Illustration by Maria Rendon

During the first half of the 21st century, America will regain energy independence, while carbon emissions will diminish. Patient, informed energy investors will prosper. How? The following six factors will bring about very gradual, but adequate, improvement in the quantity and quality of the U.S. energy-supply mix.

Clean-coal plants will provide base-load electricity, plus gradually but increasingly use coal gasification to provide fuel for gas-turbine-generated peak-load electricity. CO2 will be captured and stored. U.S. coal reserves hold at least two or three times the Btu content of Saudi Arabia’s oil reserves.

Nuclear generation will also provide base-load electricity. Concerns over global warming will accelerate the U.S. trend toward this zero-emissions source of electricity. Technology is available for storage of spent fuelrods. Nuclear-generated electricity even provides super-clean transportation fuel, when used to recharge battery-powered vehicles.

Gas-to-liquid technology (GTL) commercialization will provide for the production of diesel and jet fuels. Pilot plants have been built and operated.

Coal-to-liquid technology (CTL) commercialization will produce transportation fuels, including gasoline. The basic technology was used by Germany during World War II and by South Africa during apartheid. Pollutants will be captured in the processing, leaving only those carbon emissions created by combustion, which are significantly reduced by catalytic converters.

Renewable energy, including wind, solar, tidal and biofuel, will increasingly be used. Even though they are unlikely to provide a large percentage of either U.S. domestic or worldwide energy supply, they are beneficial and will be maximized to their economic limits.

Conservation will result in incremental increases in energy efficiency. There is no cleaner and generally no more cost-effective way to mitigate our energy requirements.

The current global-warming trend is an empirically demonstrable fact, as is the incontrovertible evidence of warming and cooling trends throughout geologic time. There is no reasonable basis to conclude that these natural cycles have been suspended.

The unanswered questions relate primarily to the extent that the current warming trend is influenced by human activity. While the human contribution is certainly more than a 1% factor, it is also certainly less than a 99% factor.

While it is usual for humans to want to feel in control of their destiny, Mother Nature frequently moves with such force as to make man’s attempts at intervention almost completely impotent. Even so, to whatever extent mankind is able to moderate the present warming trend by capturing and storing greenhouse gases, it will be in position to moderate the next cooling trend by releasing them from storage.

Because of the “creative destruction” process, technologies tend to transition in typical bell-curve patterns. Consider the path from vacuum tubes to transistors to silicon chips. To achieve similarly dramatic energy transitions, essentially all that is needed is to once again allow Adam Smith’s “invisible hand” to operate through free markets. Oil at $100 per barrel is holding a price umbrella over the process.

To the extent that the world attempts to establish a global bureaucracy for regulating carbon emissions, the risk is of retarding progress and increasing costs.

It is no accident that the cleanest countries on Earth are characterized by free markets operating under democratic governments. Those countries have cleaned up their air and water, because that is what the people who live there want and are willing to pay the cost to achieve. There is no need for economically or politically destabilizing intervention. What is being dealt with is very long-term climate change, not imminent annihilation.

Developed countries have demonstrated the capacity to deal with environmental concerns. For example, municipalities have stopped dumping untreated sewage into streams and lakes, and industry has incrementally reduced pollution. Automotive emissions have been drastically reduced.

A zero-discharge society has not been achieved and is unlikely as long as living creatures, human and otherwise, continue to emit CO2 by merely breathing. However, the trends are obvious. Look at London, Paris or New York as they are today, compared with 100 years ago. Free people chose to clean up their environment through incremental improvement, sometimes with government stimulus being a positive factor.

Historical perspective

In 1957, upon entering a petroleum engineering career, oil was $3 per barrel and natural gas sold for 25 cents per thousand cubic feet. Prices would have been even lower except for “proration” conducted by the Texas Railroad Commission. Each month, the commission determined how much oil was required by the market and advised producers how many days the allowable limit could be produced, sometimes as few as eight days for the month.

This situation created a great hue and cry about the flood of cheap imports having ruinous effects on the domestic industry. However, the allowable days per month gradually crept up to 30.

At that point, exporting nations knew U.S. oil production had maxed out and the U.S. had lost energy independence. The price of imported oil then began its long and erratic rise, which has thus far reached $100.

