Not long ago, the idea of the United States producing more oil than Saudi Arabia seemed like a pipe dream. But then fracking, a technique the energy industry has been using in some capacity since the 1950s, came into its own. Huge advances in hydraulic fracturing and horizontal drilling over the last decade have coaxed crude oil and natural gas from shale beds once considered impenetrable in the United States. The implications are huge: According to the International Energy Agency, the U.S. could be the largest oil producer in the world as soon as next year. Remarkably, many industry conversations now revolve around exporting – not importing – oil and gas.
So-called unconventional shale gas and oil supplies are coming online in both the energy industry’s Texas heartland and as far afield as North Dakota and Pennsylvania. In October, the U.S. was producing 7.8 million barrels of crude oil per day – outpacing imports for the first time since 1995. By 2016, American producers should be cranking out 9.5 million barrels per day, according to the U.S. Energy Information Administration. American reliance on imported crude oil has been falling since 2008, and net imports are at their lowest level in two decades.
But that abundance has created its own challenges. Combined with major efficiency gains, the development of shale gas fields has driven a sharp decline in prices for natural gas, of which the United States is now the world’s largest producer. Prices at the Henry Hub, a key distribution point in Louisiana, averaged $3.63 per million BTUs in 2013 – up 83 cents from 2012, but still far below the $9-plus prices of 2008. While last year’s price bump prompted some exploration and production companies to restart drilling operations they had temporarily shuttered, producers remain wary of oversupply.
That raises a question: Could ramped-up U.S. oil production cause domestic crude prices to fall as sharply as natural gas did? As domestic production has increased, the spread between the benchmark U.S. crude price, known as West Texas Intermediate, or WTI, and Brent crude, a global oil benchmark based on production from a cluster of North Sea oilfields, has indeed widened, unsettling domestic oil executives. Starting in 2011, Brent has increasingly traded at a premium to WTI—as of Jan. 21, the spread was $14.66 per barrel.
But there is reason to believe that abundant shale oil will not drive a collapse in prices similar to that of natural gas, according to Credit Suisse Head of Global Energy Research Jan Stuart. One of the problems domestic gas producers face is that demand has lagged the ocean of new supply. It is taking time for fertilizer and chemical companies to build new manufacturing facilities that can take advantage of cheap gas inputs, though such factories have begun popping up near the Gulf of Mexico. And although American producers are eager to sell liquefied natural gas to Europe and Asia, where it can fetch a higher price than in the U.S., it isn’t possible yet. Exporting LNG remains controversial among U.S. politicians, who fear it will push domestic gas prices higher. So far, only one export terminal — being built by Cheniere Energy — has been approved, though the Federal Energy Regulatory Commission is considering others.
The shale boom has also largely reversed the geography of natural gas flows, and infrastructure hasn’t kept pace. While the majority of the country’s natural gas used to originate around the Gulf of Mexico, it now comes from shale fields in Ohio, Pennsylvania and New York. New pipelines are mushrooming to carry gas to markets in the Mid-Atlantic, Midwest and New England, but the Northeast is flooded with an oversupply of natural gas in the summer, when frigid buildings no longer need to be heated. That pushes prices down. Existing pipelines built to carry imported and domestic gas north from the Gulf need to be reconfigured to run in both directions, but Credit Suisse analysts say current plans to extend pipeline capacity to the southern half of the country are likely to prove inadequate. For gas producers to decide it is worth their time and money to invest in two-way pipelines, Stuart says, prices of Northeast natural gas will have to keep falling relative to gas at the Henry Hub. Stuart sees that happening over the next three years, particularly in summer, but for now, much of the brand-new shale gas supply tends to get stuck in a saturated market for at least part of the year.
Sufficient demand for crude oil, on the other hand, is already in place. The United States has long imported large amounts of crude, and both the infrastructure to refine it into products such as jet fuel and gasoline, and the markets for those end products are well established. If oil refineries currently processing imported crude simply switched to the Made-in-the-USA variety, there would be enough demand to absorb the new supply, Stuart says. Of course, the price would have to be right for them to do so, and that’s where the WTI-Brent spread comes in. At present, that spread has motivated some refiners to start retrofitting their plants. It also helps that the investment required to make the switch is relatively low. Most refiners were built to process medium- and heavy-grade crudes, but American oils are much lighter, and it is cheaper and simpler to retrofit refineries to process lighter crude than the reverse, Stuart said.
Stuart says that most oil-exporting countries could easily sell much of the oil they’re currently sending to the U.S. to customers in Europe and Asia. But some may also choose to set prices low enough to compete with domestic producers in order to maintain a toehold in the world’s largest economy. It’s unclear to what extent that will happen, though, as it could become awkward for Gulf State producers to explain why Japanese customers are paying a great deal more for oil than their American counterparts.
Credit Suisse analysts don’t believe it is likely that the U.S. will stop refining imported crude oil altogether. Nor is Stuart convinced, as the International Energy Agency has forecasted, that the U.S. will ever become a net exporter, largely because production is expected to decline sometime after 2020. Right now, with the exception of Canada, the U.S. doesn’t export at all. Overseas crude oil shipments are currently prohibited, with a few exceptions, but there has been a push recently on Capitol Hill to change that. And some American oil producers think they have a good case for doing so. Oil production is booming in West Texas, but local refineries in Houston are overburdened, as are the crude-carrying ships to Louisiana. There is a possibility that the U.S. could try to negotiate crude oil exports as part of a trade deal, Stuart says, though that would be a hard sell to an American public wary of anything that seems like it could drive gasoline prices up.
In the end, however, the trade balance that matters most to shale oil’s future prices is going to take place on American soil. “The system now is in a transition,” Stuart says. “The key to it all is, can we incentivize U.S. refiners to reject imports and instead accept the growing indigenous supplies? We think so.” It wouldn’t be the first—and probably not the last—time that accepted wisdom about the U.S. energy industry got flipped on its head.
Above: Increased U.S. oil production won’t lead to a sharp drop in prices.