Gas-to-Liquids Potential of the U.S. Uncertain

The U.S. is exploring the potential of monetizing its copious shale gas supplies by converting them to petroleum distillates through the gas-to-liquids (GTL) process. My recent article published with Oilprice examines the promise and challenges of GTL's commercial application in the U.S. in light of an interest from South African energy company Sasol to build the second-largest GTL plant in Louisiana. The article argues that the high cost of the GTL technology, volatile oil and gas prices as well as carbon emissions from GTL plants will meet stronger resistance in the U.S. than compared to Qatar, which is now a leading GTL produer in the world. Here is a link to the full article.

Challenges Facing International Energy Companies

In light of the terrorist attack against the In Amenas gas field in Algeria two weeks ago, which ended in deaths of nearly 80 people, there is a renewed sense of vulnerability among international oil companies (IOCs) to security challenges in politically unstable countries. Wall Street Journal blogged this week that “energy firms are re-evaluating their presence in the [Middle East and North African] region” after the attack in In Amenas. While the attack was unprecedented, it is unlikely to that IOCs will pull out altogether from one of the most the prolific and profitable regions in the world. In fact, the security situation is just one of many pressing challenges that IOCs confront at this point. While the challenges are many, it is worth looking into five of the most prominent ones.

Number one challenge for IOCs is something that was mentioned in the last post on this blog – resource nationalism and the rise of national oil companies (NOCs). High oil prices and the rise of NOCs since the 1990s have significantly reduced the bargaining power of IOCs and weakened any leverage they formerly had on energy-rich countries. As a result, IOCs have learnt adapt to less favorable contract and investment terms and take greater risks to operate in more unstable geopolitical environments. 

A related, second, challenge is political instability (e.g. Arab spring), weakening of energy-rich nation-states and terrorism (e.g. Nigeria, Algeria). Many energy-rich countries in the Middle East, North Africa and Sub-Saharan Africa, for example, Nigeria, Sudan, Iraq, and Libya, face grave security problems, which are not only due to the lack of the rule of law and security, but a more fundamental issue of weak nation states with weak governments that wield little influence and legitimacy in their respective countries. Some energy analysts point out that there have been a growing number of attacks against Western interests since 2000. Because of that, companies are likely to continue to invest in extensive security needs in physical workplace, including Algeria.

The next challenge facing IOCs is tight supplies of economically extractable oil and gas and competition to produce energy sources in geologically difficult, remote, harsh and economically costly areas (e.g. unconventional sources such as shale and tight gas and oil, oil sands, exploration of the Arctic) ultra-deep waters, or tar sands. Developing unconventional energy sources in such challenging environments require significant investments in technology.  But even heavy investment in technology cannot guarantee successful finding of oil or gas, as was the case with the deep-water drilling in Gulf of Mexico’s Alaminos Canyon or the recent outcome of shale gas drilling in Poland that turned up dry wells.   

Fourth challenge is cyber security threats and cyber espionage (hacking on energy companies to obtain vital information on energy activities). Energy companies are increasingly targeted by hackers aiming to obtain valuable information on new oil findings or other valuable corporate data. For example, coordinated hacking in 2010 via malicious e-mails sent to employees of ExxonMobil, ConocoPhillips and Marathon Oil evidenced that hackers aggressively seek proprietary information. There is also politically or ideologically driven hacking to disrupt petroleum operations not only against IOCs, but also NOCs.  For instance, perpetrators of a massive cyber attack on Saudi Aramco in August 2012, which damaged 30,000 computers and aimed to stop production of oil and gas, reportedly blamed Saudi Arabia for “crimes and atrocities” in Syria and Bahrain. Highlighting ideological motivations of cyber attacks, it was reported in August 2012 that an Anonymous hacker group planned an attack on computers of energy companies developing Canada’s Alberta oil sands. This group invoked environmental harm from oil sands operations as its motivation to attack. Hacking is more sophisticated now than a few years ago and protection of data of energy companies and critical infrastructure from cyber attacks appears is becoming a serious concern for corporate and government interests. 

Fifth challenge is addressing climate change and pressures from environmental groups to regulate the energy industry. While political debate over global warming goes on, executives of major IOCs appear to have come to accept the scientific consensus on climate change and to expect that regulations to cut greenhouse emissions would be inevitable. The current challenge for energy majors is to have a strong voice in the climate-change policymaking and work out the levels of regulations through a coordinated national approach to cut greenhouse gases as opposed to a multitude of regulations devised by various local governments, at least in the U.S. Another layer of challenge here is an increase in shareholder resolution filings in the U.S. to pressure energy companies on sustainability and climate change issues, sometimes even tying executive compensation directly to a company’s sustainability metrics. With many other challenges facing IOCs, as well as NOCs, this list is hardly exhaustive. But could this be a first-tier list?

Algeria’s New Security Risk Profile Unlikely to Be a Dealbreaker for IOCs

The terrorist attack on the In Amenas gas field in Algeria on January 16, 2013, has caught the country and foreign companies operating the field completely off the guard and left them shocked at the ability of militants to bring down layers of security to take hostages. Algerian authorities invoked cooperation between militants and an insider(s) at the gas field to plan the assault. Some say the attack has either been a response to the French military operation against Islamists in Mali earlier this month, while others believe that it may have taken place regardless and the French intervention in Mali was a trigger. The fact that In Amenas was targeted by an assortment of jihadists from Mauritania, Mali, Algeria, Egypt, Tunisia and Egypt, who crossed Algeria from its loose border with unstable Libya, is unsettling at best.  

The move by Algeria’s parliament last week to endorse an oil and gas law, which cancels windfall tax on profits of foreign firms that sometimes reached up to 50 percent on some contracts, was seen by some Western companies as a tad bit late in the wake of 80 deaths in In Amenas and foreign firms anticipated high costs of operating in such an unstable environment. No date has been set to restart the In Amenas gas complex. As much as the terrorist attack has been unprecedented and extremely bloody, it is hard to bet that foreign energy companies will pull out from oil and gas operations in Algeria.  As the world’s “eighth largest natural gas producer in 2010 and the third largest gas supplier to Europe,” primarily to Italy and Spain, Algeria is an important energy player in OPEC and outside it. Because dependence between Algeria and its energy importers is mutual, with hydrocarbons constituting nearly 98 percent of this North African country’s export revenues, all is not lost and a lot still can be gained.

This is important in the context of the rise of resource nationalism and national oil companies (NOC) since the 1990s, along with the steady increase in oil prices. Unlike a few decades ago, NOCs, such as Sonatrach of Algeria, Petróleos de Venezuela, S.A. (PDVSA), Gazprom and Rosneft of Russia, Pemex of Mexico and Saudi Aramco in Saudi Arabia, are better consolidated, maintain stronger control over resources in their home countries and they are in a position to change rules and regulations, limit foreign ownership in joint ventures, alter contract terms and increase taxes and royalties for IOCs.  So, the ability of IOCs to compete with NOCs on the latter’s home turf has been vastly curtailed. Consequently, IOCs deal with greater uncertainty, more unfavorable investment conditions, have lesser access to new oil reserves, and seek profits in politically riskier and geologically challenging environments. For these reasons IOCs have not left notoriously unstable places like Nigeria, rather the opposite, they boosted their presence there. In fact, despite high political and operating risks, Africa is the next big hot market for IOCs. Quarter of ExxonMobil's production came from West Africa since 2000. Maintaining technological edge and eyeing relatively better contract terms, IOCs will beef up physical security and continue operating in unstable parts of Africa, including Algeria.

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.