Today, OPEC members produce what is possible, and at the equivalent of 28 days per month. OPEC is only about 5% away from having maxed out its currently sustainable capacity, while worldwide oil depletion is running about 7% per year.

Also, the relationship between IOCs (international oil companies) and NOCs (national oil companies) has changed since the 1950s. Then, IOCs were able to make reasonable E&P-sharing agreements with host governments. Typically, they brought a potent combination of three factors to the table: near exclusivity on the technology and experience, risk capital, and market access through their transportation, refining and retailing networks.

Since then, negotiating strength has gradually shifted to the host governments. Technology has been well dispersed and is available in the open market to NOCs as well as IOCs.

Risk capital is also available from many sources, some of which are oil-exporting governments themselves. And in a world where there is approximately a 3% gap between worldwide oil production capability and demand, market access is no longer a challenge.

The result? The NOCs, having been tutored by the IOCs, now own or control approximately 80% of the world’s reserves, and they also control at least that proportion of those prospects large enough to matter to the major IOCs—making upstream growth very difficult for majors.

About 10% of the world’s reserves and about the same percentage of the big-opportunity prospects are now controlled by major IOCs. What the U.S. public thinks of as “big oil” is not very big at all, when viewed in worldwide context. Even so, “big oil” continues to be a convenient target for populist rhetoric.

If one could find and produce oil for 50% of market in a world starved for oil, would one be returning capital to shareholders or expanding production, assuming there was this option? Yes, there is a fear factor in the current price of oil—at times it could be as much as 30%.

To the extent one could believe sustainable brotherly love is about to break out all over the world, discount oil-price expectations accordingly. Logic suggests that nobody would sustain the cost of drilling deep wells a hundred or more miles out at sea, in water a mile or more deep, if able to expect to achieve similar production by drilling relatively shallow wells in a cow pasture.

This contrast provides an idea of what incremental barrels are worth now, and how difficult it has become to access large prospects on secure terms. When supply of a commodity is being overtaken by demand, the incremental unit of supply tends to price the whole market.

Investment strategy

Where does this lead in terms of investment strategy? For traders, it may lead nowhere. For the long term, meaning decades, it leads investors into the still-early stages of a mega-trend, with opportunity to pick the right participants and let investments ride. One can probably do well with an initial list that is only 50% correct, if having the humility to recognize and prune mistakes, plus the courage to let winners run, regardless of market gyrations.

How does an investor get advantageously positioned? Over the years, it has been clear that a good way to become proficient at anything is to learn about the strategies and techniques employed by master practitioners. Applied correctly or not, here are certain points of view of Warren Buffett:

• Read and otherwise assimilate information continuously.

• Stay within your personal circle of competence.

• Buy stock only when understanding the underlying business and wanting to be a long-term owner.

• Invest with a preferred holding period of forever. Taxes are due when selling a winner.

• Don’t be distracted by the daily noise from Wall Street. Instant dissection and analysis of events du jour can be very important to traders, but are seldom important to investors.

How, then, should one invest in the mega-trend toward more diversified, multi-sourced, cleaner and more abundant energy? Consider the following categories, with specific players mentioned only as representative examples.

International oil companies (IOCs) Evaluate these as conservative, dividend-paying investments. However, be aware that the upstream side of the house tends to be fighting a rear-guard action. They have enormous existing reserves, which will profitably deplete asymptotically over 20 years. Those existing reserves will be supplemented, with varying degrees of success, by prospect-constrained exploration programs.

Beware of ever-increasing amounts of capital flowing into more and more stock repurchases. In excess, that is an indicator of partial liquidation. Where meaningful amounts of capital are being redeployed downstream into liquefied natural gas (LNG), GTL, CTL and similar technologies, expect growth over the long term.

National oil companies (NOCs) There are NOCs open to U.S. investors, some of which have experienced management, adequate capital and secure access to world-class prospects. They are advantaged by host governments’ reluctance to abuse an NOC. It is an arm of another sovereign nation. Petrobras is an example.

Gleaners Numerous E&Ps are able to obtain reasonably secure access to prospective acreage on reasonably economic terms. The prospects are inadequate in size for the majors, but still large enough to allow small- to midsize companies to do well, if they efficiently and aggressively employ cutting-edge technology. These companies tend to prosper by maximizing opportunities that generally are not of meaningful size to a major. Apache Corp. and Devon Energy Corp. are examples.

