Who is Holding the Cards?

The booming U.S. shale oil and gas production is not necessarily a recipe for the country’s energy independence because China will prevent the U.S. from reaching it. So goes the argument of an article by Matthew Hulbert featured in Forbes on August 23, 2012. In Hulbert’s view, China’s relentless acquisition of physical assets and sucking out of the North American energy will basically render the notion of energy independence an illusion.

 

While Hulbert makes a good point about China’s active role in gaining a foothold on North American energy market both in terms of investment and imports of oil and natural gas, it appears his argument on China stopping the U.S. from reaching energy independence is as uncertain as China’s ability to single-handedly rebalance WTI and Brent crude oil benchmarks. The starting point for energy-hungry China is to increase supplies at home and from abroad and the U.S. is potentially an important supplier. The frenzy to gain access to the North American energy market is driven by China’s goal to obtain technological know-how to develop its own copious reserves of shale gas as well as to secure oil and gas supplies. China’s access to North American physical assets would help China achieve these goals. But China would not be the one calling the shots in the U.S., which is dominated by domestic energy majors as well as foreign investors other than China. 

 

For better or worse, America acts in its self-interest in terms of its energy supply security. It is a country that instituted a law banning crude oil exports under the Mineral Leasing Act of 1920 and Outer Continental Shelf Leasing Act. The ban has eased somewhat in recent years due to booming domestic shale oil supplies. But as recently as March 2012, Congressional Democrats sought a bill that would ban any export of American oil to keep energy costs down. It make sense to sell them abroad because most local refineries are better fit for processing heavier crudes. It is possible that U.S. may export its excess cheap natural gas to China, but it will be sensitive to changes in domestic market fundamentals and prices, which will determine the level of exports. At the moment, U.S. would benefit from clearing the natural gas glut, but it is uncertain that low domestic natural gas prices and exports will be a long-term development. A change in domestic gas demand and price will affect how much of it will continue to be exported.

 

One thing that Hulbert is on point is America’s inability to insulate itself from fluctuations of international oil prices because of their interdependence. U.S. cannot control that, so full energy independence as such may never be achieved.

US: Higher Gas Prices with Plenty of Energy Supplies

Oil prices are on the upswing in the U.S. again. National average for a gallon of gas has increased by 34 cents since July 1. Factors that attributed to the spike include anticipation of more stimulus aid to Western and Chinese economies, uncertainty over the status of the Strait of Hormuz as a result of tightening sanctions against Iran and its threat to close the globally important waterway, high driving season that summer tends to be, production disruptions in South Sudan and North Sea as well as a few refinery outages in the U.S. Some observers predict the price of gasoline would ease after Labor Day, which might just happen without releasing oil from the U.S. Strategic Petroleum Reserve.

In fact, there is no shortage of oil in the U.S. right now and, if anything, oil production and refining have been on aggressive rise. What seems to matter to understanding the vagaries of oil prices is not necessarily the scarcity of domestic oil supplies, but global market reactions to geopolitical events and sudden changes in physical factors, such as refinery shutdowns. In fact, recent developments in the U.S. refining sector should give signs optimism about supplies of refined oil products available in the country. U.S. could benefit more from it once prices of various domestic crude benchmarks narrow (e.g. Louisiana Light Sweet, West Texas Intermediate, and Bakken); if its capability to refine both heavy sour (Canadian imports) and sweet crudes (from domestic shale formations) improve; and if more supplies become available to the East Coast.  All three factors appear to have positive indications. It is worth noting that the Atlantic region has faced a price spike at various times due to limited refining capability on the East Coast and relying more on imports of sweet crudes from abroad.

In recent years, availability of copious supplies of oil and gas in the U.S. boosted its refining industry, which has been increasingly willing to “improve value through share buybacks and dividends” and investments in upgrading a lot of its coking capacity to profit from processing heavier crudes. It is likely that easing of prices for refined oil products, including gasoline, may maintain for a few years in the U.S., aided by a recent reversal of the Seaway pipeline from Cushing, Oklahoma, to Texas and with weakening of Louisiana Light Sweet and Brent crude benchmarks, which have traditionally been linked to refined oil products. In the end, the level of domestic oil supply alone cannot be the answer to price fluctuations, but it can be found more in exogenous factors such as weather, a geopolitical crisis or war, shifts in global oil demand and supply, natural disaster, or unexpected production or refinery shutdowns here or abroad as a result of these.

Love It or Hate It, You Need the Keystone Pipeline

The controversial Keystone pipeline is in the news again after the Canadian pipeline company, TransCanada, secured last three permits from the U.S. Army Corps of Engineers to extend the southern leg of the pipeline to the Gulf Coast. This move upends the January 2012 rejection of the Keystone XL pipeline by the U.S. Department of State, which was reportedly based on insufficient time to evaluate the pipeline’s environmental impact. Unpopular among environmental groups in America, the Keystone pipeline’s new extension is likely to generate another wave of disagreements and protests over a potentially damaging impact of the heavy and low-quality Canadian oil on ecosystem of the U.S. Some of my friends have been eager to express their disappointment and frustration in various social media outlets on the approval of the Canadian pipeline at what they see the time of hastening rate of climate change.

