March 2019 Exclusive Story
Pending Regulation Has Broad Market Impacts
By 2025, the United States will export more energy than it imports, according to an integrated outlook by Wood Mackenzie’s Global Trends Service. That will mark the first time since 1952 that the country has attained “energy independence,” at least in a nominal sense.
“Energy independence” is a shorter and punchier term than “net exporter of energy,” but the latter is more accurate, observes James Brick, senior analyst at Wood Mackenzie. “Globally, the United States is still very much interlinked in energy trade,” and not just in terms of the physical pipeline links to Canada and Mexico. “What is changing is our relationship to the global energy market, from net buyer to net seller. Both of those positions have their own advantages, risks, and considerations.”
As that relationship changes, Wood Mackenzie concludes that the investments driving the United States toward energy independence will have substantial direct and indirect benefits for the U.S. economy, whereas any direct benefits from energy independence itself are more muted. Furthermore, U.S. energy independence will not isolate the U.S. energy markets from international risk, but it will change how these risks are considered.
“Irrespective of the timing of independence, the U.S. has started its transformation from energy consuming giant to prominent exporter,” Brick says. “With this role shift comes obvious economic benefits but also new risks and responsibilities.”
From the producers’ perspective, the successes in shale development is clearly a paradigm shift for the industry, the U.S. economy, and the global energy business, says Lee Fuller, executive vice president of the Independent Petroleum Association of America (IPAA). “Less than a decade ago, we were debating how many terminals we needed to build for importing liquefied natural gas and were concerned with ‘peak oil.’ The dramatic increase in this country’s ability to produce energy is a huge shift in thinking for everyone.”
Two main trends are behind the United States’ reversal of fortune and march toward energy independence, according to Wood Mackenzie’s outlook: higher production and lower demand.
“A country can achieve energy independence through two channels, it can either produce more or consume less, and the United States is doing both,” says Brick. “Over the past seven years, the United States has added 3 million barrels a day of tight oil and 27.5 billion cubic feet a day of shale gas to the global energy mix, a spectacular 42 percent increase in production.” Meanwhile, oil demand is decreasing primarily because of efficiency gains in the transport sector.
Production is the more important of the two drivers, Brick says, explaining that it is responsible for at least two-thirds to three-quarters of the net gain, in contrast to lower demand.
While the drivers are clear and steady, they are by no means inexorable, Wood Mackenzie cautions. The firm indicates that the uncertainties facing the U.S. energy market fall into two broad categories: those that make it more likely the United States will achieve energy independence before 2025, and those that will delay it. The key uncertainties that can speed U.S. energy independence include lifting of the U.S. crude-oil export ban, higher tight oil production and lower demand in the transport sector.
Economics and Consumer Behavior
Between the two drivers identified, there are nuances and reciprocal relationships, Brick suggests. “Of course, there is basic economics. High prices supported unconventional development, and higher production has put downward pressure on prices. Higher prices before the shale boom encouraged drivers to buy more fuel-efficient vehicles, which are still on the roads. There was also a recession, which reduces demand,” he illustrates.
In addition to economics and consumer behavior, there is government policy aimed at reducing U.S. oil consumption. “There has been a steady increase in the corporate average fuel economy standards for the entire passenger-vehicle fleet,” notes Brick. “There also has been fostering of natural-gas vehicles and biofuels. Those were seen as low-hanging fruit, and by international standards, there is still plenty of low-hanging fruit.”
For all the known data points and clearly advancing curves, there remain several variables. “For example, power generation is becoming more efficient, whether it is from gas-fired, coal-fired or combined plants,” says Brick. “The implication is that any calculation for gas demand growth in the power sector will be much more complex than a simple one-for-one Btu replacement of gas-for-coal.”
Within the producing sector, there are important variables as well. Brick credits the industry with vast and substantive advances, noting that those continue apace. “There are synergies being found on the drilling pad, there is down-spacing of wells, there are multiple benches being developed, and there still is plenty of upside from unconventionals,” he offers.
On a financial basis, he adds, “break-even costs are coming down in most basins. Tight oil is still very new, so for all the advances that have been made, recovery rates still are low–maybe half what conventional development would achieve. There is a very long way to go.”
IPAA’s Fuller concurs. “The big shift in thinking is on what can be produced. Current volumes look huge, but even in the Bakken, the amount of recovery still is a small percentage of the oil in place. More advanced recovery can continue to grow. This is extremely meaningful.”
If the crude export ban is lifted, Wood Mackenzie predicts the price realized by U.S. producers would increase as they gain access to higher-priced international markets. If crude exports resulted in U.S. producers receiving an additional $5 a barrel, production could increase by 350,000 to 450,000 barrels a day. To produce that additional oil, an investment of around $5 billion would be needed, Wood Mackenzie calculates.
“Not all companies would benefit from lifting the crude oil export ban,” allows Brick. “It is likely that upstream producers generally would benefit the most through increased volumes and higher prices. Oil field service companies and rig manufactures would also benefit from the additional investment.”
