Energy security: Strength in reserve; The shale boom will strengthen US diplomatic influence but will not allow it to disengage from the Middle East

September 5, 2013 7:19 pm

Energy security: Strength in reserve

By Ed Crooks and Geoff Dyer

The shale boom will strengthen US diplomatic influence but will not allow it to disengage from the Middle East

“When word of a crisis breaks out in Washington, it’s no accident that the first question that comes to everyone’s lips is: ‘Where’s the nearest carrier?’” President Bill Clinton, aboard the USS Theodore Roosevelt, 1993.

Twenty years after Mr Clinton’s tribute to the might of America’s fleet, the location of its carriers still reveals much about US foreign policy priorities. Of the US navy’s 10 operational aircraft carriers, three are in foreign waters: one in Japan and two with the Bahrain-based 5th Fleet in the Gulf. One of the two, the USS Nimitz, sailed into the Red Sea on Monday, moving into position for possible air strikes on Syria. The other, the USS Harry S Truman, remains in the Arabian Sea, launching missions to support US troops in Afghanistan. Both are also positioned to keep watch over the oil-producing countries of the Middle East, and in particular the Strait of Hormuz at the mouth of the Gulf, the conduit for a fifth of the world’s supply.The 100,000-ton carriers are physical evidence that while a great deal has changed in the global oil market in the past five years, a great deal has not. The US shale boom has unlocked huge reserves of oil and gas, transforming the country’s energy industry and raising hopes that America can begin to disentangle its economy and its foreign policy from the messy politics of the Middle East.

Anxiety over energy supplies has gripped the US since the Arab oil embargo of 1973. Every president since Richard Nixon has talked about breaking America’s addiction to foreign oil, without success. Until now.

Thanks to a combination of soaring production in places such as the Bakken shale of North Dakota and domestic demand that is still 10 per cent below its 2005 peak, the share of US oil demand met by imports has fallen from 60 per cent in 2005 to less than 40 per cent this year. The International Energy Agency, the rich countries’ think-tank, believes that the US could be more or less self-sufficient in energy by the 2030s.

Tom Donilon, until recently Barack Obama’s national security adviser, has described the shale boom as a “transformational moment”, which “affords us a stronger hand in pursuing and implementing our international security goals”.

China set to become top oil importer

The global oil market will hit a milestone next month when China overtakes America to become the world’s largest net oil importer, if projections by the US Energy Information Administration are correct.

The switch highlights the shifting international relations driven by the steady growth in China’s oil imports and the steep decline in America’s.

Continue reading ‘China set to become top oil importer’

Others have gone further. Lisa Murkowski, the ranking Republican on the Senate energy committee, wrote this year that US dependence on Opec, the oil cartel, “makes it difficult for us to advance our values and defend our interests” but by 2020 that dependence could be broken.

Amid this optimism, the Syria crisis has been a reality check. Syria neither exports much oil nor controls a critical trade route. But its civil war has become a proxy battle for the world’s largest energy producers, with Russia and Iran backing President Bashar al-Assad, and Saudi Arabia, Qatar and the US supporting the rebels.

Fears that the conflict will spill over to countries that are important oil exporters, including Iraq, helped push US crude prices to a two-year high last month. American motorists are paying six cents more for a gallon of petrol than they did last week.

If the US begins strikes against Mr Assad’s forces, analysts expect the price of crude to rise further. The crisis is demonstrating both the potential of the US “energy weapon” and its limitations.

“Energy independence”, which would make it possible for the US to turn its back on the rest of the world in general and on the Middle East in particular, remains an alluring vision. The reality is not so simple.

. . .

“Everything’s better with Bakken” reads the sign taped up in a control room at the Phillips 66 refinery in Bayway, New Jersey.

It is a joke – a play on the popular line “everything’s better with bacon” – but also utterly serious. A few years ago, all the oil processed here came in tankers from north or west Africa, or from the east coast of Canada. Now, about a third of it comes in rail cars from North Dakota. When a new rail terminal is completed next year, that proportion could rise to two-thirds.

The competitive advantage offered by Bakken crude, costing about $10 per barrel less than its internationally traded equivalent, has thrown the Bayway refinery a lifeline.

As a result, the residents of New York and New Jersey are increasingly likely to fuel their cars with petrol that originated not in Algeria, Nigeria or Angola but in the American heartland.

Advances in the techniques of hydraulic fracturing (“fracking”) and horizontal drilling have enabled a 50 per cent rise in US oil production since 2008.

They have also been responsible for a boom in natural gas, which is now much cheaper in North America than in Europe or Asia. There are more than two dozen projects in development for exporting liquefied natural gas from the US. Even if only a few of them go ahead, it will be a significant exporter in the next decade.

Mr Donilon says that rising oil and gas production is helping the US to meet its foreign policy objectives.

Last year, when the US and other countries imposed tighter sanctions on Iran, international action was easier to co-ordinate because rising US production eased fears of a damaging rise in oil prices.

