February 25, 2014
THE WORLD has been caught by surprise by the United States’ shale-oil boom. Analysts and experts are still clashing about both its true extent and the possibility of extending a shale revolution beyond North America. In just a few years shale oil could make the United States the world’s top oil producer. But a shale revolution is unlikely in the rest of the world, due to some unique factors that characterize the U.S. oil and gas patch. The single-minded focus on the future of shale oil, however, risks obscuring another evolving dimension of the global oil picture that defies the past pessimism spread by peak-oil theorists who claimed that shortages loomed: beyond the United States, the world’s oil-production capacity is also growing much faster than demand.
So far, this imbalance has been offset by two things: continuous outages of existing oil supply affecting several Arab and African countries, and the recurring fears of escalating crises in the Middle East. But supply capacity is bound to grow in the future as well, so that unless demand rebounds strongly in the next few years, a significant downturn of oil prices may well occur. The connections among a number of factors—the U.S. shale boom, the global rise of oil supply, and the inner volatility of oil prices due to temporary outages and political crises—provide a somewhat contradictory picture of the global oil market. These contradictions may, in turn, trigger unexpected changes in the direction of the oil market. All of these changes may have deep and sometimes paradoxical consequences for U.S. energy security.
THERE ARE several issues in the current debate over the boom in so-called U.S. tight and shale oil (hereafter referred to as shale oil) that serve to reinforce extreme and seemingly irreconcilable attitudes. One of the central questions revolves around the real potential of this boom and can be formulated simply as follows: Is oil production from shale formations just a temporary bubble, or is it capable of significantly altering the U.S.—and possibly global—energy outlook? To answer this question, I studied more than four thousand shale wells, along with the activities of about one hundred oil companies involved in shale-oil exploitation. The main results of this analysis are multifaceted. On the one hand, the large resource size and the ability of the industry to develop it through steady improvements in technology and cost suggest that the United States may become the largest global oil producer in just a few years, and maintain a high output for many years to come. The U.S. shale-oil boom is thus not a temporary bubble but a long-term, transformational phenomenon.
However, the unique characteristics of shale oil—the drilling intensity in particular—make it vulnerable to both price drops and environmental opposition in new and populated areas. What’s more, shale development benefits from some specific factors that are especially present in the United States but not worldwide, and that makes the global extension of a shale boom unlikely, at least in this decade. Even with a steady decline of crude-oil prices (for example, from $85 per barrel in 2013 to $65 per barrel in 2017), the United States could be producing 5 million barrels per day (MBD) of shale oil by 2017. With the present output of 1.5 MBD, that would more than triple the current production. More than 90 percent of such production will come from just three large shale-oil formations: Bakken-Three Forks (North Dakota), Eagle Ford (Texas) and Permian Basin (Texas). Together with a relatively resilient production of conventional oil, an increasing production of natural-gas liquids (NGLs) and a steady output of biofuels (NGLs and biofuels are considered part of the overall oil production in most statistical sources), the United States could become the leading oil producer in the world by the end of 2017, with an overall oil production of about 16 MBD and a sheer crude-oil production of 10.4 MBD.
Reinforcing this prospect is the resilience of U.S. conventional-oil production, once deemed bound to decline irreversibly. In fact, thanks to the extensive application of advanced technology to mature and once-declining oil fields, U.S. conventional-oil production is also doing better than generally expected.
Among the fourteen main oil-producing states or areas of the United States, so far nine have already witnessed a reverse of their declining oil production. What’s more, the relative decline in the Gulf of Mexico is just a result of postponed development following the Deepwater Horizon incident in 2010. Yet the driving force behind the U.S. oil boom—namely, its huge shale-oil potential—depends crucially on the U.S. oil industry’s ability to bring on line an astonishing number of wells each year. In fact, the extremely low porosity of shale reservoir rocks limits the recoverability of oil from one single well. On average, each loses 50 percent of its output after twelve months of activity; by the end of the fifth year of production, output almost stabilizes around 8–10 percent of initial production. To offset this dramatic decline in production, an oil company must thus drill an ever-increasing number of wells.
