March 15, 2012

Energy Independence and the New American Century?

Philip K. Verleger, Jr., the petroleum economist, is publishing this year in his Petroleum Economics Monthly a series of reports under the general heading "Energy Independence and the New American Century." Verleger was recently interviewed by NPR and predicted that the United States would be in a net energy export position by 2023. That date is the 50th anniversary of Richard Nixon's 1973 call to achieve energy interdependence by 1980, which didn't exactly work out as planned. Nixon proposed what Verleger calls a "high-cost dirty path to energy independence." It featured off-shore resource development, fast-breeder reactors, expanded coal use, and the intensive development of shale oil in Colorado using the same techniques now employed on Canada's tar sands. Had it been followed, "Nixon's strategy would have saddled the US with high-cost energy supplies and very high emissions of harmful global-warming gases." Instead, the United States took a different path, accidentally stumbling upon a "low-cost clean path to energy independence."

A number of key developments, in Verleger's retelling, came together to produce this result. First in importance was the entrepreneurial development of natural gas and oil from shale rock by smaller U.S. firms, now "freed from the multinational oil industry's high-cost yoke." These companies were able to utilize new financial instruments invented by Wall Street that enabled them to hedge their production and stay in business even when gas prices collapsed (while also shifting their new techniques to oil). Finally, "the United States is profiting from dramatic increases in auto fuel economy, a change that came after the 2008 gasoline price surge and GM and Chrysler's subsequent bankruptcies."

It seems somewhat doubtful that Verleger fully accepts his own thesis that energy independence will arise simply because of dumb luck. He himself emphasizes that entrepreneurial inventiveness has played the key role, and the larger thrust of his analysis is to suggest the foolhardiness of statist solutions. But such is his arresting conclusion: by 2023 the United States will have "blundered into energy independence."

This profound transformation in world energy markets, he contends, will produce a "New American Century" made possible by the cheaper energy supplies available to American companies: "Such an advantage, combined with construction of new advanced manufacturing facilities and competitive domestic labor costs, will give the US economy an unprecedented edge over other nations, particularly China and northern Europe." Already, the huge disparity in costs--recently "US firms paid less than $3 per million Btu for natural gas while South Korean buyers paid $13.50"--is having an effect on industrial competition, and Verleger thinks the big price disparity will continue. Russia and OPEC, the big oil and natural gas exporters, look set to continue to tie the cost of natural gas to crude. If they are successful, that will only increase the US competitive advantage.

How plausible is this scenario? Verleger does not explain in the publicly available executive summary the respective roles that increased production and reduced consumption will play in achieving energy independence by 2023.  As we saw earlier, the US is still a net energy importer of some 8 million barrels per day, so that is a lot of ground to cover in ten years.

The argument regarding the new financial instruments is novel and intriguing, though here too the summary report is short on specifics. Presumably he is referring to both the ability to raise capital to fund risky investments and to hedge production. For the longer term, however, hedging would not seem to provide a way out of the dilemma in which natural gas producers now find themselves. While hedging has certainly facilitated the ability of natural gas companies to keep drilling and to increase supplies despite the collapse in prices, it is difficult to see how this can keep going. Even futures prices a few years out look to be well below the cost of production, customarily estimated at between $5.50 to $6.00 per million btu. Barring a sharp fall in supplies stemming from drilling halts or company bankruptcies, the only way to overcome the disparity between extremely low domestic prices and ramped up production is to begin exporting natural gas on a large scale, bringing US prices more in line with the world prices--but that would diminish the expected US competitive edge and also inhibit the large scale conversion of domestic electricity generation and transportation to natural gas.

Larger questions remain regarding the longevity of US oil and gas reserves, expected flow-rates, the price of extraction, and the relative "cleanliness" of natural gas versus alternatives, but Verleger has given us an arresting vision of the future. Remarkably, it is a projected future of American dominance that has little room for the major oil companies. "Twenty years from now, we expect most large energy firms, which seem so important today, will have disappeared. It is even possible that a person born in the United States or Europe in 2020 will never know about Exxon." That prediction seems other-worldly to me; alas, Verleger does not explain in the executive summary how he arrives at it.

Citigroup has also produced a recent report arguing that the United States is on course to achieve energy independence "this decade" (which one supposes means by 2019 rather than Verleger's 2023 date). Noting that net imports of crude oil and petroleum products are around 8 million barrels per day, Citigroup gets to energy independence with the following calculations. "If shale oil grows by 2 mbd, which we think is conservative, and California adds its 1 mbd to the Gulf of Mexico's 2 mbd, we reduce import reliance to 3 mbd. Canadian production is expected to rise by 1.6 mbd by 2020 . . ., and much of this will effectively be stranded in North America, and there is the potential to cut demand both through conservation and a shift in transportation demand to natural gas by at least 1 mbd and by some calculations by 2 mbd--adding to demographic and fuel efficiency impacts the switching of heavy and medium-duty trucks to LNG- and CNG-fuelled vehicles."

There is a sharp critique of the Citigroup report by Chris Nelder of The Energy Futurist, who notes that Citigroup appears to ignore the question of declining production from existing fields and gives highly optimistic forecasts for both oil shale and Gulf of Mexico production. In contrast, the EIA's forecasts (see chart below from a February 2012 report) are much more restrained. The chart shows domestic production rising nearly 2mbd to around 7.5 mbd in the 2015-20 period--a sharp turnaround from projections only a few years back but still a long way from the 8 mbd needed to close the net energy trade deficit.

See also this critique of the cornucopians by Nelder and Greg McDonald, responding to a piece by Daniel Yergin:
Conventional crude ended its 150-year-long growth trajectory in 2004 and flattened out around 74 million barrels per day. Crude supply did not budge when oil prices tripled from 2004 to 2008, but global demand remained firm, shrugging off a recessionary dip in 2009. All the growth in supply since then was not crude but unconventional liquids, including natural gas liquids, biofuels, refinery gains, synthetic oil from tar sands, and other marginal resources. These liquids are by no means equivalent to crude. Yergin's calming charts [showing current world production of oil at 90 mbd] include these unconventional liquids and hide the fundamental issue of the depletion of mature fields. They also hide the declining energy density, higher cost, and lower flow rates of these new resources.

As Shell, Chevron, Total, the IEA, and a host of other serious observers have openly declared since 2005, the age of cheap and easy oil has ended. The "oil" that's left is progressively expensive, difficult, risky, marginal, and fraught with secondary effects like increasing carbon emissions, demand for water, and competition with food.

A wide spectrum of agnostic analysts with decades of distinguished service in the oil industry and its press have addressed this. We like the formulation of petroleum economist Chris Skrebowski, which defines peak oil as the point where "the cost of incremental supply exceeds the price economies can pay without destroying growth at a given point in time."

Update: There is a critical review of the Citigroup report at The Oil Drum, by Heading Out, posted on April 1, 2012. 


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