Issue #29, Summer 2013

There Will Be Oil

Suddenly, the United States is energy rich. The problem is that we’re still guided by policies that assume the opposite.

Have you ever seen one of those nighttime satellite photos in which North Dakota is lit up nearly as brightly as Chicago? Those lights are a result of “flaring,” the practice—environmentally harmful and economically wasteful—of burning off natural gas that can’t be collected and put into pipelines because our pipeline system has not kept up with the boom in North American energy production.

And when you think about moving crude oil around North America, do you envision pipelines stretching thousands of miles, like the proposed Keystone XL pipeline that has attracted so much controversy? Most people do. It may then surprise folks to learn that the fastest-growing form of oil transportation in North America is a throwback to the industrial era—the locomotive. Warren Buffett’s big bet on rail is paying off, with the BNSF railroad he bought in 2012 projected to ship almost six times as much oil by the end of this year as it did in 2011.

The sharp increases in flaring and crude-by-rail shipments are just two manifestations of how the North American energy infrastructure is struggling to catch up to the transformational changes in the North American energy landscape. U.S. oil producers cannot fetch world prices because of pipeline bottlenecks. Although the United States is now a net exporter of refined petroleum, the East Coast still imports a million barrels of it per day, thanks to regulatory and logistical constraints on moving it from the Gulf Coast—where more of the refineries are—to East Coast markets. Even as oil production surges in North Dakota, drivers in New York and New Jersey last fall had to sit in line for up to ten hours to fill up because our fuel-system infrastructure was unable to withstand Hurricane Sandy’s wrath.

But it’s not just a lack of infrastructure. Indeed, the United States has a vast network of oil and gas pipelines, about 2.5 million miles—and has built enough miles of pipeline in the last eight years to travel three-quarters of the distance to the moon. It also has 2.5 billion barrels of fuel storage capacity, and many of the most sophisticated refineries in the world. The problem is that the changed energy landscape has rendered this infrastructure outdated. Our energy infrastructure was built to move oil from the Gulf Coast up into refineries in the middle of the country. But that entire infrastructure now needs to be flipped on its head to accommodate the massive growth in production from Canada, North Dakota, and other parts of the midcontinent.

Moreover, the policies and regulations that govern our energy infrastructure largely date from the 1970s, when concerns about shortage and the Middle East dominated the minds of policy-makers and the public. Today, the outlook has shifted from scarcity to abundance. Suddenly, policy-makers are being asked to consider questions that would have been hard to imagine just a few years ago. Should the United States export oil and gas? What are the safety and other implications of moving vastly larger quantities of oil by rail? How should our policy for engagement in the Middle East change if we import very little oil from the region? And there are many other questions.

Policy-makers must deal with these dilemmas while confronting not only a changed supply outlook, but also rapidly accumulating evidence that the effects of climate change are likely to be felt with increasing severity and frequency. Thus, they must consider whether committing now to large, long-term capital investments in our oil and gas infrastructure will make it harder and costlier to transition to lower carbon forms of energy in the long term.

To be clear, government does not need to build this infrastructure for the most part. The private sector will finance the build-out of our pipeline network; indeed, pipeline spending in North America is projected to increase nearly fivefold in 2013 from the prior year, and dozens of pipeline projects are planned. But federal and state governments have a key role to play. By putting in place the right policy and regulatory frameworks, they can allow economically viable infrastructure investments to happen and help rationalize individual projects that collectively must form an integrated energy transportation system. Moreover, these policy reforms also hold the promise of bringing industry to the table to support serious action on climate. Although oil and gas will remain important parts of our energy infrastructure for the foreseeable future, we must act now to avoid the worst impacts of climate change. The new energy infrastructure that the changing landscape requires can be an essential part of a compromise that seeks to advance domestic supply increases while taking meaningful action to address climate change.

The Changing Energy Landscape

We are at a transformational moment in energy history. Just a few years ago, all energy projections forecast increased imports, increased scarcity, and increased natural gas prices. Today, we’ve shifted from scarcity to abundance. U.S. oil production increased by nearly one million barrels per day (B/D) in 2012, the largest annual increase in U.S. history. In 2013, the United States is projected to be the largest producer of liquid fuels (including crude oil, natural gas, and biofuels) in the world, overtaking Saudi Arabia. U.S. oil imports are at their lowest level in 25 years and are projected to decline much more steeply as a result of surging production and reduced gasoline use due to higher prices and the Obama Administration’s increase of fuel-economy standards. And these projections may well be too conservative, as reflected in numerous private-sector forecasts.

