US becoming energy kingpin

On Friday, May 17, the US Department of Energy (DOE) approved an application allowing the export of liquefied natural gas (LNG) to countries that do not have a free-trade agreement with the United States.

India does not have one and this decision clears the stage for the export of shale gas to India, which could be a game-changer if Indian companies get their act together quickly.

In December 2012, China surpassed the US in becoming the world's leading importer of oil – for the first time in nearly 40 years. That same month, North Dakota, Ohio and Pennsylvania together produced 1.5 million barrels of oil a day – more than Iran exported.

As the data demonstrate; the development of US shale resources is leading to a dramatic shift in how energy is being produced and consumed around the world.

This has enabled the US to achieve its highest level of energy independence in two decades, which could lead to far-reaching changes in the geopolitical order.

Such change could bring with it both great benefits for the US (namely ‘manufacturing renaissance’) and risk of upheaval in countries heavily dependent on oil exports.

This could also have a ‘chain reaction’ in global transportation, processing and storage of oil as other countries try to replicate the American oil boom.

Biggest beneficiaries

The US and its allies – particularly its North American neighbours – would be the biggest beneficiaries. In fact, the West already has realised one major benefit: increased US oil production has kept oil prices stable despite the loss because of sanctions of one million barrels a day in Iranian exports. Crude futures for settlement in 2018 are trading at a discount to current prices, signalling expectations for increasing supplies.

The International Energy Agency (IEA) in its closely watched and just-released semi-annual report predicts that US shale oil will help meet most of the world's new oil demand in the next five years, even if the global economy picks up steam.

Longer term, OPEC and many of its member nations are likely to be the biggest losers as the US continues to cut oil imports, likely decreasing oil prices in the process.

Cheap and abundant natural gas will facilitate transition of the US economy towards broader use of the fuel.

Global refining capacity expansions would outpace upstream supply growth as well as demand growth, bringing refining margins under pressure. Higher-cost refineries will face strong competitive headwinds. European refineries are at particularly high risk of closure.

Effect of expansion

A dramatic expansion of US production could push global spare capacity to exceed 8 million barrels per day, at which point OPEC could lose price control and crude oil prices would drop, possibly sharply.

Such a drop would take a heavy toll on many energy producers who are increasingly dependent on relatively high energy prices to balance their budgets.

An IMF analysis indicates that many major oil-producing states need more than that lowest price level to meet their budgets (Iran, Libya and Russia, at $117 a barrel; Iraq, $112; Yemen, $237; and the UAE, $84) and would be forced to increase output or reduce spending, which could trigger unrest.

OPEC heavyweight Saudi Arabia, which controls vast reserves of oil and needs $71 a barrel to meet its budget, could re-orient to Asian markets, turning left instead of right.

Some members of the oil cartel – particularly Nigeria and Angola – already are feeling the impact of the US production surge.

US imports from the two countries dropped to 700,000 barrels a day at the end of 2012, down from 1.6 million barrels in 2007.

That's because US production of light, sweet crude – the kind of oil the West African nations produce – has burgeoned in recent years.

Giving a push

Longer term, say by 2020, cheaper heavy oil from Canada, freed from the so-called oil sands by new recovery technologies, could push similar oil from Venezuela out of the US Gulf Coast market (assuming that the Obama administration approves construction of the Keystone XL pipeline to carry it).

Mexico also is expected to increase production, offering the US access to another convenient and friendly provider.

The Eagle Ford formation in Texas extends into Mexico and if you look at the Gulf, you'll see thousands of black dots marking oil platforms on the US side but nothing on the Mexican side.

That's changing. You will see less immigration from Mexico. Mexico could become more of a BRIC (the term used for fast-developing economies like Brazil, Russia, India and China) than Brazil.

The US also could use its increased natural gas production to weaken rival Russia's near monopoly on natural gas exports to Europe via its state-controlled energy giant Gazprom.

Already, declining prices fuelled by the USboom have benefited the European market. In a pattern similar to the abrupt slowdown in demand growth seen in the Asian Tigers in the 1990s, Chinese demand growth has slowed to a more tepid 3-5 per cent as compared to the double-digit growth seen in the early 2000s.

That slowdown is in part due to the diminishing competitive edge that China enjoys over the US. Chinese wages are going up 20 per cent a year.

US energy efficiency and increased production will help it in its mix on the global competitive landscape – Dow Chemical recently announced it will invest $4 billion in US petrochemical production.

That doesn't happen without the US advantage in energy. Its energy independence could lead to isolationist policies, but will not insulate the world from global price disruptions.

The world economy and world oil prices will still be vulnerable if someone blows up a Saudi pipeline.

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