A global perspective on tectonic shifts in energy and the current bull market

The equity market has been surprising forecasters since it hit bottom in March 2009, as market seers have repeatedly shortchanged this relentless bull market by underestimating the resilience of business and consumer fundamentals and overestimating the global risks.

One reason for the “unpredictable” rallies is the emergence of long-term drivers of market performance that we call “tectonic shifts.” Traditional short-term market forecasts typically ignore slow-moving, hard-to-measure trends whose impact on the global economy is somewhat obscured. However, it is these themes lurking below the surface of forecasting methodology that have the potential — like continents colliding with explosive intensity — to change the face of the earth. We regard these tectonic shifts as a meaningful part of the upside in advancing corporate earnings, broadening manufacturing, consumer strength and global market resilience in the face of the Armageddon scenarios favored by the financial press.

Of the four tectonic shifts described in our 2012 forecast — global trade, technology, frontier markets and energy — none has had a more profound and immediate impact than energy, which has progressed even faster than we anticipated at the beginning of the year.

Energy rose to prominence in our Global Perspectives research as it became increasingly apparent that the transformative changes occurring in this industry would culminate in energy independence for North America (and for the United States in particular). Not only does the U.S. have the largest recoverable resources of coal, we are the Saudi Arabia of natural gas; these two astounding advantages have the potential to alter not only the energy industry but also the global economy.

In fact, forget about the long-term impact we mentioned earlier — natural gas is reshaping the global economy as we speak. A few facts to consider:

• The development of horizontal fracturing (“fracking”) to tap into natural gas stores deep under the surface of the earth is expected to lead the United States to energy independence by 2020. While fracking has come under fire due to environmental concerns, significant progress has been made to assuage the public’s qualms and increase the practice’s acceptance.


• After declining about 35% in the past year, natural gas is nearly 80% cheaper in the U.S. than it is in other developed countries, giving U.S. manufacturers a distinct competitive advantage.


• By 2025, natural gas will be the second most widely used source of energy worldwide, according to ExxonMobil’s “2012 The Outlook for Energy: A View to 2040.” By 2040, electricity generation will account for more than 40% of global energy consumption, according to the ExxonMobil report. Power plants are converting from coal to natural gas, and the need for energy to generate electricity will remain the single biggest driver of natural gas demand.


• In early October a consortium of energy companies announced it was moving forward with its plans to export natural gas from Alaska’s North Slope — a project that could cost upwards of $65 billion. This is but one of more than a dozen proposed natural gas plants in the U.S. seeking federal export approval, according to a Wall Street Journal story.


• Oil intensity, the amount of oil required to produce a unit of GDP, continues to trend down, falling almost two-thirds since 1980 as the economy has become more service oriented and vehicle efficiency has improved.

Natural gas certainly deserves the attention it has received, but it would be a mistake to miss the global opportunity that coal represents. Coal, while being replaced by natural gas in America’s electric utility industry, is the preferred energy source for emerging market power plants due to the significant cost advantage it offers; Reuters has reported that China, despite its significant native stores, has been ramping up its coal imports to support its electric needs, as has India. Meanwhile, Europe has also fallen under the spell of U.S. coal as a cheaper alternative to natural gas; U.S. coal exports rose 24% to hit a new record in the first half of 2012, according to a Financial Times story.

Few observers have recognized the threat that the United States may be exposed to a “power gap” — not just the lack of power, but the consequences of very limited diversification in terms of the sources of energy to produce that power. Currently, the combination of regulation by the Environmental Protection Agency and market forces that favor cheap natural gas are putting coal out of business in America. Coal currently is used to generate 43% of our electric power supply, down from over 50% just a few years ago. If regulation were to force the electric power industry to replace abundant “dirty” coal with “clean” natural gas, well-meaning authorities will have effectively incentivized the industry to eliminate natural backups in energy supply, potentially increasing costs and jeopardizing dependability.

Meanwhile, the other source of “real” electric power — nuclear energy — is nowhere near its potential as a reliable diversifier of electric power despite recent approvals for new plants. And “government energy” (renewable sources like wind and solar) accounts for a mere 5% of the U.S. energy supply even with the vast government subsidies that support it.

The U.S. will demand as much as 28% more electricity by 2035, according to the Energy Information Administration’s recent forecast. The risks that endanger our ability to meet this increased demand are not “black swans” approaching undetected. They can be identified clearly, and, more important, they can be mitigated by both energy independence and redundancy and diversification in the system. It is imperative that the country makes use of all the available sources of electricity generation, including renewable resources, coal, natural gas and nuclear energy.

The transformation in energy may or may not be a revolution. It may not be the solution to our GDP growth and employment problems. It may not resolve our deficit issues. And it may not guarantee our security. But it is a big step in the right direction, and it is but one of the four tectonic shifts that we expect to work together to build the potential for upside surprises in the markets. We expect the private economy to continue to progress toward more abundant and cheap energy, with more jobs, more economic growth, abundant electric power and expanding global opportunity as byproducts. We doubt that the energy opportunity and the attendant reduction in risk are suitably priced into global markets, representing an opportunity for investors to build wealth.

Many forces — private capitalism, state capitalism, government stimulus — interact to make forecasting capital market returns a challenging process; notwithstanding the limited appreciation of their impact by investors, the four tectonic shifts we are following have bolstered market fundamentals during the current bull market and should continue to do so going forward. Though Armageddon-level fear may dominate investors’ better judgment in the short term, fundamentals prevail over the long sweep of financial market history, and the broader underlying trends ultimately determine — and transform — the range of possible outcomes.

Douglas Coté, CFA, is a Chief Market Strategist at ING U.S. Investment Management.