The natural gas outlook is even more striking. In its recent biennial report, the Potential Gas Committee, a group that studies future U.S. natural gas supplies, raised its estimate 26 percent from just two years ago—more than a century’s supply at current demand levels. New government estimates show that the gas resources around North Dakota are three times higher than previously believed. Surging shale gas production means the United States will be a net exporter of natural gas in a few years. Multi-billion-dollar terminals proposed not long ago to import natural gas are being flipped to export instead. Moreover, the price of natural gas, which peaked at $13 per million British thermal units in 2008, dropped below $2 last year, before inching back up to $4. The U.S. Energy Information Administration projects the price will remain below $4 for most of the rest of the decade.

This transformation is not only a U.S. story. New technologies mean that what were once challenging sources of oil and gas can now be tapped economically from the oil sands in Canada, the ultra-deepwater “presalt” off the coast of Brazil, and many other parts of the world. North America is projected to be a net oil exporter by 2030. According to the Energy Information Administration, China’s shale reserves are 50 percent larger than those in the United States. Argentina has the third largest shale gas reserves in world. Venezuela has the largest oil reserves in the world, with the vast oil sands in the Orinoco Belt. Iraq is poised to potentially double oil output over the next seven years. Massive new oil and gas discoveries off the coasts of Africa mean that that continent may see sharp increases in production.

To be sure, there is uncertainty about how much oil can ultimately be recovered from these unconventional sources and how much it will cost. Initial data from the Bakken formation in North Dakota collected by PFC Energy, for example, show that the production “sweet spots” are very small compared to the overall size of the shale play. But the fact remains that the global energy landscape has undergone a historic transformation in just the last few years, and the reality in which policy-makers must now act is a world with vast amounts of oil and gas that can be produced at relatively affordable prices.

What Does the New Energy Boom Mean?

The changing North American landscape has significant economic, geopolitical, and environmental implications. On the economic front, simply put, increased oil and gas production means more economic activity and job creation. IHS CERA, the consulting firm founded by author and energy expert Daniel Yergin, estimates that unconventional oil and gas production will support more than three million jobs by the end of the decade (though it does note that these gains may be offset by declines in other industries). As the rest of the world increases unconventional oil and gas production, there will be more opportunities to export technology and services from U.S. firms, which pioneered these new techniques. Low natural gas prices are also saving consumers money on heating, electricity, and many products we consume.

Billions of dollars in manufacturing investment are returning to the United States because natural gas prices are so low here while remaining high elsewhere. Along with dry gas (which is basically methane), production is also booming for natural gas liquids, which contain ethane that can be converted into ethylene, the world’s highest-volume chemical and the foundation for many other industries; it is used to make bottles, toys, clothes, windows, pipes, carpet, tires, and many other products. Dow Chemical recently announced a plan to spend $4 billion to expand its U.S. chemicals production, including a new plant in Freeport, Texas due to open in 2017. The last such U.S. plant was built in 2001. It costs about $300 to make a ton of ethylene here in the United States, down sharply from $1,000 just a few years ago—and far lower than the $1,700 it currently costs in Asia, where producers rely on expensive oil instead of natural gas.

Also, we have seen increased manufacturing activity to support natural gas production, like steel for pipes used in hydraulic fracturing, also known as fracking. A new steel plant was announced not long ago in Youngstown, Ohio—the heart of the Rust Belt—to make pipes for fracking in the Utica and Marcellus shale formations underneath Ohio, Pennsylvania, and neighboring areas. That said, it’s important not to overstate the impact on the manufacturing sector: Low prices matter a lot for some energy-intensive industries—like petrochemicals, fertilizer, steel, and aluminum—but not much for others. And energy-intensive sectors account for only 7 percent of overall industrial production.

The changing energy landscape is having important geopolitical consequences as well. The U.S. shale boom has increased Europe’s leverage with long-time suppliers like Russia and helped reduce European natural gas prices. It has called into question the traditional burden-sharing relationships between countries to maintain global-oil market stability, as more and more Middle Eastern oil heads east to China rather than west to North America. It has raised new uncertainties about OPEC’s ability to hold together as a coalition, as more production outside OPEC puts pressure on prices. And the increase in U.S. oil production has offset the loss of oil supply from Iran, making it easier for nations to impose economic harm on Iran without harming themselves by driving up oil prices.

