What Are Upstream Energy Companies?

Within Miller/Howard Investments' four-segment approach to the energy market, the Upstream group is where the drill bit meets the earth. Upstream companies are those involved in exploration for and production of crude oil, natural gas, and natural gas liquids such as ethane, propane, butane, and methane.

In days past, the iconic image of an Upstream energy company was the “wildcatter,” an independent exploration company drilling wells in unproven territory in hopes of striking it rich. Today's Upstream investors are less reliant on this hit-or-miss approach, thanks largely to advances in energy exploration and extraction technology.

Why Is Shale Extraction Important?

Horizontal drilling and fracking have turned oil and gas exploration into a manufacturing process with continuously improving efficiencies and reduced exploration risk. As a consequence, increased output from North America‘s shale resource and its short-cycle nature have forever altered global energy markets. US shale increased the total global supply of crude oil by 5% in just five years, by far the largest single driver of increased supply during that period. Shale has had an even greater impact on the natural gas market, raising domestic production by nearly 50% in 10 years.

At Miller/Howard Investments, we believe newfound abundance of natural gas, in particular, will prove to be a key investment theme over coming decades as our economy progressively transitions toward increased consumption of the cleanest burning fossil fuel.

Several factors, we feel, will drive this transition and the resulting demand growth for natural gas:

Increased exports of US natural gas to other countries where natural gas is much more expensive.

A longer-term shift by electric power generators—utility companies—from coal to natural gas. In 2016 natural gas will overtake coal as the dominant fuel for electricity production for the first time.

Increased industrial consumption of natural gas, primarily by companies in the petrochemical industry.

What Factors Influence Upstream Energy Companies' Stock Prices?

Upstream companies' stock prices can reflect both the outlook for oil and gas prices as well as factors specific to the individual companies. Higher energy prices may boost the companies' revenues and earnings, while lower prices may reduce them.

Commodity prices hinge mainly on supply and demand in the energy markets. When supply and demand are in approximate balance, prices remain relatively stable. But when the market experiences either excess or insufficient supply for a given demand level, prices can move dramatically, as the chart of oil prices from January 2014 through November 2015 shows (see chart, on left). On the demand side for natural gas, weather, temperatures, economic conditions, and coal prices are key factors. Cold weather increases demand for heating, and hot weather increases demand for cooling, both of which cause electric power plants to use more gas. When the economy is growing, manufacturers produce more goods, which increases their natural gas consumption. Additionally, if the price of oil is high relative to gas, companies that can substitute natural gas may consider doing so.

Company-specific factors also influence Upstream stocks' prices. Companies with efficient operations, long-life and lower-cost leases, and healthy balance sheets may be better positioned to withstand commodity-price fluctuations and produce steadier results over time.

INVESTMENT PRODUCTS: ARE NOT FDIC INSURED • MAY LOSE VALUE • ARE NOT BANK GUARANTEED

© 2017 Miller/Howard Investments, Inc. All rights reserved.

This material represents Miller/Howard Investments' views. These views may change based on changing circumstance. The information provided should not be considered a recommendation to buy or sell any security, and should not be considered investment, legal, or tax advice. Information is obtained from sources believed to be credible and reliable, but its accuracy, completeness, and interpretation cannot be guaranteed.
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