March 2012, Vol. 239 No. 3


Energy Growth Has Vast Implications For U.S.

Rich Miller, Asjylyn Loder, and Jim Polson, Bloomberg News

The U.S. is the closest it has been in almost 20 years to achieving energy self-sufficiency, a goal the nation has been pursuing since the 1973 Arab oil embargo triggered a recession and led to lines at gasoline stations.

Domestic oil output is the highest in eight years. The U.S. is producing so much natural gas that, where the government warned four years ago of a critical need to boost imports, it now may approve an export terminal. Methanex Corp., the world’s biggest methanol maker, plans to dismantle a factory in Chile and reassemble it in Louisiana to take advantage of low natural gas prices. Higher mileage standards and federally mandated ethanol use, along with slow economic growth, have curbed demand.

The result: The U.S. has reversed a two-decade-long decline in energy
independence, increasing the proportion of demand met from domestic sources over the last six years to an estimated 81% through the first 10 months of 2011, according to data compiled by Bloomberg from the U.S. Department of Energy. That would be the highest level since 1992.

“For 40 years, only politicians and the occasional author in Popular Mechanics magazine talked about achieving energy independence,” said Adam Sieminski, who has been nominated by President Obama to head the U.S. Energy Information Administration. “Now it doesn’t seem such an outlandish idea.”

The transformation, which could see the country become the world’s top energy producer by 2020, has implications for the economy and national security – boosting household incomes, jobs and government revenue; cutting the trade deficit; enhancing manufacturers’ competitiveness; and allowing greater flexibility in dealing with unrest in the Middle East.

Output Rising
U.S. energy self-sufficiency has been steadily rising since 2005, when it hit a low of 70%, data compiled by Bloomberg show. Domestic crude oil
production rose 3.6% last year to an average 5.7 million bpd, highest since 2003, according to the Energy Department. Natural gas output rose to 22.4 Tcf in 2010 from 20.2 Tcf in 2007 when the Federal Energy Regulatory Commission (FERC) warned of the need for more imports. Prices have fallen more than 80% since 2008.

At the same time, the efficiency of the average U.S. passenger vehicle has helped limit demand. It increased to 29.6 mpg in 2011 from 19.9 mpg in 1978, according to the National Highway Traffic Safety Administration.

The last time the U.S. achieved energy independence was in 1952. While it still imported some petroleum, the country’s exports, including coal, more than offset its imports.

Environmental Concern
The expansion in oil and natural gas production isn’t without a downside.
Environmentalists say hydraulic fracturing, or fracking – in which a mixture of water, sand and chemicals is shot underground to blast apart rock and free fossil fuels – is tainting drinking water.

The drop in natural gas prices is also making the use of alternative energy sources such as solar, wind and nuclear power less attractive, threatening to link the U.S.’s future even more to hydrocarbons to run the world’s largest economy.

Still, those concerns probably won’t be enough to outweigh the benefits of greater energy independence.

Stepped-up oil output and restrained consumption will lessen demand for imports, cutting the nation’s trade deficit and buttressing the dollar, said Sieminski, who is chief energy economist at Deutsche Bank AG in Washington.

Cutting Trade Deficit
With the price of a barrel of oil at about $100, a drop of 4 million barrels a day in oil imports – which he said could happen by 2020, if not before – would shave $145 billion off the deficit. Through the first 11 months of 2011, the trade gap was $513 billion, the Commerce Department said.

The impact on national security also could be significant as the U.S. relies less on oil from the Mideast. Persian Gulf countries accounted for 15% of U.S. imports of crude oil and petroleum products in 2010, down from 23% in 1999.

“The past image of the United States as helplessly dependent on imported oil and gas from politically unstable and unfriendly regions of the world no longer holds,” former CIA Director John Deutch told a recent energy

Today, signs of what former North Dakota Sen. Byron Dorgan says could be a “new normal” in energy are proliferating. The U.S. likely became a net exporter of refined oil products last year for the first time since 1949. And it will probably become a net exporter of natural gas early in the next decade, said Howard Gruenspecht, the acting administrator of the EIA, the statistical arm of the Energy Department.

