Unintended Consequences of the U.S. Shale Oil Boom

The global turmoil in energy prices is not the only problem brought about by shale oil and gas revolution in the U.S. While this revolution bolstered U.S. energy independence, the latest developments in the U.S. oil demand, refining, and storage have been far less predictable, and even seem downright illogical. Currently, the U.S. oil imports are growing, oil storage is record high and still on the rise, and American refineries are losing money from processing domestic light crude oil (with low viscosity and density) compared to imported heavy oil. This situation arose from domestic oil boom being at the right place at the wrong time.

 

Following the peak of domestic oil output and increasing imports over the past few decades until the shale oil industry shot up oil production in late 2000, American refineries had installed expensive coking units to process leftover heavy oil into higher value products such as naphtha, light oils, petroleum coke, and intermediate oils. In other words, margins for American refineries increased with processing imported heavy crude oil. Enter light oil crudes from domestic shale formations into the market. Running light crudes is not so profitable for U.S. refineries given that the latter are configured with expensive coking units designed to process mostly heavy crude oil. Given the uncertainty of long-term stability of light crude oil production in the U.S., refineries with coking units may stand idle or process light crudes at a loss.

 

Furthermore, because American refineries profit more from gasoline production than distillates (because U.S. motorists mostly consume gasoline than diesel) with the rising demand for gasoline, there are too much distillate products and not enough gasoline for domestic consumption. Given that domestic and global demand for diesel is not so strong at this point, the U.S. refineries have been storing the unwanted stocks of distillates. Meanwhile, gasoline demand is also growing in China and India and refineries in both countries are trying to get rid of surplus distillates by exporting them.

 

While American refiners are still enjoying strong margins, continued production of domestic light crude oil will mean more storage of unwanted distillates. The U.S. currently has more than 1.2 billion barrels in storage, most of which is light oil. Under the current market conditions, the cost of storage will remain important. If interest rates go up, which will increase the cost of building oil storage units, it will become more expensive to store oil. Therefore, the only way to absorb the storage glut will be to curtail the production of domestic crude oil. In turn, for American refineries to reap economic benefits from refining, overproduction of light crude oil needs to decrease and heavy oil runs should increase. Given the growing demand for gasoline and refineries built to process heavy oil, U.S. oil imports are already rising. Although the repeal of the four-decade-old export ban last year has not led to the decrease in oil storage or a significant jump in exports due to the global oil glut, the only way that the U.S. shale oil boom will be sustained is if it increases exports and global demand for crude oil and middle distillates will pick up pace. However, the status quo might last through 2016.

 

 

 

 

Looking with Caution at the Rising Power of Master Limited Parntership in the U.S. Energy Sector

On the face of it, Master Limited Partnerships in the US are a dream investment. To increase capital to finance upstream and midstream energy sectors the United States Congress enacted the Master Limited Partnership (MLP) legislation in the 1980s. Structured much like a corporation, MLP’s offer excellent tax breaks as long as profits are not retained at the end of the year but instead distributed to investors. MLP’s have been popular investment vehicles in the oil and gas industry, with a number of midstream players, in particular, structured this way. However, MLP’s have their risks. The MLP structure does not encourage infrastructure spending, which can lead to safety issues (poorly maintained pipelines, for example). MLP’s are not subject to GAAP rules, either, so there is little to prevent these entities from exaggerating earnings and engaging in other morally questionable accounting practices. In my May 2, 2014 article in the European Energy Review, I closely examine the advantages and potential pitfalls of the rising profile of MLPs in the U.S. energy sector. Here is a link to the article. 

New Communications Technology for the 21st Century Oil and Gas Frontiers

The era of easy oil and gas is over. The 21^st century frontier of the oil and gas sector is increasingly in remote, hostile, and geologically challenging areas of the world. The promising hydrocarbon areas of the world, for example, the ultra-deep offshore oil plays in the Arctic, West Africa, the Gulf of Mexico, or Brazil; shale gas and oil in the U.S., China or Australia; or oil sands in Canada, demand continuous and reliable communications technologies to withstand extreme heat, ice, snow, humidity, rain, wind, and fog.

