November 14, 2012

Hark! The American Energy Revolution…and What to Watch For

The International Energy Agency (IEA) published its new World Energy Outlook on Monday, projecting the United States to become the world’s largest oil producer as early as 2020, overtaking Saudi Arabia and Russia for the top spot. According to the IEA’s analysis, the United States may even become a net exporter of oil by 2035. The American energy revolution is driven in part by technological developments that have bolstered shale gas and tight oil production, as well as decreased demand for oil due to higher fuel efficiency standards in U.S. vehicles, according to the IEA.

The analysis should be taken with a grain of salt, as it is difficult to project as far forward as 2035 with any meaningful amount of certainty. For example, some of the tight oil projects in the United States may depend on a global price of $70 a barrel in order to remain economically viable. Some analysts are projecting prices to fall as low as $50 a barrel, which could drive developers away from investing in projects that require $70 a barrel to breakeven, upsetting some of the oil production estimates.

Nevertheless, it is possible to make some reasonable assumptions about what the American energy revolution could mean for U.S. policymakers charged with navigating this complex and ever-changing landscape. Here are a couple of things to watch for, in no particular order:

The pace of tight oil production will continue to be dynamic. U.S. tight oil production may speed up or slow down depending on the U.S. energy market. There is some reason to believe that tight oil production is moving faster in the United States than some expected because of depressed natural gas prices. Low natural gas prices have contributed to poor returns on investment for some shale gas producers, with some producers choosing to develop tight oil deposits instead of expanding shale gas production in order to earn a profit. If natural gas prices rebound in the near term though, tight oil production could slow down as development shifts back to a more profitable natural gas sector.

Energy trade will have a different role in U.S. foreign policy. Energy trade has long been an element of U.S. foreign policy. One needs to only look to the Middle East, where cheap conventional oil from Saudi Arabia and elsewhere has long been at the heart of America’s relationship with major oil producers in the region. But this relationship is changing, and the United States is poised to become a major trader in oil and natural gas with other countries. Perhaps the biggest opportunity will come from liquefied natural gas (LNG) exports, which could strengthen U.S. relations with major energy consumers in places like East Asia. For example, as Japan shifts away from nuclear power and increases its share of imports of oil and gas from the Persian Gulf, there is an opportunity for the United States to strengthen its strategic partnership with Japan by trading LNG. The caveat is that the United States needs to develop the physical infrastructure to export LNG, and amend the laws that only allow producers to export LNG to free trade partners unless the Department of Energy approves an export license, which is done on a case-by-case basis.    

The shale gas and tight oil boom will make it more difficult to address global climate change. Bryan Walsh of Time Magazine wrote yesterday about the IEA’s frightening forecast that “by 2017, the world’s existing energy infrastructure will likely ‘lock in’ the world to a 3.6º F (2º C ) temperature rise. That’s the red line that many scientists have set for global warming—anything above that and we could be setting ourselves up for a world of hurt.” Indeed, the market may be pushing countries to double down on cheap fossil fuels at the expense of dealing with climate change. Some are optimistic about the prospect of natural gas displacing coal as the dominant feedstock in electricity generation in the United States, which would help the United States curb its carbon emissions. However, ignoring the fact that the greenhouse gas footprint of natural gas depends on how well the infrastructure is developed to prevent methane leaks, cheap natural gas prices may also make it more difficult for cleaner, renewable energy production to compete in the market. The New York Times reported in October that a Wisconsin nuclear power station may have been the first nuclear power plant to be taken down by cheap electricity prices (due to natural gas): “[E]lectricity on the wholesale market is so inexpensive, its price depressed by cheap natural gas, that some reactors may not have enough revenue to justify needed capital expenditures.” It could be a harbinger of things to come for the renewable energy sector, which could make it more difficult to reduce greenhouse emissions.

Finally, America will still not be energy independent. This is important: U.S. policymakers often talk about the quest for energy independence, which is probably an unrealistic goal. Oil is a fungible commodity that is traded globally, with the price set globally. It doesn’t matter if oil is produced in the United States or Saudi Arabia, consumers will generally pay the same price. Now, there is a widening price gap between West Texas Intermediate and Brent crude oil (oil produced in Texas versus Europe), which onlookers should continue to watch. Nevertheless, despite the price gap, if there is a geopolitical crisis in the Persian Gulf, Nigeria or elsewhere, global prices will be affected, and both WTI and Brent crude oil prices will skyrocket. The bottom line: U.S. oil prices still depend on what happens abroad. This means that the United States will still have equity in the Middle East and an interest in preventing the kinds of geopolitical crises that can affect global oil prices, which have implications for the United States and its allies. 

Photo: Courtesy of flickr user gfpeck. 

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