For example, in December 2012 it was necessary to bring ninety new wells on stream each month to maintain the production rate at Bakken-Three Forks (so far, the largest shale-oil play in the United States)—770,000 barrels per day. But as production grows in North Dakota, the number of producing wells also must grow exponentially. Given the current state of knowledge and technology, the growth of shale-oil production is based on a “drill or die” logic that is not that easy to apply elsewhere. The large and less populated areas of North Dakota and Texas are capable of sustaining such ever-increasing drilling intensity for many years to come—to over one hundred thousand active shale-oil wells, compared to around ten thousand to date. This relies on an approach called “down spacing,” which means increasing the density of wells within an area. Oil companies are realizing that it is possible to drill more wells in the same area without provoking a negative interference between one well and another. Nevertheless, the “drill or die” logic will probably represent a major obstacle to the expansion of shale activity even in most areas of the United States that—unlike Texas, North Dakota and a bunch of additional states—are densely populated, and have neither vast territories nor a long history of drilling intensity. In fact, in the eye of public opinion and local residents, drilling intensity will likely emphasize the environmental problems associated with shale activity, triggering in several states a vigorous opposition to the expansion of such activities.
WHILE DRILLING intensity may prove a limiting factor in expanding shale activity in the United States outside of its core areas, it will likely prove an insurmountable obstacle for the rest of the world—for several reasons. First, the United States holds more than 60 percent of the world’s drilling rigs, and 95 percent of these are capable of performing horizontal drilling that, together with hydraulic fracturing (fracking), is crucial to unlocking shale production. No other country or area in the world has even a fraction of such “drilling power,” which takes several years to build up. For example, all across Europe (excluding Russia) there are no more than 130 drilling rigs (compared to 180 in North Dakota alone), and only one-third of them are capable of doing horizontal drilling. And it’s not only a problem of drilling rigs. Shale activity also requires highly specialized tools and people that are in short supply in the world—and all this also requires years to be built up. Moreover, no other country has ever experienced the drilling intensity that has always characterized America’s oil and gas history.
In 2012, the United States completed 45,468 oil and gas wells (and brought 28,354 of them on line). Excluding Canada, the rest of the world completed only 3,921 wells, and brought only a fraction of them on line. To my knowledge, Saudi Arabia brings on line no more than two hundred wells per year. Other factors will contribute to prevent the development of shale resources in the rest of the world. One is the absence of private mineral rights in most countries. In the United States, landowners also own the resources under the ground—and have a very strong incentive to lease those rights; in the rest of the world, such resources usually belong to the state, so that landowners often receive nothing from drilling on their lands apart from the damage created by such activity. Also absent outside North America are independent oil companies with a guerrilla-like mind-set, a crucial aspect of the U.S. boom. Until now, the development of shale resources has not proved to be Big Oil’s strength—since shale oil requires companies capable of operating on a small scale, pursuing a number of objectives and leveraging short-term opportunities. Only the United States (and partly Canada) possesses a plethora of such aggressive companies. It is no accident that they have been, and still are, the avatars of the shale revolution. Finally, we don’t even know with any reasonable accuracy either the real size of the shale formations in the world or the cost associated with their development. Indeed, the geology of the United States is by far the best known, explored and assessed with respect to any other country. As a consequence, global shale deposits outside North America are still just a matter of pure speculation.
HUGE AS IT may be, U.S. crude-production potential is still insufficient to allow for the much-sought-after goal of U.S. crude-oil independence—the only missing point in the overall equation of U.S. energy independence. America is already largely self-sufficient in terms of all other primary-energy sources (coal, nuclear, natural gas, NGLs, etc.), while it still imports about half of its daily consumption of crude oil, which is now a little more than 15 MBD. True, imports have plummeted steadily from their peak in 2007 (when they outpaced 10 MBD), and they will continue to decline in the next few years. However, even in the most favorable scenario outlined above, 25 percent of U.S. crude-oil requirements will have to be imported in the future.
This implies that if the United States wants to target the highest degree of oil security, it should rely not only on an increase of its domestic crude-oil production, but also on energy-efficiency measures that could curtail crude-oil consumption. Together with a structural shift in consumers’ behavior, the latter has already played a role in reducing American addiction to oil—and that occurred well before the economic crisis erupted in 2008. The yearly total vehicles-miles traveled by the American people peaked in 2006 at 3.1 billion, and is now down to less than 2.9 billion. On a per capita basis, the mileage peak was reached in 2004 at around ten thousand miles per year and then dropped to the current 9,100 miles annually. Nor is this all. Americans are not only consuming less, but they are also consuming better—choosing smaller, more efficient vehicles or alternative modes of transportation, whereas many among the younger seem to have turned their backs to cultural patterns which regarded the car as the embodiment of emancipation. In short, it’s no longer a caddy for daddy. The change is evident both in the urban landscapes—which are now punctuated by a large number of midsize cars once abhorred by consumers—and in the numbers: according to the University of Michigan Transportation Research Institute, in 2013 the average fuel efficiency of passenger cars and light trucks sold in the United States was close to 24.8 miles per gallon, up from 20.1 in October 2007.