Given the extreme environments that energy companies cope with, high capacity and reliable wireless communication are indispensable for continuity and safe operations. Wireless connection helps build a foundation for many networks of broadband speed and to sustain multiple applications, such as SCADA (Supervisory Control and Data Acquisition) systems, real-time video monitoring of wells and other facilities, communications and monitoring of drill rigs, surveying location of oil and gas assets, among other functions. Technology firms point out the rise in use of satellite communication in the oil and gas industry, attributing it to the challenging locations of fossil fuel drilling. Satellite companies see great opportunities in the oil and gas sector as the latter increasingly integrates video monitoring of wellheads and drilling. Fiber optic technology is also gaining a market share in the energy sector as the distributed fiber-optic sensor sector is expected to grow to $1.1 billion in 2016, 70% of which would be linked to the oil and gas market.

As the use of satellite, radio and fiber optic technologies are becoming integral parts of modern communications for all aspects of oil and gas operations, their application for some of the challenging and hostile areas of the world is still sparse, particularly in emerging markets. For example, the deepwater oil drilling in West Africa constitutes a majority of total oil and gas output for the region, but some of the most reliable communications protocols used globally are still absent in this part of Africa. The existing conventional and wireless communication in West Africa has been subject to breakdowns and stoppages, jeopardizing the safety of rigs and personnel. Remote communications are still difficult in many regions of Africa. In general, oil and gas fields that cover many miles of remote and harsh parts of the world are often short of cellular connection. If energy companies are to profit from operating in extreme environments, the 21^st century oil and gas development is likely to set the level playing field for investment in state-of-the-art communications technology, whether the drilling is in Africa or the Arctic.

Critical Point for U.S. Gas Flaring

A sign of unconventional oil boom in the U.S. can now be seen from satellite photographs of flared gas from oil wells. NASA’s pictures from the space show brightly lit areas of sparsely populated Northwest North Dakota amidst the darkness of the Great Plains. Flaring of associated gas from oil wells in North Dakota jumped up to over 50 percent since 2011, according to a non-profit organization Ceres dedicated to improved corporate sustainability. Associated gas is a form of natural gas that is found during petroleum extraction and it can be captured and processed for electricity generation or reinjected to oilfields for enhanced oil production. Hesitance of the oil industry to invest in expensive infrastructure to capture the associated gas, in view of record low natural gas prices, has catapulted the U.S. to the ranks of 5^th worldwide for the highest volume of gas flared, nearing the levels of Russia and Nigeria. 

Although flaring is less environmentally damaging than venting natural gas into the atmosphere, it is a pollutant that emits large amounts of carbon dioxide. The Bakken oil formation in North Dakota has turned this Upper Midwestern state into #2 producer of oil in the U.S. after Texas. North Dakota is also the largest contributor of flared gas. According to some estimates, the value of burnt off gas in North Dakota is close to $100 million a month. With tripling of flared gas over the last two years, companies operating in North Dakota are under pressure to reduce flaring or pay royalties and taxes in compliance with the state regulations. The state’s regulations allow oil producers gas flaring for one year without paying taxes or royalties on it, with a possibility of extending this provision on the grounds of economic difficulties of linking wells to a natural gas pipeline. After this period, “producers can continue flaring but are responsible for the same taxes and royalties they would have paid if the natural gas went to market.” 

Gas flaring is now a political issue in North Dakota. In an unprecedented move, mineral rights owners in this state have filed 10 class-action lawsuits against oil producers this October, demanding millions in dollars in lost royalties from flared gas in fracked oilfields and hoping that such pressure would expedite flare reduction. More landowners expressed interest in joining the litigation against oil companies in North Dakota. While the process is in the early stages, it is widely believed that a successful outcome of these lawsuits may increase the cost of oil drilling and slow down this state’s booming economy. However, reduction of gas flaring does not have to end in a zero-sum game. Norway’s oil production did not stop because of strict regulations imposed on management of associated gas. Oil drilling in Norway is allowed only after solutions on handling associated gas are presented to the authorities. The U.S. oil industry has reached the point that it cannot ignore the scale of economic and environmental cost of flared gas. Given the latest legal pushback from landowners in North Dakota, the U.S. has a chance to learn from the best practices in harnessing the associated gas

