July 2013, Vol. 240 No. 7

From the Burner Tip

Rising Oil, Gas Production Gives Substance To Energy Independence

The hot topic in energy circles is whether recently developed drilling and producing techniques that are raising oil and gas production will help solve the age-old problem of U.S. energy independence.

In 1973 during the Middle East oil embargo, President Nixon vowed to wean the U.S. from foreign sources and be independent in energy supplies. That program was dubbed “Project Independence”. Every president since has made the same promise – with the same results!

Now with the U.S. reaching its highest oil and gas production in current times, the question of energy independence is hot again. Whether it is realistic to think the U.S. can “kiss good-bye to all its world energy suppliers” and truly be independent raises some questions of its own. What energy products are heavily imported? What does energy independence mean exactly and what are the good and bad of truly being energy independent?

First – for what energy products is the U.S. dependent on foreign suppliers? Of the three major fuel products, crude oil, natural gas, and coal, oil is the only product with a major import market. Coal never was since there are enough reserves that imports were never important except if economics dictated cheaper supplies from foreign sources.

Through the years, natural gas saw limited U.S. import markets – 10% or less. Where location played an economic role such as the Northeast, Canadian imports offered an advantage. A decade ago, domestic gas supplies seemed to be dwindling and imports of liquefied natural gas (LNG) were thought necessary. So several import terminals were planned and built to bring in more gas supply.

But before large volumes of gas were imported, production from shale-based reservoirs was commercialized. The development of horizontal drilling and better ways to free gas from the reservoir (fracking) was the game changer for natural gas development and production as it made large volumes available domestically. No longer was there a shortage. In fact, the surplus was so large it resulted in much lower prices for natural gas.

So much gas was available that it far surpassed domestic needs. Now U.S. producers want federal approval to export LNG to increase the market potential for natural gas which would bring supply and demand in better balance. They also want to take advantage of much higher prices paid for natural gas in Asia and Europe.

Liquid fuels, mainly crude oil, are the major imported product and the only one where there is a real dependence on foreign supplies. Crude was brought in to feed many U.S. refineries making finished oil products like gasoline, diesel and jet fuel, and chemicals. Dependence on foreign oil peaked in 2005 but has declined steadily to where refinery feed was 56% imported oil in 2012 and is expected to fall to about 50% in 2013.

Most of the imported oil is from the Western Hemisphere; for 2012, 28% from Canada, 13% from Saudi Arabia, 10% from Mexico, 9% from Venezuela and 5% from Russia.

In addition to lower imports and higher U.S. production, crude demand for refined products is flat this year compared to last year as improved vehicles make better use of fuel. Higher gasoline prices also have slowed demand.

The concerns over the high amounts of imports are attributed to security of supply, the large amounts of cash that are leaving the country and affecting the trade balance. Sometimes buying foreign oil sends U.S. dollars to countries that are not favorable to our aims and goals. The last concern for wanting more independence is the thought that more of it will help control energy pricing.

Since a large portion of the imports come from North American countries that are friends and trading partners like Canada and Mexico, a better term might be North American Independency.

The very thought of supply independence raises the question, when talking about buying and selling large quantities of a world commodity like crude oil, can a buyer or consumer truly be totally independent? Market forces will always dictate the price of the commodity; the supply will always go to the highest bidder. And oil is also an easily transportable product.

There are many who believe the idea of U.S. or North American independence in crude oil trading is really a myth. Because the market is worldwide and so large with so many buyers, there may be no independence. Any thought that having independence will let one control pricing is completely illogical. To most, surplus capacity of crude in the marketplace will mean price stability which will happen as the U.S. and other nations boost production.

Some other reasons showing that independence may be wishful thinking or may only offer moderate benefits will be discussed later.

There is no question that more oil available from the U.S. and other countries does help to stabilize crude prices and prevent spikes that occur when local incidents threaten supply, be it in the Middle East, Africa or any other significant producing area.

OPEC’s ability to set prices or, what some might call its cartel ability, is greatly diminished when crude markets have excess supply and can readily adjust when a supplier fails.

The U.S.’s oil and gas increased production, along with other countries beginning to utilize the new technology, will affect global energy prices. Petro countries setting the prices will be affected. Francisco Blanch, head of commodities research at Bank of America Merrill Lynch, was quoted in an article by Edward Fishman saying, “Oil could fall to just $50 a barrel within the next two years.”

The impact of the increasing oil supply, especially coming from the U.S., offers other reasons why independence may be no more than a myth. Some feel the U.S, will become the largest oil producer and surpass Saudi Arabia by the end of the decade. But, even though the U.S. may become self-sufficient or “independent,” it will not be able to turn its back on the rest of the world. Its leadership role might have to increase for the sake of stability in the Middle East because of falling oil prices.

Many Middle East countries are held together because of petro-dollars. Loss of this excess income because of their lack of price control can only mean more uprisings and revolts. America’s role to stabilize the region might become even more important as oil-market stabilizer when prices are more in accord with the actual value of crude!

Middle Eastern and African producers are not the only ones wanting the highest prices – Russia also needs prices close to where they are now to maintain its strength. Lower prices might mean a more aggressive country determined to get what it wants and needs. Again, the closer North America is to independence, the less Russia would seek more aggressive action.

North America – the U.S. with oil potential of the outer shelf, increased production from shale deposits, Alaskan potential and other possible crude oil plays – and Canada with tar sands oil and the agreement for the Keystone second pipeline – and improved Mexican operational and economic control designed to increase output – can play a major role in making North America more independent in crude oil supply.

Maybe there is no such thing as being totally independent, but enough to increase security of supply and dampen the big price spikes that sudden moves by the petro-dollar countries can create. These alone will be a big enough benefit!