“Sanctions against Iran were more successful than people thought they would be because we were able to replace the lost supply in world markets and thus get co-operation from China and India and others,” says Jason Bordoff, a former senior White House official now at the Center on Global Energy Policy at Columbia University.

“We could pull 1.5m barrels per day off the market without causing a spike in prices, which would have hurt our economy and helped Iran.”

Increased US production is also helping blunt the threat of a rise in prices over the Syria crisis.

The global crude market is tight, with production severely disrupted in Libya and Nigeria. Saudi Arabia’s output is at a 24-year high as the kingdom attempts to make good the shortfall and Opec’s spare capacity to cover any further disruption is running low.

The recent rise in crude oil prices would have been worse without the extra supply from the US, which has brought an additional 1m barrels per day on to the market over the past year. “It has been beneficial to the US, and to everybody else,” says Stephen Eule of the US Chamber of Commerce. “And as we continue to increase production, we’ll see that even more.”

In gas markets, too, rising US production is eroding the influence of America’s rivals. Russia has been able to use its position as the world’s largest gas exporter for leverage over its smaller neighbours, especially Ukraine, and to strengthen its ties to countries such as Germany, Italy and China. That position is now threatened by competition from LNG supplies that would otherwise have gone to the US, and prospectively by exports from America itself.

Lithuania, for example, is building an LNG import terminal, potentially opening an alternative source of gas that could supply 75 per cent of the gas demand of all three Baltic states. China has been striking a hard bargain with Russia about a gas pipeline deal, demanding a lower price. Customers across Europe have been renegotiating contracts on more favourable terms and Ukraine has been blatantly confrontational, refusing to pay a $7bn bill from Gazprom, the Russian state-controlled gas company.

One direct benefit for the US, suggests David Goldwyn, a former US official and now an energy consultant, is that Russia is again prepared to open up to foreign oil companies, allowing its state-controlled Rosneft to work with ExxonMobil of the US in exploring the Arctic Kara Sea.

American gas diplomacy has scored one other notable success. Japan said in March it would enter negotiations over the proposed Trans-Pacific Partnership trade deal, a US objective, in part because joining an agreement would smooth the path for it to import American LNG.

US shale knowhow can also be a useful export. The administration has been working with countries including Poland, Ukraine, Jordan, China and Mexico to help them develop their shale resources so they can meet more of their own energy needs from domestic production rather than from Russia, Iran or other potentially unfriendly countries.

The shale boom is creating jobs and profits and boosting tax revenues. As Mr Donilon says: “A country’s political and military primacy depends on its economic vitality.”

Cutting back the US commitment to the Middle East also looks like an attractive way to save money. In response to budget cuts that went into effect this year, the Navy is planning to step down from two carrier groups in the Gulf to one.

Yet as America’s confidence in its energy resources climbs ever higher, there is a danger of the optimism running ahead of reality.

While the trends and forecast look encouraging, the US is still the world’s largest or second-largest importer of oil. (It is running roughly neck-and-neck with China.) For now, higher oil prices will hurt the US economy more than they help it by fuelling the boom in North Dakota and Texas.

As recent weeks have shown, while US oil production can help moderate prices, it cannot control them. The private sector oil producers of America will never emulate the state-controlled industry of Saudi Arabia, holding capacity in reserve to stabilise the market when needed.

Nor is the distinction between US crude and internationally traded benchmarks much help. Oil is a global market and when the world price of crude rises, the US price rises, too.

Moreover, the shale oil revolution is still very young and the industry will need to continue the rapid growth of the past few years to make good the promise of self-sufficiency suggested by the IEA.

“It would be wildly irresponsible to make defence policy decisions based on the assumption that the US is going to be energy self-sufficient in 10 or 20 years,” says Michael Levi of the Council on Foreign Relations. “If that turns out to be wrong, it could be disastrous. One of the big lessons here is: don’t be too confident.”

. . .

Even if the US could secure all the energy it wanted, it would still have to worry about supplies reaching its allies and trading partners. If the Strait of Hormuz is closed and China runs short of oil, that is America’s problem, too.

The US also has other interests in the region apart from oil. As Ernest Moniz, the US energy secretary, put it: “We import very little oil from the Middle East but it doesn’t change our security posture in that part of the world.”

For US allies that export oil, including Saudi Arabia, the shale revolution is not an opportunity, but a threat. If American production continues to grow and demand weakens, there will be a risk of a glut, forcing Saudi Arabia and other Opec members to cut output or risk a collapse in prices.

In a turbulent region, the prospect of falling oil revenues straining budgets is worrying for every government.

Trevor Houser of the Rhodium Group, a consultancy, says: “It’s not clear to me that a sharp drop in oil revenue in Saudi Arabia, Kuwait or the United Arab Emirates would improve global stability, given current instability in the region, and it’s not clear it would ultimately be in America’s interest.”

In 1973, when Mr Nixon launched Project Independence 1980, intended to make the US self-sufficient in energy by the end of the decade, he said its aim would be to make sure that “we will hold our fate and our future in our hands alone”.

Forty years on, that promise still shows no sign of being fulfilled.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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