“Drill, baby, drill!” was the mantra of the Republican faithful during the 2008 presidential election. At the time, the debate centered whether the US should expand the scope of exploration and development in prospective oil and gas fields offshore the Lower 48. Supporters argued that an uptick in drilling activity would stimulate the economy, pad the government’s coffers from lease sales and reduce the nation’s reliance on foreign oil. Critics countered that such a move would entail undue environmental risk and merely deepen the nation’s dependence on fossil fuels.

The Macondo oil spill in the deepwater Gulf of Mexico, coupled with the industry’s floundering efforts to plug the blown-out well, prompted the Obama administration to institute an extended moratorium on offshore drilling. As a result of the disaster, many operators lost more than a year on their existing leases. The effects of this drilling ban are evident in these graphs of US offshore oil and natural gas production, both of which have tumbled significantly.

Source: Energy Information Administration

US offshore oil production plummeted to 114 million barrels oil per day in 2010 from about 312,000 barrels of oil per day in 2007.

Source: Energy Information Administration

Meanwhile, the volume of natural gas extracted offshore the US tumbled to about 2.875 billion cubic feet from 3.476 billion cubic feet in 2007. Much of this decline stemmed from falling output in the Gulf of Mexico.

Expect this weakness in offshore oil and gas output to persist. Although permitting and drilling activity in the deepwater continues to recover slowly, about 300 shallow-water permits expired in 2011 and acreage acquired during the US Interior Dept’s December 2011 lease sale won’t enter production for several years.

Nevertheless, the energy sector has been an important driver of the US economy, largely because of the rapid development of oil and gas reserves trapped in shale and other “tight” reservoir rocks.

Rising production from prolific plays such as the Bakken Shale in North Dakota, the Eagle Ford Shale in south Texas and the Marcellus Shale in Appalachia has more than offset declines in offshore output. The graphs below tell the tale.

        
Source: Energy Information Administration

In 2009 and 2010 US oil production increased for the first time since the 1980s, as robust drilling activity in shale oil plays offset declining offshore output from the US Gulf of Mexico and Alaska.

Source: Energy Information Administration

Meanwhile, a surge in onshore output enabled the US to overtake Russia as the world’s leading gas producer in 2010.

Not only are exploration and production (E&P) companies such as EOG Resources (NYSE: EOG) and Chesapeake Energy Corp (NYSE: CHK), early movers in some of the nation’s most compelling shale oil and gas fields, reaping the rewards of rising production and elevated oil prices, but frenzied drilling activity in these plays has also been a boon for services companies, particularly Halliburton (NYSE: HAL).

Among the independent producers with exposure to the shale oil and gas boom, we continue to favor names with the potential to grow their oil output and take advantage of elevated commodity prices. Last year brought a wave of dealmaking in the shale oil and gas space, with international oil companies seeking to gain expertise in producing these unceonventional fields and add exposure to incremental production growth in a politically stable environment. We expect this trend to continue into 2012. The Jan. 19, 2012, issue of The Energy Strategist, “Top Takeover Plays for 2012,” will include a number of successful shale oil and gas operators that are ripe for acquisition. 

More important, many of these fields are located in regions that haven’t traditionally produced energy or that lack sufficient takeaway capacity to handle rising volumes of oil, natural gas and natural gas liquids. In a comprehensive report on this subject, the Interstate Natural Gas Association of America estimates that the US and Canada will need to spend $83.8 billion to build and expand enough midstream infrastructure to support the surge in onshore production.

Demand for these midstream assets will be met by master limited partnerships such as Enterprise Products Partners LP (NYSE: EPD) and Kinder Morgan Energy Partners LP (NYSE: KMP), which should enable these pass-through entities to grow their cash flow and quarterly distributions. Meanwhile, the boom in onshore drilling and the coming infrastructure build-out will also be a boon for equipment suppliers such as Dresser-Rand (NYSE: DRC), Robbins & Myers (NYSE: RBN) and National-Oilwell Varco (NYSE: NOV).  

But the rapidly changing domestic energy picture also has positive ramifications in other economic sectors. For one, the shale oil and gas revolution has resulted in an oversupply of natural gas that in recent years has kept the price of this commodity hovering near record lows. Depressed prices for natural gas add up to lower utility bills for many US consumers at a time when households are focused on making every penny count. My colleague Elliott Gue wrote about this trend at length in America’s Overlooked Energy Advantages.

Meanwhile, a newfound abundance of ethane has revivified the domestic petrochemical industry, giving chemical manufacturers a dramatic cost advantage over producers in Asia and the Middle East that rely on naphtha and other oil derivatives for feedstock.

Over the past decade, multinational chemical producers such as Dow Chemical (NYSE: DOW) have gradually shifted their production base from the US to Asia (to build a presence in growing demand centers) and the Middle East (to take advantage of lower feedstock costs).

But in 2011 a number of major petrochemical producers have announced plans to restart shuttered crackers or construct world-class plants to take advantage of favorable pricing on ethane and propane, NGLs that tend to trade at a discount to crude oil but still exhibit similar price trends.

For example, Dow Chemical–the world’s second-largest chemical outfit–announced plans to restart its ethane cracker at its St. Charles complex, upgrade one plant in Louisiana and another in Texas to enable them to accept ethane feedstock and build a new ethylene production plant on the Gulf Coast in 2017. The firm aims to improve its ethane cracking capabilities by 20 percent to 30 percent to take advantage of the superior economics offered by the NGL. Royal Dutch Shell (NYSE: RDS: A) in June 2011 announced that it would build a world-scale ethylene plant in Appalachia that would source its feedstock from the Marcellus Shale. Meanwhile, Chevron Phillips Chemical–a joint venture between Chevron Corp (NYSE: CVX) and ConocoPhillips (NYSE: COP)–plans to build a major ethane cracker and ethylene derivatives facility in the Texas Gulf Coast region.

Local economies also continue to benefit from the feverish activity in emerging shale oil and gas plays. For example, North Dakota’s economy has boomed in recent years thanks to the Bakken Shale, while labor shortages in the Permian Basin, Eagle Ford Shale and Marcellus Shale should provide plenty of employment opportunities in these regions. In fact, the Pennsylvania Center for Workforce Information and Analysis recently estimated that the number of people employed by the mining and timber industries increased 17.4 percent from year-ago levels in November 2011, largely because of the Marcellus Shale. As you can see in this graph, employment in the mining and timber industries has surged in Pennsylvania. Meanwhile, overall employment in Pennsylvania is up 0.9 percent from a year ago.

Source: Pennsylvania Center for Workforce Information

Local financial institutions also reap the benefit of increased economic activity, a trend we first highlighted in Energizing Local Economies. The two stocks we highlighted in that article have outperformed dramatically: shares of Texas Capital Bancshares (NSDQ: TCBI) has returned 82 percent, while Pennsylvania-based FNB Corp (NYSE: FNB) has returned 63 percent. Meanwhile, the KBW Regional Bank Index posted a total return of only 3.3 percent over the same period.