U.S. Industrial Renaissance Grapples with Looming Exports of Cheap Natural Gas

Natural gas is a new king of the hill, according to a newly released ExxonMobil’s 2013 Energy Outlook. Natural gas would displace coal as the world’s second biggest energy source after crude oil, claims the report. One of the key conclusions of the ExxonMobil report is that “North America will change to a net energy exporter from an importer by 2025.” It predicts that over “half of the growth in unconventional gas supplies will take place in North America, providing a foundation for strong U.S. economic growth with solid contributions from the energy, chemical, steel, and manufacturing industries.”

The latter points, however, appear to be a matter of debate. To a degree, industrial growth is in a collision course with America’s ambitious natural gas export plans. Gas prices hovering at around $3 per million metric British thermal units in the U.S. for many months and energy companies switching to more profitable crude oil production from shale formations, exporting natural gas seems like a sensible policy, pushed forth by the energy industry and some government officials. While it will take years before gas exports will become a reality, given the time required to secure licenses and high costs of liquefied natural gas (LNG) infrastructure, there is also a concern that exports could be a setback for the U.S.

Namely, the manufacturing and industrial sectors see greater difficulty to grow in the U.S. if natural gas exports materialize and push domestic prices up. The revolution of the shale gas industry has revitalized domestic industrial sector and brought back manufacturing from abroad to the U.S. Manufacturing costs are much cheaper in the U.S. due to low-cost natural gas compared to even places such as China, the world’s leading manufacturing workshop.

Major industrial firms began taking advantage of low energy costs in the U.S. and creating jobs. For example, “steelmaker Severstal recently expanded its Mississippi and Michigan plants, and Airbus unveiled plans for a giant, new factory in Alabama.” Dow Chemical, among other major chemical companies, “which is investing $4 billion to build three new chemical plants in Texas and restart a fourth in Louisiana, compiled a list of 102 projects across a range of industries worth a total of some $80 billion that are being started in response to the availability and low price of domestically produced natural gas.” Investment in manufacturing is attractive to even some energy companies, such as Shell Oil, which is mulling over construction of a large petrochemical complex in shale gas-rich Pennsylvania to produce ethylene, a feedstock for plastics, from ethane.

These and other companies are now concerned that exports of natural gas will increase the prices, which have enabled the U.S. industrial renaissance, and threaten billions of dollars worth investments in capital. According to Dow Chemical’s vice president of climate change and energy, George Biltz, “if a single cubic foot of natural gas is exported, it gives the United States a one-time jolt. But if you take that same cubic foot and you roll it through manufacturing, whether it's steel or chemicals or pulp and paper or rubber, this has as much as a 20x impact when you roll it through the whole GDP of the country.” A recent study by NERA Economic Consulting for Department of Energy argues that exports will not bring sharp increases in gas prices; on the contrary, “export revenue would generally help most Americans.” The NERA report admits that “natural gas prices could jump by over a dollar per thousand cubic feet, or more than 25 percent, over five years if there are significantly more exports,” which would still be much lower than just four years ago. It is to be seen whether the U.S. Department of Energy will manage to ensure that continued issuance of export licenses would not to drive up gas prices high enough to carry negative consequences on manufacturing and industrial production.

Some Caveats on IEA’s Ambitious Forecasts

The International Energy Agency (IEA) issued its flagship World Energy Outlook (WEO) report this month, which emphasized three main game-changers of the world energy landscape to date: explosive development of unconventional oil and gas in North America, increased Iraqi oil production, and energy efficiency. Presenting the report at the Carnegie Endowment for International Peace on November 27, 2012, IEA’s chief economist, Fatih Birol, stressed that the “foundations of the global energy system are shifting, with implications on everyone.” Rapid developments of unconventional oil and gas in the U.S. and Iraq’s oil production have played an important role in this shift. In fact, the most interesting point of the report is the ambitious projection for the U.S. and Iraq. Fatih Birol said that the U.S. will overtake Russia and Saudi Arabia in oil production by 2017, noting that while the U.S. may become the largest oil producer, Saudi Arabia will continue to remain the largest exporter of oil. Meanwhile, Iraq would account for 45% of the growth in oil production by 2035, according to IEA.

But these projections may be too modest, at least according to Leonardo Maugeri, a former Eni SPA executive who is currently a fellow at the Harvard Kennedy School’s Belfer Center for Science and International Affairs. Maugeri argues that oil production levels in the U.S., Iraq and Saudi Arabia could be much higher than what IEA predicts in its WEO report. Basing his statements on studies he is currently conducting, Maugeri believes that Saudi Arabia’s “production capacity would still be higher than that of the U.S., but probably the Saudis will not exploit it fully, in order to support oil prices.” Similarly, he believes that IEA’s projected oil output of 6 million barrels per day by 2020 was low and the Agency “seems too cautious about effects of investments and new production technologies.” In short, the world has not run out of oil; rather the opposite, it may be entering the era of oil abundance.

