Quick. What country will overtake Russia and Saudi Arabia to become the world's leading oil producer in just a couple of years?
If you said the United States, you would be correct.
A new report from Citigroup says that North America is now the world's fastest-growing oil-producing region, based on a combination of oil sands in Canada, tight oil in shale plays like the Eagle Ford in Texas (where production is up nearly 600% in the past year alone), the deep water Gulf of Mexico and turnaround in Mexico itself, where production had previously been declining for years.
When the Midwest Is the New Middle East
The Citigroup team led by Ed Morse sums it all in the title of their March 20 paper: "North America, the New Middle East?" Prominent oil economist Philip Verleger has another way to put it. He says we're "Saudi America."
It is hard to imagine being in such a situation. Texas began to cede its role as the world's swing oil-producing region soon after World War II and by 1971, shortly before the 1973 Saudi-led OPEC oil embargo, it had lost this role. Now it is clear the United States has more spare capacity in development than anyone else on the earth. It will soon be the United States again, and not OPEC, that is the world's swing producer.
For decades, Americans have heard that oil is a dwindling resource, and given environmental restrictions on drilling, past technology and the lower oil prices of the 1990s, that was probably true. The United States was the poster child for peak-oil theorists.
The End Seemed Near
As recently as two years ago this week, the blowout of BP's Macondo well and the fire about the Deepwater Horizon drilling rig seemed to mark the end of expansion in the rich, but technically challenging, ultradeep waters of the Gulf.
On the gas side too, things seemed dire. Back in 2001, the U.S. National Petroleum Council determined that natural gas was a dwindling resource. Not coincidentally, natural gas spot prices earlier that year had hit $10 per thousand cubic feet (mcf) at the Henry Hub and were higher still in California during the power crisis. Price spikes from then on seemed to underscore the notion that natural gas was running out. As recently as 2008, a recession year when industrial demand plummeted, natural gas prices managed to peak near $14/mcf.
Today is Different
Flash forward to today. The United States is swimming in gas. There is almost no room left to store it. The natural gas price has dipped below $2/mcf and may be $1/mcf by this summer according to some analysts. Mild winter weather has been a factor, but no one doubts that the real story has been a revolution in gas production from the shale plays.
Washington and the political system for once have been caught flatfooted by the good news. Markets and technology move much faster than politics do. Washington has just approved the construction of Cheniere's Sabine Pass project, the first-ever export terminal for liquefied natural gas, but we doubt that many more terminals will be approved and we are certain Washington won't move quickly on the next one. After so many years of energy scarcity and imports, Washington understandably has anxiety over natural gas exports.
The Problem of Plenty
The big question for the United States is what to do, first with all this gas, but now also all this oil. Most of the big decisions will be made in the marketplace. It seems likely that big investments will be needed in the upstream production capacity (lots of new wells, nearly all of them hydraulically fractured by oilfield service companies), and lots of midstream infrastructure (pipelines and processing facilities). But then, downstream, many analysts predict a renaissance in energy-intensive manufacturing and chemical industries, which indeed are already moving to take advantage of low natural gas prices and energy costs that may be structurally lower, in the United States, than in Asia or Europe. Given their druthers, political leaders and perhaps most Americans would rather export manufactured products than gas.
For now, our political leaders in Washington don't know what to do. They just want more of what's happening already. President Barack Obama is competing with Republicans who traditionally favor resource development to be more in favor of domestic oil and gas development. Politicians in both parties are following the jobs, the economic growth, the reduction of the trade deficit and the improvement in the nation's balance of payments that comes from replacing imports with domestic production and, as we are already seeing with refined petroleum products, export earnings. This year the United States has become the world's largest exporter of refined petroleum products and it is our single biggest export category.
Big Changes in Policy
Eventually, the importance of energy production to the U.S. economy will drive important changes in policy. While hydraulic fracturing will probably be regulated at the federal level in addition to what states are doing already, the substantive requirements won't be much different from what states require now. The offshore and Alaska are where we may see dramatic changes. Congress is close to passing offshore revenue sharing, given coastal states an incentive to welcome drilling along their shorelines. There is a very good chance, in our view, that some form of revenue sharing will pass Congress next year, regardless of whether Obama or Mitt Romney is President. We also see production in Alaska stepping up. Drilling may be underway in the Beaufort and Chukchi Seas as soon as this summer. It's only a matter of time, in our view, before the Arctic National Wildlife Refuge (ANWR) opens up. This may happen considerably sooner under Romney than under Obama, but it is going to happen sooner or later. One million barrels of oil a day is just too much to turn down.
OPEC Dominance Ended
Meanwhile, Saudi Arabia will see its own production growth and spare capacity steadily eaten away by domestic consumption. The Saudis burn more oil than Germany, a country with five times the population. Much of this goes to heavily-subsidized transportation fuels. Much of it also goes to producing electricity. With a developed-country lifestyle, the Saudis have developed a hefty appetite for both.
The Saudis won't curtail production, but they won't increase it much either. The developing world's demand from oil and gas will be met from a plethora of new sources: deepwater oil and shale resource that exist literally around the world. But first and foremost among these new producers will be the United States. It's a strange new world. Get used to it. And adjust your portfolio strategy for energy and industrials accordingly.
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