NEW DELHI: Celebration of America’s reemergence as an oil superpower riding on shale oil production may be cut short.
Last year may well have been the high-water mark of US preeminence. Burgeoning shale oil production helped transform the United States into a net exporter of oil and fuels in November and pushed crude output to a record of almost 12 million barrels per day – more than Saudi Arabia or Russia – positioning it firmly on the path of energy independence. America’s newfound status as major oil producer and exporter translated into geopolitical influence, giving President Donald Trump a handy club to wield when pressuring OPEC and Russia to lower oil prices or more broadly pursuing US strategic interests.
New estimates suggest this happy scenario may soon reach an end. Questions about sustainability have long dogged US shale oil’s remarkable rise, given the rapid rate at which shale oil deposits decline and leaving aside the environmental costs of fracking and increased oil production. The wells typically produce large volumes initially before quickly tapering off. The short lifespans, recognized since 2013, force producers constantly to drill more wells – and raise money to maintain and increase production.
A confluence of factors – including slower global economic growth and associated lower oil prices, lower-than-expected well productivity, weak stock markets and rising interest rates – could derail the fracking story. Higher interest rates and weaker financial markets pose challenges for debt-laden frackers, few of which managed to turn a profit, to finance new wells. Lower oil prices, down 25 percent since mid-October, on the back of US-China trade worries and slower growth further narrow margins and reduce incentives to keep drilling.
Thousands of wells in the most productive US shale formations are yielding significantly less oil and gas than company projections, suggests Wall Street Journal analysis. Oil services group Schlumberger reports a sharp drop in completion of new wells starting in the third quarter of 2018 will likely to extend into 2019. Wells Fargo predicts an 11 percent year-on-year decline in 2019 well completions compared to an earlier estimate of a 1 percent increase due to lower oil prices and a worsening macroeconomic environment.
One way to evaluate what the shale revolution’s end portends for world oil trade and the geopolitical balance is to examine what it did and did not change.
The fracking boom reduced but did not eliminate US dependency on OPEC and vulnerability to international oil price volatility. Between 2007 and 2017 shale boosted US oil production by 4 million barrels per day, or mbpd. During the same decade, US oil imports declined from 10 mbpd to 8 mbpd. Significantly, domestic barrels did not replace imported barrels on a one-to-one basis. Shale oil is light and does not meet requirements of US refineries, mostly designed to process heavier Middle Eastern crudes. Therefore, shale oil is exported.
Consequently, the United States still depends on OPEC for 39 percent of its total crude oil imports. That’s down from 54 percent in 2007, but still significant. OPEC is America’s main source of crude oil after Canada, which accounted for 43 percent of US imports in 2017.
Since Congress lifted restrictions in December 2015, US crude oil exports have increased rapidly, reaching 1.1 mbpd in 2017 and 1.76 mbpd during the first half of 2018. Most is destined for Canada, followed by the European Union, where light crudes are blended with heavier ones to fit refinery requirements. US crude directly competes with African light oil producers for EU markets. China was the second-largest US crude export market in 2017 and the biggest in the first half of 2018, but that trade ended abruptly in August following imposition of trade restrictions.
A drop in US shale oil production would reverse these trends. The US oil trade balance would weaken again, dependency on OPEC would increase, and perhaps more significantly, the US would find itself competing for Middle Eastern barrels with China, which in 2017 surpassed the US as the world’s biggest crude oil importer. This scenario could dramatically boost OPEC and Russia’s power to dictate global oil prices.
Arguably, the main impact of America’s oil renaissance has been to depress global oil prices at the margin. Lower oil prices translated into a number of benefits for the United States. Most obviously, they have helped shift the balance of power away from OPEC and Russia back towards the US. Robust domestic production means less US impact from Saudi attempts to cut crude supplies and drive up prices. Lower oil prices mean lower petrol prices and happy American consumers. Trump even boasted that the recent fall in oil prices amounted to a “tax cut.”
But the speed with which frackers can ramp up or cut production in response to prices – the tipping point for US drillers is about US$50 per barrel – creates a Catch 22-type situation for both the US and the Saudis. If the Saudis convince fellow OPEC members and Russia to cut production, the resultant higher prices will encourage US producers to drill more wells leading to a supply glut and lower prices. OPEC ends up being a victim of its own success.
Similarly, if Trump succeeds in jawboning the Saudis into eschewing production cuts, lower prices could damage the domestic fracking industry. While consumers benefit from lower oil prices, a good proportion of US business investment and jobs in key Republican states depend on fracking, and that could translate into lower economic growth. In January, Saudi Energy Minister Khalid al-Falih reportedly said that OPEC had given shale producers a “lifeline” by agreeing in December to cut production by 1.2 mpbd in the first half of 2019.
The reality is that although US shale production renders OPECs cartel strategies less effective, both sides remain locked in tight embrace. OPEC responds to the challenge by instituting cooperation mechanisms with Russia and other non-OPEC oil producers. Given the difficulty Saudi Arabia already has in securing cooperation from OPEC members, this approach may prove overly ambitious. The United States is also trying to flex its muscles – Congress debates a bill to allow the nation to sue OPEC countries for anti-trust violations, for example – but these attempts will likely fall foul of realpolitik.
A retrenchment in US shale, then, would mostly affect geopolitics at the margins by narrowing US policy options. Oil prices will rise; fracking-related investment and employment would dry up, reducing US economic growth. OPEC would regain some of its swagger, and the United States would be more beholden to Saudi Arabia. Washington would also perhaps have less leeway in its attempts to reshape the Middle East. The decision to impose sanctions on Iran was easier with a cushion of domestic oil supplies, for example. Heightened competition between China and the US for Mideast oil would add upward pressure on oil prices and could further complicate relations between the two countries.
There is a potential positive to a higher-oil-price, lower-US-production scenario. Shale’s success and fears of a demand peak have led oil majors to slash investments in the long-term, conventional megaprojects forming the basis for global crude supply. Rystad Energy estimates capital investments will fall 50 percent in the 2015-20 period as majors refocus on short-term projects.
This sets up the prospect of an undersupplied market and another spike in prices in the early 2020s, according to the International Energy Agency. Given the globe’s continued oil dependence – with 81 percent of total energy derived from oil, the same level as a decade ago – a sharp rise in prices may well be the catalyst for jumpstarting the long-delayed transition to renewables.
Reprinted with permission from Yale Global.