While the Organization of Petroleum Exporting Countries (OPEC) will likely be unable to defend its position on both market share and prices in the wake of growing U.S. tight oil supply, growth in non-OPEC supply does not mean the United States will be immune from a disruption of Saudi Arabian oil exports, a policy expert told attendees at a June 12 forum at Rice University.
The U.S. shale boom changed the perception that Saudi Arabian Oil Co. (Saudi Aramco) would dominate the global oil supply, shifting the center of the energy world back to America, said Amy Myers Jaffe, executive director for energy and sustainability at the University of California at Davis, at the Energy Market Globalization: Investment and Commodity Price Cycles and the Role of Geopolitics.
Jaffe referenced a Wood Mackenzie study that estimates $80 billion will be invested in 2015 in North America tight oil plays as new pipelines and refinery upgrades transform the U.S. energy landscape. U.S. liquids production also could potentially keep growing, with some estimates has high as 10 million barrels of oil per day. While Jaffe is not sure she agrees that production will rise as high as 10 million bopd, the production trendline is definitely up, with initial estimates of 3 million bopd looking "very achievable".
Saudi Arabia may find itself swimming upstream if it decides to defend its position on price, given the decline in miles that Americans are driving due to the recession but also to generational and lifestyle choice factors and its impact on U.S. oil demand.
But while Saudi Arabian production could be used to replace exports from a neighboring country if a disruption occurred, no substitute exists for Saudi Arabia oil supply if a disruption of exports occurs, Jaffe noted. And a disruption of supply is possible, given that several worst case scenarios – including the strain of unemployment, citizens' anger over government corruption and fear of arrest by secret police – have already occurred in the Middle East.
The presumption that the Arab Spring could not spread to the Persian Gulf as it did through Tunisia, Egypt and other countries is not an accurate, Jaffe noted. Like other countries that experienced the Arab Spring, the Persian Gulf region suffers from the same issues that sparked revolt in other countries. These trends may not be true of very small Persian Gulf countries, but is true of larger nations, Jaffe said.
With Saudi oil exports, Jaffe sees an instantaneous reversal of economic recovery and a possible financial and banking crisis worse than the previous crisis. Jaffe anticipates a huge U.S. response would result from a disruption of Saudi exports, including greater investment in master limited partnerships MLPs to finance U.S. shale play activity, increased use of alternative energy sources, including natural gas in transportation and wide adaption of the Millennial generation lifestyle. Jaffe described Millennials as urban dwellers who believe in telecommuting, living local and distributed energy, and who would be perfectly happy without fuels or cars.
Prior to the U.S. shale boom, analysts believed numerous pipelines and tankers would be needed to bring supply to user markets. But how does this supply affect geopolitics? Barring a war in the Middle East that destroys infrastructure and disrupts supply, the immediate impact of other geopolitical events such as a leadership change on oil production might not necessarily be so dramatic, Jaffe noted.
The cycle of oil prices over time definitely have a pattern, but catalysts from the geopolitical arena – which are difficult to predict – accentuate part of the curve or disrupt prices off the pathway for a particular time, Jaffe said, adding that the chart was like a inkblot, with different people coming away with different interpretations from the same data.
Jaffe likened the rise of U.S. tight oil production in recent years to the start of North Sea oil production in the early 1980s. U.S. tight oil production has grown through funding from master limited partnerships, while North Sea production was funded by trusts. Between 1980 and 1984, North Sea production grew at a rate higher than anticipated, and began its decline later than anticipated. Jaffe also sees similarities in the trends that impacted oil prices between 1973 and 1982 and 1999 and 2008.
Major differences that Jaffe sees in factors affecting oil prices then and now include a more intense regulatory environment now versus the 1980s. Other factors that could cause a price collapse include higher regulatory costs, and expensive renewable technologies that could have a breakthrough or a policy boost, Jaffe noted. This type of atmosphere could really accelerate demand disruption.