Even if the crude export ban is not lifted, the United States could produce more tight oil than is currently anticipated. Brick adds. “Tight oil and shale gas plays are still evolving, and there are many opportunities to apply new production techniques. Production could be as much as 3 million barrels a day higher than our view of 10.3 million barrels a day by 2030 as a result of technologies such as enhanced oil recovery and refracturing. EOR techniques currently being tested are especially promising and early indicators suggest recovery rates could double,” he explains.
While Wood Mackenzie forecasts the U.S. vehicle fleet to become at least 40 percent more efficient by 2030, there is potential for efficiency to improve faster, or for a more pronounced shift to cars away from less efficient light trucks and sport/utility vehicles. Any improvement in vehicle efficiency or reduction in vehicle miles travelled per capita would reduce U.S. oil demand and therefore net oil imports, Brick notes.
He says the three key uncertainties that would stall U.S. energy independence include delays in developing critical export facilities, environmental regulations, and energy policies that would encourage more natural gas to be used in power generation.
“If local or national regulation that discourages fracturing is passed, oil and gas production will be lower,” says Brick. “Also, if U.S. energy policy is enacted to reduce carbon dioxide emissions, it is likely gas use by the power sector will increase.”
Among the many different permutations and combinations possible for crude exports, Brick reckons that the most likely evolution will be moving along the spectrum of options. “However, Congress could flip the light switch and say all exports are allowed.” The basic logic there is that the U.S. exports just about everything else, including coal, natural gas, steel, food, and technology both civilian and military.
“Another option is more like a dimmer dial than a light switch,” continues Brick. “There are swaps and exports of condensate by special permission.” He also mentions the Jones Act, which requires coastwise trade between U.S. ports to be in U.S.-made vessels that are owned by U.S. companies and manned by U.S. crews. The law is older than the crude export ban, but it is similar in that it was enacted to accomplish a specific goal–preserving the U.S. maritime industry–but has had unintended consequences and has been hotly debated for years.
Given the difficulty of enacting any sweeping legislation or reform, Brick is not alone in saying that one possible scenario is that crude exports will grow slowly but could build some momentum until the ban becomes effectively moot and is removed.
“The self-sufficiency issue is difficult to assess,” says Fuller at IPAA. “Once gathering and processing infrastructure is in place, getting the tight gas to the end user is purely a distribution issue, but oil is the economic driver behind recent activity. For all the shale oil the United States is producing, it still all has to be refined. U.S. refiners can make more fuels and lubricants than the country can consume. As a result the U.S. is now the number one exporter of gasoline in the world.”
Balancing Domestic Demand
Offering some downstream insight, Fuller explains that “a lot of the crude export issue is wrapped in the historic investments that refiners have made. During the past 30 years or so, they have tended to reconfigure their operations for heavier, sour crude in response to the relative prices and availability of crude types on the global markets.”
In terms of process technology, refineries configured for light, sweet feed slates cannot process heavy sour crudes, but refineries configured for heavy sour crude can still handle light, sweet feeds, at least in terms of chemistry and catalysts. The problem, Fuller elaborates, is that the ratio of fractions runs into bottlenecks. “If a refinery is optimized for heavy crude and is sized to get, say, 30 percent diesel and 15 percent gasoline, then lighter crude is likely to yield higher percentages of those cuts—and the plumbing cannot handle the volume. The refiner has to keep the balance in the refinery, as well as the ratio of finished products it has arranged to sell.”
That does not mean there is little domestic demand for U.S. crude. “Many refiners run blended feed slates,” says Fuller. “We have also seen light, sweet imported crude being backed out.” He points out that at recent IPAA Oil & Gas Investment Seminars, some producing-company officials have reported they can get Light Louisiana Sweet premium pricing for some of their crude.
Refiners can also debottleneck or modify their process units and piping, notes Fuller, but always with an eye to the cost-benefit balance and also possible emission restrictions for their areas. “The question remains how far refiners are willing to go before shale oil fills the available processing capacity. We could start to see the early answers in 2015 or 2016. There is also the possibility for the midstream to do some simple processing, fractionation or distilling that could qualify the output for export.”
This is a very dynamic moment for both producers and processors, says Fuller. “The potential for our members to produce a lot of light, sweet shale oil is large and growing. Refiners always look for the most economical feed slate for the configuration of their processes and for the markets they serve.”
Returning to the original theme, Fuller summarizes, “the U.S. can be self-sufficient in total barrels of crude produced, but it is better to think in North American terms. It makes more sense to include the heavy Canadian and Mexican crudes in the equation. Given the current configuration for most refineries in the United States, there is a large volume of light, sweet crude that is most economical for export.”
Striking a hopeful note, Fuller adds, “The administration is grappling with all of these issues and is moving forward slowly, mostly to determine the impact on product pricing at the consumer level. The price of gasoline is a point of contention in the whole crude export question. Studies so far indicate that gasoline already is a global commodity, which means its price is determined by the international market.”