World’s Oil Industry Won’t Be the Same in the Wake of Shale

From Business Day

By Malcolm Maiden

In the column of December 1 I wrote about America’s gas and oil shale ”fracking” boom and the risk-reward trade- offs involved, including ones revolving around environmental concerns. This column is about the broader implications of the fracking boom, and they are huge.

Reports about the boom being a game-changer have proliferated after last month’s prediction by the International Energy Agency that the United States will overtake Saudi Arabia and Russia to become the world’s biggest oil producer in about five years, and be energy self-sufficient by 2030.

Tectonic shifts are occurring, and there is no clear consensus yet among bankers, economists and energy analysts about what the world and the world’s energy markets will look like when they are complete.

The US, for example, was buying around 13 million barrels of foreign oil a day between 2004 and 2006, before the fracking boom ramped up. By 2011 it was importing 11.5 million barrels a day to help meet domestic consumption of 18.8 million barrels a day.That reflected two things: a decline in domestic demand in the wake of the 2008-09 global financial crisis, and increasing US oil production out of America’s shale fracking fields.

US domestic oil production has jumped by 18 per cent in the past year as the shale boom has expanded, and in the first eight months of this year oil imports were 800,000 barrels a day fewer than a year earlier. America’s oil exports rose over the same time by 300,000 barrels a day, so net imports have fallen in just one year by 1.1 million barrels a day, or about 6 per cent of total consumption. If that pace if sustained the International Energy Agency’s prediction of self sufficiency for the US by 2030 will prove to be conservative.

Oil production from shale in the US is rising much more strongly than expected because the boom itself is working to shift production into liquids. The shale contains a mix of gas and liquids including oil, and enough gas has been discovered to produce a structural downshift in the price of US domestic gas, which by law cannot be exported.

Companies that have bought into the shale boom, including BHP Billiton, have reacted by pulling drilling rigs out of fields that are gas-rich and relocating them in ones that are rich in liquids that take a price that is roughly four times higher, pushing US shale oil and liquids production up. It is now running at about a million barrels a day, and is predicted to reach about 3.5 million barrels a day by 2016.

That’s enough to underpin a fall of about 25 per cent in oil imports that is worth $US100 billion a year at the present oil price, but the bottom line for the US is bigger.

Bank America Merrill Lynch calculates that there is already a combined value shift, or ”energy carry”, of more than $US300 billion a year in America’s favour, as the US oil import bill falls, oil exports rise, and as gas reserves that have expanded to 100 years’ current demand underpin cheap energy generation and an international cost advantage for US heavy industry.

Heavy industry can buy US gas currently at a price of $US3.60 per thousand cubic feet (between a third and a half of the price being paid in the rest of the developed world).

The price advantage that has opened up for US users is not going to disappear quickly. Opening US gas up to global prices by allowing it to be exported as North-West Shelf style liquefied gas would push prices between 22¢ and $1.11 higher, according to a report for the US government that was released this week.

But even if Washington agrees with the report that that is a price worth worth paying to turn the US into a major gas exporter, it will take at least a decade, perhaps two, to negotiate regulatory and environmental approvals and construct liquid gas processing and export facilities.

The geopolitical ramifications of the boom are also potentially immense, and currently unfathomable. US shale production will, for example, not only reduce America’s reliance on Middle Eastern oil, it will make it less reliant on oil from nations including Nigeria

and Venezuela.

A more self-sufficient US that had lower energy input costs as it increasingly tapped into its gas reserves would, meanwhile, be more capable of growing its way out of its debt problem, but also, perhaps, be more politically self-contained, even isolationist.

As I have previously mentioned, the world’s economic speed limit will rise if oil supplies expand because of the shale boom, as the oil price will rise less aggressively in response to rising demand. By extending the supply-side, shale oil also changes the peak oil equation and arguably militates against alternative energy: is shale oil production already balancing declining production from established ”peak oil” fields?

Shale is also going to produce a new pecking order in the oil industry as the economics of oil production move against conventional oil, and the petroleum multinationals that control it, and towards new unconventional producers including Australia’s BHP Billiton.

Shale oil isn’t cheap to produce, certainly not as cheap to produce as conventional well once was, but it’s commercial at the current oil price range of $US86 and $US108 a barrel (West Texas Intermediate oil and North Sea Brent, respectively), and likely to become less expensive and higher-yielding as the boom ramps up. Cash returns from the conventional fields that are owned predominantly by the world’s multinational petroleum giants, meanwhile, are falling.

The majors have bought into the shale boom: but heavy exposure to old fields that cost progressively more to maintain and produce progressively less oil means they are becoming less profitable than independent producers more heavily exposed to ”new oil”.

According to Goldman Sachs, cash returns from conventional fields have fallen by 28 per cent from a peak in 2005, despite a doubling in the oil price.

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