Cheniere Energy Partners LP is seeking a construction and operating permit from the FERC for the first new plant capable of exporting natural gas by ship to be built since 1969 in the U.S. Houston-based Cheniere said it expects the $6 billion plant to export up to 2.6 Bcf/d.

Mitchell The Pioneer

The shale-gas technology that’s boosting U.S. natural gas production was spawned in the Barnett Shale around Dallas and Fort Worth by George P. Mitchell, who was chairman and CEO of Mitchell Energy & Development Corp.

Helped by a provision inserted in the 1980 windfall oil profits tax bill to encourage drilling for unconventional natural gas, the Houston-based oil man pursued a trial-and-error approach for years before succeeding in the late-1990s. The fracking method he devised cracked the rock deep underground, propping open small seams that allowed natural gas trapped in tiny pores to flow into the well and up to the surface.

Recognizing that Mitchell was on to something, Devon Energy Corp. bought his company in 2002 for about $3.3 billion and combined it with its own expertise in directional drilling, a method derived from offshore exploration.

Hunting For Oil

Traditional vertical drilling bores straight down. Directional drilling bores horizontally sometimes a mile or more through the richest layer of rock, allowing more of the trapped fuel to make it into the well.

The oil boom a century ago tapped reservoirs of fuel that rose out of those layers and got trapped in large pockets closer to the earth’s surface, or used vertical wells that could get out only a portion of the fuel stored in the rock.

The new technology has Devon and its competitors hunting beneath decades-old oil plays long thought depleted. An hour’s drive north of Oklahoma City, Devon is exploring for oil in the Mississippian and other formations, where oil majors once made their fortunes. It’s racing companies such as Chesapeake Energy Corp. and SandRidge Energy Inc. to buy leases and drill wells.

North Dakota Booming
Crude production in the U.S. is already increasing. Within three years, domestic output could reach 7 million bpd, the highest in 20 years, said Andy Lipow, president of Lipow Oil Associates in Houston. The U.S.
produced 5.9 million bpd of crude in December while consuming
18.5 million barrels of petroleum products, according to the Energy Department.

North Dakota – the center of the so-called tight-oil transformation – is now the fourth-largest oil-producing state, behind Texas, Alaska and California. The growth in oil and gas output means the U.S. will overtake Russia as the world’s largest energy producer in the next eight years, said Jamie Webster, senior manager for the markets and country strategy group at PFC Energy, a Washington-based consultant.

While U.S. consumers would still be susceptible to surges in global oil prices, “we’d end up sending some of that cash to North Dakota” rather than to Saudi Arabia, said Richard Schmalensee, a professor of economics and management at the Massachusetts Institute of Technology in Cambridge.

1.6 Million Jobs
The shale gas expansion is already benefiting the economy. In 2010, the industry supported more than 600,000 jobs, according to a report that consultants IHS Global Insight prepared for America’s Natural Gas Alliance, a group that represents companies such as Devon Energy and Chesapeake Energy. More than half were in the companies directly involved and their suppliers, with the balance coming at restaurants, hotels and other firms. By 2035, the number of jobs supported by the industry will rise to more than 1.6 million, IHS said. Some 360,000 will be directly employed in the shale gas industry.

The oil boom is also pushing up payrolls. Unemployment in North Dakota was 3.3% in December, the lowest of any state. Hiring is so frantic that the McDonald’s Corp. restaurant in Dickinson is offering $300 signing bonuses.

State governments are reaping benefits, too. Ohio is considering a new impact fee on drillers and increasing the tax charged on natural gas and other natural resources extracted, Gov. John Kasich has said.

In Texas, DeWitt County Judge Daryl Fowler has negotiated an $8,000-per-well fee from drilling companies to pay for roads in the district, southeast of San Antonio.

Lot Of Traffic
“It takes 270 loads of gravel just to build a pad used for drilling a well, which means a lot of truck traffic on a lot of roads that nobody except Grandpa Schultz and some deer hunters may have used in the past,” said Fowler, whose non-judicial post gives him administrative control over the county.

The federal government will see tax payments from shale gas rise to $14.5
billion in 2015 from $9.6 billion in 2010, according to IHS. From 2010-2035, revenue will total $464.9 billion, it said.

