Monday, April 27, 2015

Peak oil or not, the U.S. is well positioned for the future

Peak oil refers to the point in time when the production of petroleum reaches a maximum rate of extraction, after which production is expected to terminally decline. The rise of American shale production in recent years has been a major factor contributing to the decline in oil prices, and has led some analysts to predict we have finally reached peak oil. This projection is alarming, as the period following the peak is often associated with insufficient supply and rapidly escalating oil prices. However, I do not see the current situation as concerning to energy security over the short or medium-term in the United States. Production of oil is expected to increase over both time horizons. Shale oil viability in the United States has fundamentally altered the global oil market, flooding it with new supply and, thus, setting the equilibrium price at a considerably lower level. Additionally, the rise of shale has decreased OPEC’s share of global oil production, diminishing its ability to manipulate prices and allowing American shale to balance the market.

Non-OPEC Supply
Non-OPEC countries supplied 56.45 million barrels per day (mb/d) of petroleum in 2014, a 2.1 mb/d increase from the previous year. Production is projected to increase by 0.8 mb/d in 2015 and 2016. Production growth is slowing in the U.S., Canada and Brazil, three major contributors to growth in recent years. However, the forecasted reduction in the rate of growth is attributed primarily to low projected oil prices rather than diminishing supply.  This leads us to the importance of shale in North America.

One characteristic that makes shale oil production unique is its highly responsive price elasticity relative to conventional crude. Short lead-time, payback time and rapid well depletion allow shale producers to respond faster and more effectively to changes in supply, reducing production when oil prices are too low for profitable extraction (most projects are profitable at $80/barrel) and increasing production when prices are attractive. Given the United States’ high level of oil consumption, this is a fortuitous development. As was witnessed in November 2014, when OPEC and other conventional sources of low-cost crude attempt to protect market share by pricing shale out of the market, American consumers benefit tremendously through reduced gas prices. Alternatively, any attempt to increase oil prices by reducing supply will be met with a quick shale production increase in the United States, creating domestic economic activity and stifling market manipulation. This new dynamic is allowing shale producers to take the, traditionally Saudi, role of market balancer.

OPEC Supply
OPEC members produced 36.49 mb/d of petroleum in 2014, unchanged from the previous year. Production growth took place in Iraq and Iran, but was nullified by declines in Libya, Angola, Algeria, and Kuwait. Production is expected to decline by 0.1 mb/d in 2015 and 0.4 mb/d in 2016. Over the two-year forecast, Iraq is expected to contribute the most to production growth within OPEC. However, Iraq’s growth is unlikely to outpace declines in production from other Persian Gulf countries. Additionally, the threat of the Islamic State (IS) make Iraq’s production level difficult to project.

OPEC producers experienced high levels of oil supply disruptions in 2014, averaging 2.4 mb/d and increasing by 0.6 mb/d compared to the previous year. Almost all growth in disruptions came from Libya and Iraq. If a level of stability can be restored in the Persian Gulf and North Africa, there is significant potential for production growth through the reduction of supply disruptions.

Global Demand
Consumption of oil increased by 0.9 mb/d for an average of 92.1 mb/d in 2014. Similar levels of growth are projected for 2015 and 2016. The center of gravity for oil consumption is shifting to the Far East, away from OECD members. China is leading the way, accounting for 0.4 mb/d of growth in 2014, nearly half of all global consumption growth. China’s consumption growth is projected to drop slightly to 0.3 mb/d in 2015 and 2016 due to recent declines in key manufacturing indicators.

Despite sluggish demand in OECD countries and significant declines in projected consumption in Russia due to its recent economic downturn, total world consumption is expected to increase by 1.0 mb/d in 2015 and 2016 on the strength of demand from non-OECD members and the United States, which is projected to experience consumption growth of 0.3 mb/d in 2015. Rising oil demand puts additional pressure on supply, particularly if a peak oil situation arises. However, the shale revolution is likely to keep prices suppressed to a reasonable, if not attractive, level in the short and medium-term.

I do not see peak oil as a major concern to the United States' energy security or economic health. Most experts do not project a downturn in total oil production in the short to medium-term; long-term projections are inconsistent, reflecting the difficulty of projecting far into the future with any degree of accuracy. However, we can be certain that shale oil has placed the United States in a much better energy security position, both prior to and after peak oil. The availability of domestic shale limits the effectiveness of OPEC’s supply suppression. Additionally, when prices rise to the (still reasonable) point that shale operations are profitable, the production will be domestic. This keeps capital in the U.S., supports jobs, and can have a multiplier effect that is beneficial to the greater economy.

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