The American Midwest as an emerging market

The American economy is undergoing a transformation that arguably could be a turning point of historical proportions. While the so-called new economy is often credited with propagating change, the old economy — especially the oil-and-gas sector — is going through an evolutionary phase that our team believes is among the most important economic developments of recent years.

Largely on the momentum of so-called fracking technology (properly known as hydraulic fracturing), nontraditional exploration techniques have turned global oil and gas markets upside down. One can call the effects a rebalancing perhaps, or maybe even a restructuring. Either way, it represents a momentous shift.  In our team’s view, the United States can realistically be described as an emerging market when it comes to energy exploration and production.

Let's consider a handful of telling data points:

  • According to estimates published by the U.S. Energy Information Administration, U.S. crude-oil production had its largest ever one-year gain in 2011.
  • The U.S. Department of Energy estimates that U.S. oil production will likely pass Saudi Arabia by 2020.
  • Between 2009 and 2012, the amount of oil shipped by rail in the U.S. grew by 2,000% (Data: Association of American Railroads, via Bloomberg).

Changing energy trade balance

Nontraditional sources of energy, especially shale formations, have boosted the pace of energy production in the U.S. Overall, this increased production has helped the U.S. become a significant exporter to trading partners around the world. At the same time, energy imports have begun to level off in recent years, even beginning a slight downward trend (see chart below), suggesting that (1) America’s path to energy independence isn’t just a far-away dream, and (2) nontraditional energy sources are helping to create a new position for the U.S. within the global energy supply network.

Data: Energy Information Administration, via Ned Davis Research (ndr.com). For additional information about data collection, including disclaimers, visit ndr.com/vendorinfo. Annual observations.

Source: Energy Information Administration, eia.gov 

Chart above is for illustrative purposes only and is not representative of the performance of any specific investment.

An expanding resource

In 2000, shale beds produced an estimated 1% of America’s natural gas; in 2013, that figure is up to 25%. (data: The Economist). Here’s a look at the geographical distribution of major U.S. formations.

American Midwest emerging market

Source: Energy Information Administration, eia.gov

Chart above is for illustrative purposes only.

Additional, less-obvious benefits to nontraditional energy development include the profound effects that new drilling can have on local communities. Consider, for instance, the economic lift experienced in shale-rich North Dakota: The state leads the U.S. in job growth, wage increases, and low unemployment.

At the company level, the resources that are brought to market by nontraditional energy development can be beneficial. Petrochemical companies, for instance, who use gas to make plastics used in our everyday lives, stand a good chance of seeing lower input costs. A second example is playing out in the steel indusry, where new mills are being built to support nontraditional drilling projects. An abundance of low-cost gas is presenting opportunities that were unavailable not too long ago.

Investment implications

As nontraditional energy sources come online, proactive companies will have opportunities to improve efficiencies, boost financial performance, and invest in new projects. We will seek to uncover companies that can take such steps, with a special emphasis on firms that we believe have diversified business models, stable earnings, deep management teams, and a history of increasing dividend distributions.

In recent quarters, the oil-and-gas segment has been among the highest allocations within the equity income fund we manage, Delaware Dividend Income Fund. Going forward, as this segment continues to feel the effects of nontraditional energy development, we will be following the outcomes. As we do so, we will consider new holdings for the Fund when we identify investment candidates that (1) meet the criteria mentioned above, and (2) complement the existing portfolio in a way that is consistent with the Fund’s objective.

The views expressed represent the Manager’s assessment of the market environment as of October 2013, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager’s views.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting the fund literature page or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.

IMPORTANT RISK CONSIDERATIONS

Investing involves risk, including the possible loss of principal.

Diversification may not protect against market risk.

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