Clearly, energy abundance is good news. But there are a few important caveats. The long-term future and implications of the revolution in technology, namely, hydraulic fracturing and horizontal drilling, that changed the U.S. energy landscape overnight, are likely to be less concrete than they seem at the moment. We do not know what kinds of regulations await the development of unconventional energy sources down the road if there is a serious accident or if the industry fails to win the tenuous public trust due to poor environmental practices. There is ongoing tension between the energy industry and communities in the U.S. that resist drilling of shale gas and oil on their territories.

The future of Iraqi oil is also uncertain given the many challenges it faces, ranging from domestic divisions and grave security problems to geopolitical threats (influence of Iran, competition in energy markets with Saudi Arabia, split of the northern Kurdish region, dependence on water supply from upstream neighbors to support oil production). Iraq still sorely lacks the hydrocarbon law, which is crucial to the development of its energy sources. So perhaps, it is wise to be less ambitious in making projections on production levels of energy in the U.S. and Iraq, which are in abundance, but are as much subject to sound policies as they are to wildcards. Most importantly, we should not be blindsided by the abundance, but put emphasis on energy efficiency. A sound energy policy in any country cannot be without energy efficiency given the ever growing energy demand, rising world population as well as concerns over climate change, something that Fatih Birol strongly emphasized in his presentation this week.

Growing Crisis of the U.S. Electrical System

Hurricane Sandy was just the latest test to the resilience of the U.S. electrical infrastructure, which has proven again to be woefully weak and outdated. According to Bloomberg, Sandy left “more than 8.5 million homes and businesses across 21 states” in dark on October 29, with 1.4 million still remaining without electricity last week. Sandy is one of the latest storms that brought a mass blackout to the East Coast, following the June 2012 derecho, Hurricane Irene in August 2011, and a snowstorm in October 2011. Some analysts predict that storms will become increasingly harsh with climate change.

 

But aside from putting the blame on severe storms, aging electricity infrastructure of the country has been begging attention for a while. While some parts of the electrical system are modernized, certain grids in the U.S. date back to a century ago. CNN reported in 2010 that “non-disaster U.S. power outages [were] up 124 percent since early 1990s [and] U.S. electricity reliability [is] low compared to some nations.” By 2010, nearly 50,000 consumers were affected by non-disaster electricity outages.

 

Sandy’s aftermath has generated a heated discussion among energy experts about upgrading the electrical infrastructure, integrating smart grid technology to effectively control and respond to a potential crisis, and burying power lines. While they come with a massive cost, it appears that the U.S. is bound to bear heavier economic losses by prolonging the inevitable dealing with the problem. The alternative is learning to live in darkness.

U.S. One of the Top Gas Flaring Countries in the World

Women’s Council on Energy and Environment published my article on flaring of associated gas in the U.S. last week. Gas flaring is becoming a major issue for the U.S. with the rise of North Dakota’s oil production from its Bakken Shale formation, which reached 660 thousand barrels per day (bbl/d) in June 2012. Oil extraction from the Bakken Shale accounts for a substantial amount of associated gas, which is a raw natural gas released as a result of petroleum production. Natural gas is often found in oil wells, where it is either dissolved in crude oil or exists separately in a form of a cap above oil.

With a back-to-back 5 percent rise in oil output every month, North Dakota does not expect the pace of production to slow down. Rapidly growing oil production and infrastructure problems are starting to pose serious environmental challenges. The United States now ranks as one of the world’s top five flaring countries, according to the World Bank’s recent report. That is largely due to the rise in oil drilling in North Dakota. In 2011, the United States represented 5 percent of all gas flaring. Presently, most companies burn off associated gas rather than invest in pipelines and processing plants to capture and sell the gas because of added costs.

 

With no regulation on gas flaring at the national level, largely due to a limited flaring problem since the 1970's, it is also becoming an issue in the Eagle Ford shale field in Texas, as well as potentially in other states endowed with unconventional oil sources, such as Ohio, Oklahoma and Arkansas. Given the size of the Bakken Shale play and expansion of shale drilling in other states, the era of the U.S. unconventional oil and gas seems to portend not only massive infrastructure changes to streamline transportation of domestic crude oil and gas, but also a more careful regulation of this relatively novel industry to prevent an environmental backlash.