Manufacturing companies, particularly chemical makers, also stand to win as the shale bonanza keeps natural gas cheaper in the U.S. than in Asia or Europe. Dow Chemical Co., which spent a decade moving production to the Middle East and Asia, is leading the biggest expansion ever in the U.S. The chemical industry is one of the top consumers of natural gas, using it both as a fuel and feedstock to produce the compounds it sells.

First Since 2001
Midland, MI-based Dow is among companies planning to build crackers,
industrial plants typically costing $1.5 billion that process hydrocarbons into ethylene, a plastics ingredient. The new crackers will be the first in the U.S. since 2001, said John Stekla, a director at Chemical Market Associates Inc., a Houston-based consultant.

Vancouver-based Methanex plans to take apart the idled Chilean factory and ship it to Louisiana to capitalize on natural gas prices.

The shift to increased energy independence is also the result of government policies to depress oil demand.

“Vehicles are getting more efficient, and people who travel won’t be driving more miles,” said Daniel Yergin, chairman of IHS Cambridge Energy Research Associates.

Automakers have agreed to raise the fuel economy of the vehicles they sell in the U.S. to a fleetwide average of 54.5 miles per gallon by 2025 under an agreement last year with the Obama administration.

No ‘Silver Bullet’

The 2008-09 recession helped lower oil demand, and consumption has lagged even as the economy has recovered, said Judith Dwarkin, director of energy research for ITG Investment Research in Calgary. Coupled with higher domestic output, “this has translated into an import requirement of some 15.4 barrels per person per year – about on par with the mid-1990s.”

She cautioned against thinking that rising oil and gas production is a “silver bullet” for solving U.S. economic woes.

Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York,
agreed, advising clients that oil and gas output accounts for just 1% of gross domestic production and isn’t likely on its own capable of pulling the economy into above-trend growth.

Cooling On Wind
Some companies are hurting from the shale gas glut. With abundant supplies making it the cheapest option for new power generation, Exelon Corp. scrapped plans to expand capacity at two nuclear plants. Michigan utility CMS Energy Corp. canceled a $2 billion coal plant after deciding it wasn’t financially viable. NextEra Energy Inc., the largest U.S. wind energy producer, shelved plans for new U.S. wind projects next year.

Investors also are cooling on wind investment, partly because of falling power prices. Boone Pickens, one of wind power’s biggest boosters, decided to focus on promoting natural gas-fueled trucking fleets after dropping plans for a Texas wind farm in 2010.

“Wind on its own without incentives is far from economic unless gas is north of $6.50,” said Travis Miller, a Chicago-based utility analyst at Morningstar Inc.

When Obama lauded increased energy production in his State of the Union speech, he drew criticism from some environmentalists opposed to fracking.

Waning Confidence
“We’re disappointed in his enthusiasm for shale gas,” said Iris Marie Bloom, director of Protecting Our Waters in Philadelphia. Obama “spoke about gas as if it’s better for the environment, which it’s not.”

Deutch, who headed an advisory panel on fracking for the Energy Department, is concerned public confidence in the technology will wane if action isn’t taken to address environmental issues. The potential positive impact of increased North American production are “enormous,” he said.

Higher U.S. output lessens the ability of countries like Iran and Russia to use “energy diplomacy” as a means of strengthening their influence, Amy Myers Jaffe, director of the Baker Institute Energy Forum at Rice University, and her colleagues wrote in a report last year.

While the U.S. must still pay attention to issues such as Israel’s security and Islamic fundamentalism in the Mideast, which could affect oil prices, it won’t have to be as worried about its supplies.

Positive ‘Shock’
Carlos Pascual, special envoy and coordinator for international energy affairs at the State Department, suggested at a Council on Foreign Relations conference that the increased production in the U.S. and elsewhere gives Washington more “maneuverability” in using sanctions to deal with Iran and its nuclear aspirations.

The increased U.S. production of oil and natural gas is a “positive supply shock” for the economy and for national security, said Philip Verleger, a former director of the office of energy policy at the Treasury Department and founder of PKVerleger LLC, a consulting firm in Aspen, CO.

“We aren’t there yet, but it looks like we’re blundering into a solution for the energy problem,” he said.

(This article is published in P&GJ courtesy of Bloomberg Business News).

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