But Keystone is, in many ways, inevitable for the U.S. The country is still over 90 percent reliant on gasoline for transportation and it seems like people here tend to forget (or to not know) how the recent history of U.S. oil production, trade and refining have permanently changed the types of oil used in the U.S.  Steady decline of U.S. sweet crude oil output from the early 1990s through the middle of 2000s have led to a change in the relationship of the West Texas Intermediate (WTI) benchmark towards other regional benchmarks, shutdown of many refineries in the Gulf Coast and reversal of directions of some, as well as to an increased demand for more offshore imports of sweet crude to meet local refinery needs, including rapidly rising Canadian supplies.

As imports of Canadian synthetic crude oil to the U.S. began to increase, Gulf Coast refineries were adjusted to handle heavier crudes from the northern neighbor. In fact, the recent surge in shale oil development in places such as North Dakota, which ramped up domestic sweet crude production again, is likely to find a good market abroad since “the Gulf Coast refining hub is more suited to process heavier crudes,” in the words of the recently appointed head of the Energy Information Administration (EIA), Adam Sieminski. Canadian oil, which stood at number one in U.S. net crude imports (29 percent) in 2011, is bound to increase its market share in the U.S. via the existing Keystone pipeline and its planned southern leg. So, what to do with the dirty Canadian oil? The answer lies in oil (gasoline) consumption of every American, who cannot, and should not, separate the influx of dirty oil from Canada from his/her own contribution to its rising supply to the U.S.

China in the Driver’s Seat on Direct Coal-to-Liquids Production

Coal is here to stay. More in some countries than others. In places like China, while coal is still king, its role appears to be slowly morphing to liquid fuels such as gasoline and diesel. With the world’s third largest reserves of coal after Russia and the U.S., China sees the future in coal-to-liquids (CTL) fuels in order to reduce dependence on foreign oil and to maintain robust domestic CTL production as an alternative to petroleum. Despite environmental and economic costs of producing liquid fuels from coal, China’s state-run Shenhua Group began profiting from its first direct coal-to-liquids (CTL) facility in Inner Mongolia Autonomous Region, China, and producing 216,000 tons of refined oil products in the first quarter of 2011. Although China wavered to use the CTL technology in 2008 due to high production costs and concerns with water use, its push forward resulted in stable production for the past nine months, bringing in 100 million yuan ($15.38 million) in earnings in the first quarter of 2011 to Shenhua.

Direct-liquefaction CTL, which converts coal to liquid fuels by way of heating finely ground coal above 400 degrees Celsius with hydrogen and a suitable catalyst and further processing to obtain naphtha and middle distillates, has not been widely used in the world yet. The reasons include high production costs, technical challenges, comparatively cheap global oil prices that make it difficult to invest in expensive CTL technology, as well as its carbon footprint, which would not be insignificant due to emissions from hydrogen production and thermal loss. There have been long-standing concerns with toxicity and carcinogenicity of liquids produced from direct CTL fuel production, which still warrant detailed studying. For these reasons, the CTL industry has not developed in the U.S., another country with vast coal supplies.

It is unlikely that CTL will gain much traction in the U.S. in the near term, particularly given its massive shale oil and gas production that have further displaced coal in its energy mix. But China’s continued experimentation with direct CTL production to make it economically viable and less taxing on the environment, or failure to do so, would be worth monitoring and taking a note. The true cost-benefit analysis of the direct CTL technology and any serious attempt to develop or invest in it in the U.S. might occur when domestic natural gas prices begin to rise from their current historic lows as well as sustained high crude oil prices.

The Elephant in the Room: Fuel Exports

Much has changed in the U.S. energy landscape that some of the unthinkable scenarios of the yesteryear might just be realistic these days. For example, the U.S. is beginning to flirt with the idea of potentially exporting natural gas, coal and maybe even crude oil.  At least in the words of the newly appointed head of the Energy Information Administration (EIA), Adam Sieminski, the U.S. should be open to crude oil exports to benefit its economy, particularly because the “selling the U.S. oil abroad could help provide a market for light sweet crude produced from shale formations in places like North Dakota, since the Gulf coast refining hub is more suited to process heavier crudes.” While Sieminski’s proposition on oil exports will need to overcome the U.S ban on selling most unrefined crude oil under the Mineral Leasing Act of 1920 and the Outer Continental Shelf Lands Act, which make oil exports nearly impossible, the possibility of exporting natural gas and, especially, coal appears to be less far-fetched, partly because they have created a huge glut in the country.

