The US Energy Sector: An Overview

To understand the US energy sector, it’s essential first to understand the country’s energy needs. The US uses various energy sources to meet its energy needs. Fossil fuels, nuclear power, and renewable energy sources are the country’s primary energy sources.

Fossil fuels accounted for nearly 80% of the country’s total primary energy production in 2018. Primary energy is energy in its raw form ahead of any transformation. For example, natural gas is a primary energy source. It can be used to generate electricity, which is a secondary form of energy.

Fossil fuels primarily include coal, natural gas, and crude oil. Among these, natural gas and crude oil account for roughly 80% of the energy production from fossil fuels. It’s not surprising that oil and gas companies primarily dominate the US energy sector.

Energy sources continue to evolve away from coal. Natural gas and renewable energy are evolving to have a much bigger share as energy sources in the coming decades. Low natural gas prices have contributed to a rising number of gas-fired plants being built for electricity generation. At the same time, less-economic coal and nuclear plants continue to be retired.

Energy sector companies in the oil and gas industry are usually categorized as upstream, midstream, and downstream on the basis of their operations.

• The upstream segment includes oil and gas exploration and production companies. These companies bring the commodities out from under the ground. ConocoPhillips (COP), EOG Resources (EOG), and Apache Corporation (APA) are a few of the companies operating in the upstream segment.
  • Oilfield services companies provide services to upstream energy companies. Examples of these companies include Schlumberger (SLB) and Halliburton (HAL).
• Midstream companies process and then transport extracted hydrocarbons through pipelines. Kinder Morgan (KMI), Enterprise Products Partners (EPD), and ONEOK (OKE) are some of the larger midstream companies.
• Downstream companies refine and distribute petroleum and gas products to retail outlets and end customers. Phillips 66 (PSX) and HollyFrontier (HFC) are a couple of the companies operating in this value chain.
• Integrated energy companies such as ExxonMobil (XOM) and Chevron (CVX) operate across all three segments of the energy value chain.

Energy supply and demand, as well as the prices of energy commodities, drive the performance of energy companies. Demand and supply dynamics, in turn, drive commodity prices.

• Energy demand: A number of variables drive the long-term demand for energy. These include economic growth, technological development, consumer preferences, and government policies. Higher economic growth generally translates into increased demand for energy. However, improvements in energy efficiency can partially offset demand growth.

Technological advancements, consumer preferences, and government policies can also drive demand higher or lower for a particular source. For example, electric cars may drive the demand for petroleum down. Similarly, climate change policies are driving demand away from coal and toward natural gas.

• Energy supply: Political events, OPEC’s actions, and other factors affect the supply of oil and gas. The shale revolution has made the US the largest oil-producing country in the world.

The chart above gives an overview of US crude oil demand and supply. Refinery inputs and exports reflect the demand for crude oil. Produced and imported crude oil creates the supply to fulfill this demand. Trends in crude oil inventory mirror the difference in demand and supply. For example, if demand exceeds supply, inventory draws meet the excess demand, which reduces crude oil inventory levels.

• Oil prices: WTI crude oil is generally used as a benchmark for oil prices in the US. The graph above shows WTI crude oil spot prices at Cushing for the last 20 years. As the graph shows, oil prices (USO) were volatile during this period. Brent crude oil prices are a benchmark for crude prices globally. The average WTI price in 2018 was $65 per barrel. Prices averaged $51 in 2017. WTI traded at a $3–$10 discount to Brent in 2018.

• Natural gas prices: Natural gas spot prices at Henry Hub serve as a benchmark for US natural gas prices. The chart above shows Henry Hub gas prices over the last 20 years. Henry Hub prices averaged $3.12 per thousand cubic feet during 2018. While many global factors affect crude oil prices, demand-supply dynamics in regional markets drive natural gas prices.
• Natural gas liquids: Natural gas produced at the wellhead contains varying amounts of NGLs (natural gas liquids). NGLs are heavier hydrocarbons—primarily ethane, propane, butane, and pentane. Raw natural gas containing NGLs is usually not acceptable for transportation through pipelines or for use as fuel. Therefore, the raw gas should be processed to remove the NGLs and other impurities. “Wet” natural gas has high amounts of NGLs, whereas “dry” natural gas is relatively free of NGLs. Dry natural gas can be transported and used as fuel with very little processing.

Crude oil and natural gas prices affect the performances of upstream companies. Midstream companies are generally less vulnerable to oil and gas prices because a significant portion of their earnings comes from fixed-price contracts to transport the hydrocarbons.

• Upstream capital expenditure: The amount of upstream capital expenditure affects midstream companies’ performances. If exploration and production companies spend more capital on production, the demand for transporting the produced hydrocarbons is higher.
• Crack spreads: The prices of crude oil and refined products drive refining margins. Refining margins are the difference between what a refinery pays for its raw materials (which are primarily crude oil) and the market prices for the products produced. A refinery’s produced products primarily include gasoline, heating oil, diesel oil, jet fuel, and fuel oil.

Refineries generally use market crack spreads such as the Gulf Coast 3-2-1 crack spread or the Gulf Coast 2-1-1 crack spread as benchmarks. The Gulf Coast 3-2-1 crack spread assumes that refining three barrels of crude oil produces two barrels of gasoline and one barrel of distillate fuel. It’s calculated as the difference in the price of three barrels of WTI Cushing crude oil and the total price of two barrels of gasoline and one barrel of ultra-low-sulfur diesel.

In the next part of this series, we’ll discuss the key operational metrics to consider when analyzing energy companies. We’ll also discuss the S&P 500 energy companies, the sector’s valuation, and its outlook.