Given that oil is a fungible commodity, a disruption of Middle Eastern exports would impact prices, but Greg Priddy, director of global energy and natural resources at the Eurasia Group, is uncertain whether prices would react to these events as they would have before. Jaffe sees it as a revenue inflow-outflow issue, with people in the United States receiving cash flow, not Saudi Arabia.
While the United States is not immune from a disruption of Saudi oil supply, U.S. exports of liquefied natural gas (LNG), propane and refined products have also presented the nation with a unique opportunity from a policy point-of-view to shape the global energy market into the transparent, cost-effective market it desires, making it difficult for OPEC and Russia to keep a price contract system in place.
The expansion of the Panama Canal will make it commercial to export products that will compete with traditional naphtha and liquefied petroleum gas. The fact that products will be exported at West Texas intermediate and Henry Hub prices, and the volume of natural gas, condensate and product exports, will put double pressure on OPEC and countries such as Russia and Qatar.
"It will be 100 percent spot, 100 percent transparent and market adjusted," Jaffe noted. Given these factors, Jaffe questioned how Russia or Qatar or OPEC would could impose a fixed price contract in this new market.
Inaction Creates Concern for US Energy Future
However, the Obama administration's actions and inactions on energy-related decisions go against the stated policy of doing what's best for U.S. business and U.S. global competitiveness, said Charles D. McConnell, former assistant secretary for the U.S. Department of Energy (DOE). These actions and inactions include the administration's plan to cut DOE's fossil fuel budget by 25 percent while increasing DOE's overall budget, and failing to move forward with the Keystone XL Pipeline and LNG exports, despite findings these would have no negative impacts on the environment or U.S. gas prices.
"The biggest detriment to investment in the United States is uncertainty," McConnell noted. "Actions are tactics that speak loudly to strategy, which drives the marketplace you're in. Whether it's real or imagined, it creates an underlying concern for investors as to what the future looks like."
This uncertainty could halt the flow of investment in shale plays and prevent the United States from reaping the advantages that shale gas could bring for the next 20 to 40 years, including job and economic growth.
"There's been a lot of enthusiasm over rising U.S. oil production, which everyone is happy to take credit for, but whether it's really due to federal energy policy, I would argue not much," McConnell noted.
Regulatory uncertainty surrounding coal-fired power generating capacity has resulted in no new coal-fired power plants being proposed for construction in the United States. As a result, natural gas usage is growing. However, natural gas will not get a hall pass either on carbon dioxide emissions – a fact not said but true – meaning that large-scale carbon capture sequestration will become necessary.
The United States has a regional energy policy rather than a grand U.S. policy, with oil and gas exploration and production moving forward in some states and not others. McDonnell points to North Dakota's Bakken play – now home to the world's second largest McDonalds – as a great example of states creating U.S. energy policy by encouraging exploration and production.
The state of Mississippi has also benefited from energy policy to incentivize oil production. The state's royalties from oil have grown from $7 million a year to over $150 million a year and increased the amount of oil produced through enhanced oil recovery (EOR) from 5 percent to over 50 percent of the state's production. These increases in royalties and production have occurred thanks to policies to incentivize EOR production.
The primacies of U.S. states that have the technological capability are establishing U.S. policy on hydraulic fracturing. The federal government has not gotten involved unless states ask for help. Some states like Texas would rather not see a Fed, while other states such as Michigan have asked for help and made the most of it. Other states such as California have banned hydraulic fracturing, rather than deal with the issue, McConnell noted. However, the uncertainty over federal involvement in hydraulic fracturing and possible changes to laws has made investors in some cases reluctant to sink capital into the ground.
"Sometimes stepping in and making a decision is the only thing to do. Even if it's not politically expedient, but it's what business is screaming for," McConnell said.
