For two large U.S. educational endowment offices, here’s some news that didn’t come as much of a surprise. The Paris-based International Energy Agency recently published a report announcing that the “supply shock” created by a surge in North American oil production will transform the energy market as dramatically over the next five years as rising Chinese demand did during the past 15.
“It’s been going on a few years,” observes Erik Lundberg, CIO at the University of Michigan. “What you see is increased production of oil in the U.S. and a massive amount of gas.” The IEA report forecasts that between 2012 and 2018, North American oil supplies will grow by 3.9 million barrels per day, or nearly two thirds of the non-OPEC daily supply growth. At the $8.5 billion Michigan endowment, Ann Arbor–based Lundberg oversees a 10 percent allocation to active managers that invest in oil and gas reserves. “We’re finding there’s so much oil, the market will be driven by supply, not demand,” he predicts. “It will have big implications for companies and how investors subsequently invest.”
Lundberg, who spent a precollege summer in the late 1970s building oil-drilling platforms in his native Norway, has seen firsthand how a surge in supply can affect an economy. He foresees a fight for market share that low-cost producers will win. Although Lundberg won’t reveal the details of his strategy, he points out that the low-cost players tend to be larger companies that can benefit from scaling their operations.
Notre Dame is another Midwestern university with an $8.5 billion endowment fund and a 10 percent allocation to energy (although 2 percent of that total lies outside the dedicated energy portfolio). CIO Scott Malpass says the recent boom in North American energy production has created many opportunities and challenges that didn’t exist a few years back. “It was not long ago when we were talking about $14 natural gas here in the U.S., heavier reliance on OPEC and peak oil,” he recalls. “Today natural-gas prices are around $4 and the U.S. is on a path towards energy independence.”
The South Bend, Indiana–based CIO agrees that North American oil abundance will have implications for broader energy commodity strategies and lead investors to consider tactical changes. Those could include scaling back new commitments to private energy when supply and demand look out of balance or using futures or equities to gain exposure to an energy sector that looks cheap, Malpass notes. But one of an endowment investor’s great advantages is a long time horizon, he says: “We continue to believe the long-term positive thesis for energy and commodity investing is still intact.”