Although it’s highly probable that demand for oil has already peaked in the United States, as it did in Europe in the mid-1990s, and will follow a pattern of secular decline, the economic recovery will surely be accompanied by a rebound in consumption of both cars and oil—a phenomenon that is already showing up. This, in turn, could reduce American energy security. That’s why a sound approach to energy security cannot look just to supply, but also to consumption. What’s more, in terms of security it’s likely that a lower rate of U.S. crude-oil imports would have paradoxical consequences for U.S. energy security. In fact, among the most endangered foreign sources of supply would be countries traditionally considered to be “safe.” The most important of these is Canada, because it relies almost completely on the U.S. market as an export outlet for its oil.
A shrinking U.S. market implies a short- and medium-term blow to the development of the massive potential of Canadian oil sands that currently have no alternative markets. This also explains why the construction of additional pipelines to the United States—such as the highly debated Keystone XL—is key for Canada if it wants to expand its oil production. To a lesser extent, lower U.S. crude-oil imports will pose challenges for Venezuela and Mexico: along with Canada, these “safe” oil exporters to the United States will need to secure new, reliable markets and partners for their crude in the future so as not to be overly dependent (as in the past) on the shrinking U.S. oil market. This potential shift will represent an opportunity for U.S. energy competitors like China, and it will make the United States a bit more vulnerable in the future to an oil crisis because it will no longer be able to count on the Western Hemisphere’s oil as its almost-exclusive domain. Finally, even the highest degree of oil independence will not insulate the United States from the global oil market. To the contrary, any major event concerning the world’s oil will always affect the United States and could also endanger its own oil boom. The latter possibility involves a careful consideration of both global oil-production capacity and demand, as well as the price of oil.
THE CONTINUATION of the current U.S. oil boom will require, at least in the next few years, adequately high prices of oil that, in turn, would allow for escalating shale activity. Such a scenario, however, cannot be taken for granted because, almost unnoticed, the world too is facing a production boom. By December 2013, actual oil production reached almost 93.5 MBD. On top of this, there were more than 2.5 MBD that couldn’t be produced or marketed either because of different kind of disruptions (mainly due to political tensions, strikes or accidents in countries such as Libya, Egypt, Nigeria and Sudan), or because of international sanctions against Iran. What’s more, there were 3 MBD of voluntarily shut-in production—what the oil-industry jargon calls “spare capacity”—mostly concentrated in Saudi Arabia.1 When actual production, supply disruptions and spare capacity are combined, the world seems to possess a potential oil-production capacity in excess of 99 MBD—also an all-time record.
Conversely, oil demand is growing sluggishly, as a consequence of the troubled global economic situation, the slowdown in China, India and other emerging economies, the unsolved problems of the euro zone and the impact of energy-efficiency legislation across the world. Due to all these factors, according to the International Energy Agency world oil demand was just 91.2 MBD in 2013 on average, meaning that by December of last year almost 8 MBD of oil formed stocks or simply were not produced or marketed. This imbalance is not only big, but it’s also growing, as a consequence of a bullish investment cycle in global exploration and production that started in 2003 and dramatically escalated from 2010 onward. High oil prices, the need of most companies and countries to replace their reserves, and the extensive application of new technologies to oil recovery are the major factors driving this unprecedented spending spree that in just four years has totaled almost $2.4 trillion in upstream investments.
The impact of these investments on new production capacity could be particularly acute by 2015. In particular, if the United States, Iraq, Canada, Brazil and Venezuela could deploy their full oil potential, supported by investments already under way, global oil-production capacity could reach 110 MBD by 2020. This evolution could be helped by a lower decline rate in aging oil fields, whose maturity is now contrasted by means of either massive redevelopment plans (such as in the case of Iraq), or by the application of more advanced production technology. In addition, the world’s current production leaders, Russia and Saudi Arabia, are continuing to increase their production capacity—defying the dire predictions of most pundits, who deemed those countries destined to face an irreversible decline of their oil output.
For over a decade, year after year, most experts have been predicting an immediate decline of Russian output. However, the country’s oil production has continued to rise, and it’s now at around 10.6 MBD, with the potential to grow more if the fiscal system is modified to incentivize the redevelopment of mature oil fields. As for Saudi Arabia, the Kingdom has been a preferred target of oil doomsters since the 1980s, when it was first accused of manipulating the real extent of its oil reserves. Since then, according to the “peak oil” theorists, the country should have been producing less and less. This bogus perception earned a revival in the middle of the last decade, when Matt Simmons’s book Twilight in the Desert recast doubts on the Kingdom’s effective oil potential, predicting a sudden fall of its production. By the time of Simmons’s book, however, Saudi Arabia announced a plan to expand its oil-production capacity by about 2 MBD—or the equivalent of Brazil’s production today—in just four years, and in late 2009 it reached its target.