Water: The Achilles’ Heel of the U.S. Unconventional Energy Sector

Growing global scarcity of freshwater has made this resource more valued than oil due to an increasing world population and demand for water, pollution, and climate change. Water shortage is a colossal economic and social cost to all consumers, including the oil and gas industry, which is critically dependent on this commodity for its operations. With an expected rise in water consumption in the U.S. by an estimated 7 percent by 2030 from 2005 levels, 85 percent of which will be used by the energy sector, fuel production is likely to both increase its impact on water availability and quality and become vulnerable to potential water supply disruptions.

With the 36.5-percent increase in U.S. unconventional fuel extraction between 2005 and 2012, this energy sector faces challenges in balancing its water needs. While some reports claim that water demand amounts to nearly 5 million gallons of freshwater per shale gas and tight oil well drilling, there is conflicting information and uncertainty about the amount of water the unconventional energy sector consumes, which complicates water management in and between the states. Safe disposal and treatment of produced water from hydraulic fracturing, or fracking, are some of the pressing concerns for the industry and nearby communities. As competition for freshwater rises in areas of the U.S. where water demand for unconventional fuel production is highest, for example, in North Dakota, Texas, and Colorado, recurring severe droughts pose a risk to the long-term sustainability of water resources in energy producing states.

This complex energy-water predicament necessitates a comprehensive water management strategy and collaborative government-industry led solutions. The lack of comprehensive data and research on water supplies, the energy sector's use of this commodity, consumption levels, and wastewater from fuel extraction stands out as a main barrier to framing energy and water-related problems and developing measurable solutions. Collection of such information could help determine the future sources of water for the energy sector, the impact of the energy industry’s water use on the society, and decision-making on allocation of water.

An important step to improving data collection could be establishment of minimum standards for information-sharing on the oil and gas sector's water consumption, set by the federal government. The federal government should establish an online platform dedicated to disclosing information on the amount of water used in oil and gas production, the volume of wastewater derived from petroleum operations, and wastewater treatment, recycling, and disposal practices. Penalties should apply for failure to report. Reliance on voluntary disclosures could be ineffective due to insufficient and irregular reporting, as evidenced by the experience of FracFocus, an online registry designed for disclosure of chemicals used in fracking.

Further, due to the heavy role of state governments in regulating operations of energy companies in their jurisdictions, states could step up efforts to manage produced water from shale gas and oil drilling. Pennsylvania's requirements to recycle flowback water from shale gas production and limitations on surface wastewater disposal have increased water recycling in shale gas operations. Texas enacted new rules that encourage water reuse by eliminating recycling permits for drilling operators if they recycle fluids on their leases or transfer the water to another operator's lease for recycling. Such efforts could incentivize the industry to look for innovative solutions to treating and reducing produced water.

Extending the efforts to improve water management, state governments and the industry should also consider adopting best practices in seawater desalination in states near the sea, for example, Texas and Louisiana, to shift from freshwater use for drilling. This is particularly relevant given that the industry prefers freshwater for fracking because it is less corrosive. As part of the measures to prevent freshwater contamination, it is also imperative for the unconventional energy sector to improve well construction, casing, and leakage containment, especially in light of heightened public concern about the impact of fracking on groundwater. The U.S. Environmental Protection Agency's anticipated 2014 report on the impact of fracking on drinking water is likely to help chart the course of further policymaking toward this industry.

Lastly, the U.S. should consider expanding trading water access rights in some of the arid southwestern states, as competition for water resources is set to increase between energy, agricultural, and municipal usage. State governments should study successful water trading schemes in western U.S. and globally and adopt the best practices. An effective water trading mechanism will hinge on distinctly and uniformly established water rights, which is not the case in some of the most energy- and water-intensive states, such as Texas.