US Energy Security Grows While China More Dependent on Unstable Oil
With International Energy Agency forecasts calling for 6 million bopd to come online in the United States between 2012 and 2018 and U.S. tight oil growing by 2.3 million bopd, the reduction in North America oil imports is likely to accelerate. While North America will still be a net importer by 2018-2020, most of those imports will come from the western hemisphere. A crowding out of production among OPEC countries is expected to result, with some reducing production, but Saudi Arabia will do what is has to do to keep exporting oil to the United States for political reasons, said Priddy.
While North America's energy supply security will grow, Priddy sees the opposite picture for China, where liquids production is not likely to increase very much, and the nation has no choice but to take a growing amount of supply from OPEC countries such as Saudi Arabia, Angola and other Persian Gulf countries such as Iraq and politically unstable regions.
China, a free ride on the United States' security presence in the Persian Gulf, would like to be on good relations with everyone in the region, but the environment of increasing polarization is not just being driven by headlines such as Syria and Iran, but the coming crowding out effect of a better supplied oil market.
Even with sanctions on Iran oil, Saudi Arabia had to pull back on production late last year, and will likely have to pull back below 9 million bopd later this year to preserve Brent oil prices in the low $90/bbl range as supply capacity expected to continue exceeding global demand growth in the near-term. Saudi Arabia will likely ask Kuwait and Abu Dhabi to help in reducing volume, but no other countries beyond that will come to its aid.
A production pullback will work in the short-term, two to three year time horizon, but the long-term trend is troubling as its unknown whether Saudi Arabia can meet its internal spending needs on lower prices in the long-term or return to a market share strategy. Even with a modest reduction in spending, Saudi Arabia could deal with prices being low long enough to kill off shale.
Two wild cards could complicate the situation: the likely plateau of Iraqi oil production in 2015 with no water injection facility in place and need to resolve the Kurdish issue, Priddy noted. The other wild card is Iran and the unlikely chance that the nuclear issue will be resolved. However, the Iranian sanctions have pushed back the day of reckoning, allowing OPEC to be compliant and bring down production volumes to 30 million bopd without Saudi Arabia handling the entire volume.
Sweet Crude Destined for US Now Headed for Asia
The backing out of light sweet crude imports from the United States means that more sweet crude will likely head from the Atlantic basin to Asia, which has been building out much more sophisticated heavy conversion capacity to handle the expected supply increase of medium sour crude from Saudi Arabia and Russia. Some refineries in countries with shrinking domestic demand have been consolidating capacity; this consolidation and the question of Canadian product exports could put additional pressure on the Asian market.
The Middle East's share of the international oil trade is expected to increase only slightly, but Africa is expected to be 21 percent of market by 2018 as production its production grows. Africa production that previously flowed to the U.S. East Coast is making its way to Asia. Russia will also have to direct more of its oil east as it adjusts to the new trend of lower European demand, Priddy noted. These factors mean that relatively lighter and sweeter crude will play a growing role in Chinese oil supply.
Despite political and regional risks facing some projects, more LNG is expected to come online, bringing more gas on gas competition globally beyond 2015 and creating more of a buyer's market. While strong government support is in place for not moving away from oil-linked pricing for LNG projects outside the United States, U.S. LNG will offer negotiating leverage for companies with contracts already in place. A good deal of U.S. LNG exports will be directed to Asia, but Priddy anticipates the Obama administration will take its time on approving a third LNG export project in order to "open the spigot at a gradual, measured pace" to minimize the impact on pricing.
Japanese, Chinese and Indian importers continue to seek to gain a foothold in U.S. upstream and access to technology. LNG projects in other regions face cost pressures, as is the case in Australia and Tanzania, and political pressures as seen in Israel and Cyprus
Wildcards facing U.S. LNG projects include Chinese gas demand with skepticism surrounding China's five-year plan to rapidly increase gas consumption and Japanese LNG demand. It remains to be seen how much nuclear capacity returns to operation in Japan in the next few years. The question of whether Japan can reach an agreement that would allow them to import U.S. LNG as a free trade agreement country must also be addressed.
Karen Boman has more than 10 years of experience covering the upstream oil and gas sector. Email Karen at email@example.com.