Furthermore, last year the Kingdom brought on line another big oil field, Manifa, which in 2014 will reach its full production at nine hundred thousand barrels per day. Then, by 2017, Saudi Arabia plans to add another 550,000 barrels per day by expanding the capacity of two additional oil fields, Khurais and Shaybah. Apparently, this expansion should not add new net capacity to the country’s potential, because the Kingdom’s decision makers want to relax older fields’ production as the fresh capacity comes on. If this is the case, Saudi Arabia will just preserve its current production capacity of about 12.3 MBD (including the output from the “neutral zone” shared with Kuwait), the largest in the world. As a consequence of the upward trend in global oil production, unless a substantial rebound of oil consumption takes place across the world in the next few years, the gap between global oil supply capacity and demand will widen. This phenomenon may not affect oil prices so long as new political crises scare market operators and threaten the stability of the entire Middle East. But the basic truth remains: in the long term, a growing imbalance between supply capacity and consumption will turn into a prerequisite for a collapse of oil prices. Because the full development of shale oil in the United States requires an oil price higher than $80 per barrel in the short term, and higher than $65 per barrel in the longer term (five years), the above scenario could have a dramatic impact on the U.S. oil boom.
IN ORDER TO manage the growing imbalance between supply and demand, so far the Organization of Petroleum Exporting Countries (OPEC) has been relying on two pillars: first, Saudi Arabia’s willingness not to inundate the market with its full production capacity, which is obliging the Kingdom to preserve a spare capacity of at least 2.5 MBD; and second, Iran’s inability to export a sizable amount of its oil-production potential—more than 1 MBD—due to international sanctions. In the coming years, however, OPEC’s ability to manage growing global oil supplies will continue to decline, due to an Iraq struggling to become one of the world’s top producers, African countries looking for new outlets for their oil, the great potential of the United States, Canada and other countries—and an oil demand still stagnating due to a global economic crisis that shows little prospect of improvement.
What’s more, the recent interim agreement between Iran and the group of countries—including the United States—that are negotiating a solution to the long-debated Iranian nuclear program is now raising the prospect of the full return of Iran’s oil production to the international markets, perhaps as soon as the second half of 2014. All these elements will likely put OPEC under stress in the next few years, and Saudi Arabia in particular. Due to its spare capacity, the Kingdom remains the central bank of the world’s oil market, and holds the capability to stabilize or destabilize it. Faced with an effective oil-production surge from OPEC’s countries that hold the highest potential to grow, namely Iraq and Iran, and an overall rise of global oil production, Saudi Arabia will have to consider two opposite policy options.
On the one hand, it could opt to act as the world’s swing producer, reducing its output dramatically to make room for others’ in an attempt to support oil prices, as the Kingdom did in the early 1980s. But if such a reduction became an endless retreat, the Saudi government could also consider producing at full capacity to get rid of more expensive oil producers and oblige other OPEC members to taper their own output, as it did in 1986. In this case, a mild version of the 1986 oil-price collapse could not be ruled out, and that would put in danger both U.S. shale oil and the more expensive Canadian oil sands. The final result would be highly detrimental to U.S. energy security.
This is not the only Persian Gulf scenario that may negatively affect the United States. Needless to say, if a major political crisis endangers the oil production of Saudi Arabia or another big oil producer in the short term, oil prices would skyrocket, no matter how much oil America could produce. This could be good for U.S. shale but awful for the U.S. and world economy. These scenarios show that it would be a mistake for the United States to confuse notions about energy security and energy independence and, above all, to envisage the possibility of abandoning its historical involvement in Persian Gulf affairs, not to mention turning its back on Canada and other secure oil suppliers. Whatever the degree of energy security and independence the United States can achieve through the shale revolution, it will always be inextricably linked to what happens across the global oil market, and particularly in the Persian Gulf. This is also true when it comes to the evolution of its relations with suppliers of oil such as Canada. Shale oil may bring more energy security to the United States, but it cannot bring energy independence. Thinking otherwise can only lead to a rude reawakening.
Leonardo Maugeri is a senior associate at the Harvard Kennedy School’s Belfer Center for Science and International Affairs and chairman of Ironbark Investments LLC. He was formerly a top manager of the Italian oil and gas company Eni.'
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