian energy reserves. For the Europeans to get off their Russian energy habit, they need a new supplier. Our continent beckons.

Markets have reacted to these disruptions accordingly. Spot natural gas prices in Europe and the UK have continually made new highs in price as the ongoing conflict in Ukraine seems endless. Brent crude and WTI oil are both steady at >$100 a barrel in the spot market. Consumers are feeling the pain at the pump as refined products like gasoline and diesel skyrocket in price. US refinery capacity keeps plummeting- several refineries shut down in the US due to COVID in 2020-2021 and the country has yet to respond to this dislocation in capacity and product demand.

Winston Churchill once said, “never let a good crisis go to waste”. Where Russians once sold their oil and gas, US energy infrastructure companies stand to benefit. Companies across the value chain – refineries, pipeline operators, and exploration and production – all stand to benefit from increased US production of oil. Current production levels have still not returned to pre-COVID levels as the industry has been starved of capital from investors. We think this provides the current opportunity in the public markets.

Given that there is questionable political will from current American and Canadian governments, as well as ESG-inspired investors for hydrocarbon expansion, drilling efforts may be slow to respond. So, the better place to start sniffing out winners will be in midstream pipeline companies and oil refiners. Before new drilling hits the markets, we will work the current infrastructure and supply hard. As potential supply comes online, specific areas of the energy value chain will benefit refiners that have ample space to bring capacity back online to meet product demand, and the capital expenditures that midstream companies are putting into the ground today will have substantial paybacks to investors today.

Eventually, the rocketing supply of oil and gas coming to market will have broad-based benefits to all North American pipeline operators as more supply will come online rapidly to fill the void left by Russian oil and gas majors sanctioned from the global market. Some quick back-of-the-envelope math: Russian crude oil exports are roughly 5 million barrels per day of output. OPEC+ has promised to bring only 400,000 barrels per day of latent capacity to the global market. If Russia is to be frozen out from the global market, the market is short 4.6 million barrels per day. In a market where even a million barrel/day shortage would cause price spikes, this is a dangerous shortfall. Supply must come from North America to handle this shortfall.

With more hydrocarbons flowing through the midstream pipelines and more infrastructure needed for new oil wells, economics from these activities will flow through to equity investors. ETFs focusing on refining and pipelines are available and pay strong dividends. And if this becomes a secular trend, today’s value stocks will be tomorrow’s growth stocks.

In the TV series, Boris never really harmed the moose and squirrel and eventually he went the way of the USSR- cancelled!

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