 

Iraq’s Oil Boom: Pie in the Sky or a Cautionary Tale

 

Iraq can become Saudi Arabia of today in terms of size the economy and wealth in the next couple of decades, if it develops its hydrocarbon potential. Those were the words of Fatih Birol, chief economist with the International Energy Agency (IEA), who presented the agency’s new “Iraq Energy Outlook” report at the Center for Strategic and International Studies on October 22, 2012. Iraq has been steadily increasing its oil production, now ranking as the second-biggest producer after Saudi Arabia. According to an Iraqi oil official, “oil exports were expected to rise above 2.8 million barrels per day (mbpd) this month [October 2012] with shipments on the rise from both the north and south of the country. Exports of 2.6 mbpd in September were already the highest in more than 30 years.” IEA’s central scenario predicts that oil output in Iraq would increase to over 6 mbpd in 2020 and reach 8.3 mbpd by 2035, largely driven by developments of super giant fields in the south.

Although cautiously optimistic about Iraq’s ability to fulfill its oil potential, given its currently dire political, security and economic challenges, Fatih Birol predicts that this Middle Eastern country will account for nearly 45 percent of the growth in global oil production between 2011 and 2035, if it does it right. The rest of the members of the Organization of Petroleum Exporting Countries (OPEC) will provide 42 percent, with non-OPEC nations filling about 12 percent of global oil production. According to Birol, Iraq is set to play a crucial role in global oil markets, even with conservative estimates about its oil production.

Meanwhile, Iraq’s Kurdish autonomous began selling its oil to global markets this month through independent export deals with two of the world’s major trading houses, Trafigura and Vitol. This move presents a further challenge to the central government’s attempt to exert its full authority on trading oil and gas in the country. With little leverage on the trading houses because of its own dependence on them to import refined oil products, Baghdad is basically powerless to rein in on them or on Kurdish trading. Kurdistan’s latest move drives a wedge to the already tense relations with Baghdad, after they recently survived a major dispute over payments for oil exports.

In Fatih Birol’s view, political consensus on oil governance and legal framework, such as the long-awaited hydrocarbon law, speed and coordination of investment along the supply chain, Iraq’s long-term oil and natural gas strategy as well as international market conditions would be determinants of the country’s pace of oil and gas development. It appears that without addressing the Kurdish question in the short to medium term, production of oil and gas in Iraq will be uneven and chaotic. What is worse, Baghdad could find itself in a potential real clash with the north if it keeps ignoring de facto energy deals of the Kurds with foreign companies and does not work out a mutually beneficial deal with the autonomous region.

Book Review: “America Needs America's Energy: Creating Together the People's Energy Plan”

This summer I attended a discussion of a book by Mark Stansberry entitled America Needs America's Energy: Creating Together the People's Energy Plan at The Fund for American Studies in Washington DC. Given that DC is a regular stomping ground for many events on energy, I was not sure how this one would be different. Having read the book, I think it is quite timely and relevant. What is interesting about Stansberry’s book is that it is not just an overview of energy issues facing the U.S., replete with policy recommendations to high level officials, but he calls for Americans to take individual responsibility for their use of energy, to be better educated about the industry, and to get involved in crafting an energy plan for the country.

 

In Stansberry’s view, the ability for the U.S. to maintain its economic growth and standard of living (true for just about any other country in the world), it needs security of energy supplies, which cannot be achieved without a strategic energy plan that has been missing for decades. According to Stansberry, a national energy plan is long overdue to meet the demand, to secure supply, to more effectively and efficiently build energy infrastructure, to harness new technologies as well as to bridge the knowledge gap between energy users, policymakers and the industry. He provides a general overview of major energy sources used in the U.S. with their pros and cons and changes in supply and demand over the past few years. For those who work in the energy industry, most of the factual information in the book may not be too in-depth, but valuable nonetheless.

 

The most interesting part of the book for me was the chapter on “Energy Education,” where Stansberry’s take on the importance of a public-private partnership to educate ordinary people about their energy  use and to change their perception of the industry resonated strongly with what I have been thinking a lot lately. Without advocating the fossil fuel industry, it is worth remembering that it is unarguably an important part of our lives along with, hopefully, the growing share of renewable sources of energy. As Stansberry notes, “nothing moves without energy […] our quality of life is dependent upon the development of all forms of energy, as well as the conservation of our natural resources.” Without knowing, or more importantly appreciating, what aspects of our lives are touched, changed and improved by use of energy, nobody can truly value where and how it is obtained. In my view, Stansberry’s emphasis on starting “Your Personal Energy Journal 2012-2016” is a brilliant way to begin to understand your personal energy consumption and to create your personal energy plan in hopes to ultimately integrating the well-informed citizenry to discussion on creating a comprehensive, regional, state, and national energy plan. I know I will start using the charts on individual energy use provided in Stansberry’s book, and hopefully others will start, too.

 

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.