So the economic and geopolitical gains are considerable. But what about the effects of all this activity on climate and the environment? On climate, there are two effects to look out for. On the one hand, increased oil production can worsen the climate outlook by pushing down oil prices, thus increasing consumption and emissions. On the other hand, cheap natural gas has begun to displace coal in our electricity system and is poised to displace some oil in transportation, particularly trucks, trains, and ships. Roughly half as carbon intensive as coal, natural gas is a key reason—along with the weak economy and wider deployment of wind energy—that U.S. greenhouse gas (GHG) emissions in 2012 reached their lowest point in almost 20 years, and since 2005 have declined faster than Europe’s.

To be clear, natural gas alone will not allow us to meet our climate mitigation targets. But it can buy some time if it continues to displace coal—and not just here, but in coal-intensive countries like China and India as well. This is not a given, and policy will need to help drive that switch. Already in 2013, coal has recovered some of its market share as natural gas prices have risen from their historic lows of 2012. And the climate benefit from natural gas depends, in part, on the extent to which methane leaks into the atmosphere during production and distribution; recent reports from the Environmental Defense Fund and World Resources Institute confirm that cost-effective ways to reduce that leakage do exist. Climate policy—such as putting a price on carbon through cap-and-trade or a carbon tax, or using existing authorities like the Clean Air Act—will ultimately be necessary to avoid the worst impacts of climate change.

As for other environmental effects, there is a more direct benefit from the switch to natural gas from coal: The health costs to society from local pollution associated with coal-fired electricity are 17 times higher than that from natural gas-fired electricity. This is not to say that there are no environmental risks associated with unconventional oil and gas production. To mitigate these risks, wells must be properly cased and cemented; wastewater must be properly disposed of or recycled; chemicals used in fracking must be disclosed; emissions and flaring must be reduced; among other requirements. As we tap our new sources of energy, it is critically important that robust regulation and enforcement exist to ensure operators act consistently with best practices, not only to protect the environment, but also to reassure the public that energy is being produced safely.

The Energy Boom and U.S. Policy

Modernizing our nation’s energy infrastructure to meet the new energy reality is not government’s job. It doesn’t require a massive new public-works program or large amounts of government spending. The private sector has adequate incentives to make investments and build infrastructure where it makes economic sense to do so. This is already evident in the sharp increase in investment, leading Deutsche Bank to dub 2013 the “year of the pipeline.” So while the private sector will put up the capital, government needs to modernize policies that will allow America’s new energy abundance to find its way to market in the safest and most economical manner. Those policies span at least six areas: exports; the Jones Act; flaring; permitting; resilience; and rail safety.


Issue #29, Summer 2013
Post a Comment

Archibald Tuttle:

Your uncritical acceptance that the social costs of carbon should be a driving force in energy policy seems to lurk as the 'peak oil' moment in an otherwise cogent recognition that carbon is pulling America out of recession.

Jun 12, 2013, 8:02 AM
Evil Overlord:

At last, an honest article about energy policy. I appreciate that, despite pressing for more fossil fuel use, the author recognizes that it does have substantial financial and environmental costs, and that climate change is an actual problem.

@Archibald Tuttle - I come at this from the opposite perspective. I find the author's critical acceptance of carbon use to be the weak point in an otherwise cogent discussion of the flaws in current energy policy.

Jun 18, 2013, 11:14 AM

The U.S. is actually not energy-rich. At best, production for North America will reach 12 Mb/d in a decade, but current U.S. consumption alone is 19 Mb/d.

In addition, non-conventional production has problems with decline curves and energy returns.

Jul 17, 2013, 1:09 PM

The U.S. is actually not energy-rich. At best, production for North America will reach 12 Mb/d in a decade, but current U.S. consumption alone is 19 Mb/d.

In addition, non-conventional production has problems with decline curves and energy returns.

Jul 17, 2013, 1:09 PM
Irvin Dawid:

I've just begun reading this comprehensive piece - but from reading the comments, it seems that they miss Jason Bordoff's key point: this article is about the lack of infrastructure - not about energy. Consequently, natural gas is simply burned in the Bakkens - how does that help the environment - to those whose concerns lie there?

Jul 19, 2013, 12:50 PM
Anne Mackin:

We are not oil-rich. We have developed extremely costly and environmentally-destructive technologies for extracting oil from sands and shales. Alternative energies are still the future. Please see the prescient 1976 article by Wm. Baumol & Wallace Oates ("Conservation of Resources and the Price System," in Economics of Resources).

Jul 31, 2013, 11:24 AM
Andrew Helms:

A very well thought out and cogent piece that examines energy and energy infrastructure from a holistic perspective incorporating transportation, regulations, infrastructure requirements, politics and global energy trends.

Would enjoy reading more from you in the future

Aug 6, 2013, 2:48 AM

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