Oil services and equipment Technological leadership, geographic diversification and a strong NOC customer base are important factors. The leaders in the acquisition and interpretation of seismic and logging data, particularly subsalt offshore, will continue to do well and also the leaders in services such as cementing and fracturing. These and other critical services are purchased by all E&P companies. Contract drillers, particularly those providing highly capable people and equipment for subsalt and deepwater applications, will do well, as will the leaders in subsea equipment and services.

Transportation Pipelines, when well situated, offer growth opportunities. Kinder Morgan is an example. Railroads can be a two-part play on energy. First, they are the most energy-efficient way to move massive tonnage over land for long distances, such as directly from a mine to a CTL-processing facility. Second, if their tracks are in the right place, they will be moving increasing amounts of coal. Ocean tanker companies are subject to extremely volatile rate changes, but they can be good investments for those who understand the forces involved.

Refining In terms of heavy oil, GTL and CTL, the refining industry may be moving into an era of very strong growth, having far more margin potential than the crack spread associated with processing light, sweet crude. Valero Energy Corp. has done well by positioning to handle heavy and sour crudes, which are frequently available at substantial discounts to premium crudes like Brent, Saudi Light and WTI. The coming commercial leaders in GTL and CTL are not yet clearly visible, but Sasol Ltd. probably has the current experience lead.

Fuels Whether conventional or alternative, any company that provides a growing stream of economically competitive fuel, particularly derived from or feeding into clean technologies, will have a ready market. Oil and gas producers that can grow their rate of production, while maintaining or growing reserves, are the leaders here. In addition, consider those new technology companies that upgrade and refine heavy oil produced by strip-mining and increasingly, by SAGD (steam-assisted gravity drainage).

Consider growing companies that produce coal and uranium. These two segments continue to be reviled by those who have not yet accepted that nuclear is the cleanest source of base-load electricity and that coal, through use of proper technology, can be nearly as clean. Coal can also be used to produce transportation fuels that are less polluting than those burned in cars, planes, trains and ships today. Common sense will gradually prevail. Suncor Energy Inc. in heavy oil, Cameco Corp. in uranium, Peabody Energy Corp. in coal and Sasol in CTL and GTL technology are examples.

First-half 21st century

Lack of energy will not cause major interference with the progress of civilization. The U.S. will certainly not be forced back to anything resembling a pre-industrial society, with all the degradation that implies in terms of quality and longevity of life.

It will bring ever-increasing amounts of ever-cleaner and more diversified energy to market—the enabling technologies are at hand. They will be utilized, because deprivation is not economically or politically acceptable.

The transition process has already begun. Of course, it will be turbulent at times. While the exact methods, exact timing and exact costs are not yet fully determinable, the outcome is inevitable. Hundred-dollar oil is actually part of the solution, because of the enabling price umbrella it holds over the transition process.The convenient truth is that market forces work. They will take mankind partially beyond petroleum during the next 50 years.

Oil and gas will continue to be contributors to the energy mix. During the next 50 years these will be increasingly supplemented, but not supplanted, by a variety of other energy sources. Taken with coming technological improvements, the result will be a leveling of Btu costs and reduced carbon emissions plus renewed energy independence for the U.S.

Energy independence is not necessarily represented by an absence of imports, but rather the option to import only that amount economically and politically beneficial.

Recall that 50 years ago, when the U.S. could produce more energy than it could consume, Americans chose to use a mix of domestic and imported fuels. The option to choose the appropriate mix is the essence of independence.

Interestingly, the whole transition from our lost energy independence to $100 oil to a regained energy independence will have required about 100 years. The best news is that the more-difficult half of the journey is already behind America. The necessary tools have been created. As the U.S. more fully uses and develops these tools, it will create enormous economic and political opportunity.

C. Russell Luigs is a retired director of GlobalSantaFe Inc., which merged with Transocean Inc. in November 2007. He was president and chief executive of its predecessor, Global Marine Inc., from the year he joined, 1977, to 1998. He is currently a director of Petroleum Helicopters Inc. and is a petroleum engineering graduate of the University of Texas.