Proponents of the idea of exporting natural gas from shale formations, production of which increased from nearly nothing to 23 percent of all U.S. gas production in 2010 with prices hovering around $2.8 per million British thermal units, point out that prices and profits are likely to stay depressed for decades without alleviating the glut of natural gas. They have a point. Given that the surge in shale gas production began inevitably eating into the coal market in the U.S. with its record low prices and coal-to-gas switching, King Coal maybe looking at markets abroad as well, particularly since demand for coal is rising in Europe. Reportedly, U.S. coal companies “are spending at least $530 million to increase their coal-export capacity in order to meet high overseas demand.”

Exporting U.S. energy sources may not be swift, but it will be unavoidable provided that the gas glut and unused coal stay idle in the U.S. market. And too bad that it is not receiving as much attention in the government as it should. Even if opponents of natural gas exports argue that keeping gas prices low would be key to many industries, including domestic manufacturing and transportation sectors, few politicians on both sides of the aisle appear to be opposed to gas exports. But even fewer politicians openly state their support to exports lest should they be accused of causing domestic price hikes.  And even if there is an eventual agreement to export natural gas, it looks like there will be cap on the amount. As Cheniere Energy won the bid to build an LNG export terminal in Louisiana to begin operation in 2015, political will to agree on exporting fossil fuels in the U.S. may emerge by that time. Perhaps, it will be ushered in further with influential figures such as Sieminski. When that day comes, the ultimate question will be how much energy should be exported.

Challenges of China’s Fuel of Choice

The Chinese economy has grown by an average of 10 percent a year over the past two decades, crossing the milestone to become the second-largest economy and energy user in 2010 after the U.S., as well as the world's largest emitter of greenhouse gases. Stable energy supplies being at the core of China’s rise, they remain pivotal to its continued economic growth, especially coal, oil and gas. While coal still constitutes around 68 percent of China’s energy use, Chinese policymakers and energy executives lean more and more towards cleaner fuel sources, particularly natural gas. According to International Energy Agency’s June 2012 report, the share of natural gas is set to rise in China’s energy mix, which is expected to have strong implications on the country’s energy usage in the years to come.

Analyzing the new role of natural gas in China, my new article published in Oilprice looked into China’s natural gas policy, main players in its gas market and problems it faces with the rise of Central Asian gas imports (full article can be accessed here). I concluded that mounting natural gas demand, combined with the official endorsement of clean energy sources, is bound to solidify the position of natural gas in China’s energy mix in the years to come. But liberalization of domestic natural gas prices will be absolutely key to attracting private investment to successfully develop domestic gas and to continue importing this energy source without hurting Chinese energy companies.

Why U.S. Shale Gas Will not Be a Cookie Cutter Model

A new report of the International Energy Agency (IEA) on unconventional natural gas earlier this month predicted that “global exploitation of shale gas reserves could transform the world's energy supply by lowering prices, improving security and curbing carbon dioxide emissions.”  But unconventional gas revolution may fall short of its promise if social and environmental issues are not adequately addressed. The IEA report points out many common concerns about shale gas extraction in the U.S. and other countries.  Chiefly among them are groundwater and air pollution, dangers of structural faults in well drilling, disposal of flowback water, and emissions of polluting gases from wells, which are some of the factors of public skepticism about the industry’s safety.

As more countries begin to tap shale gas, the learning curve promises to be steep.  Countries with major shale gas reserves, such as China, Australia, Poland, and Canada, are aware of the long lead times, high capital and operational costs, necessary price environments to attract investment, and the importance of overcoming regulatory and environmental constraints before this resource becomes a reality.  Just this week, Europe’s biggest shale potential in Poland came under question and confusion after ExxonMobil pulled out of shale exploration in this Eastern European country due to unsatisfying findings, legislative foot dragging and complex geology.

Conditions that existed in the U.S. to revolutionize this industry may not exist in other countries to easily replicate its success, which include geological differences, inadequate or lack of access to equipment, water, manpower, and infrastructure as well as complex land ownership issues. Because maturity of the shale gas industry outside the U.S. will take anywhere from five to ten years before it reaches commercial production levels, developments in this unconventional gas sector in America are likely to set the tone to other countries.  In other words, what happens in the U.S. shale gas is bound to have ramifications on the trajectory of the industry elsewhere because the U.S. is far ahead of the rest of the world in exploiting this energy source. 

As much as there is enthusiasm and effort to follow the footsteps of the American unconventional gas evolution, a possible serious incident in the U.S. shale gas may set the newly emerging industry back in the rest of the world.  Given an already complex set of costs and public concerns over hazards of shale gas in many countries, an incident in one country is likely to cause more stringent regulations, and even more moratoria, in others.  In such a scenario, costs of drilling and operations are likely to be even higher for investors and operators with an added challenge of winning hearts and minds of the distrustful public.  The U.S. may have brought down the costs of taking natural gas out shale rocks, but its global success and acceptance will hinge on minimal mistakes and no major disasters.