Oil Boom 2.0 – An American Dream Updated

The impact of the US shale “revolution” has people all around the world scratching their heads – over what it means: Is North America really on the road to self-sufficiency? Of oil, of gas, or of all fuels? And increasingly, people wonder about the implications for their own regions: Are there similar resources? What would it take to get at them?

By the numbers, this already IS a big development. Last year, the US witnessed the world’s largest increase in oil as well as gas production. Not only did oil production expand faster than in any other country, last year also saw the biggest oil production increase in the history of the US – a country, mind you, which has produced oil since 1859.

So far this year, production has grown even stronger.

The reason is tight oil - oil generated with the same technologies that gave us shale gas.

Production

US production last year grew by over 1 million barrels per day, 80% of which came from North Dakota and Texas, currently home to the country’s most prolific tight oil formations. North Dakota surpassed Alaska to become the second largest producing state and in Texas, the number one, output has doubled over the past five years.

Meanwhile, the US is well on its way to replace Saudi Arabia as the world’s largest oil producer – the switch may take place as early as next year.

How did this happen?

Parts of the story are well known:

• The existence of a massive resource base.
• A decade of high and rising prices for both oil and gas.
• Most importantly, a competitive environment, allowing entrepreneurs and their companies to take a gamble to connect the two.

Everyone can invest in oil and gas in the US or Canada – and many did. It was actually mostly small or medium sized firms which tried to develop the technologies to make it possible to connect high prices and known shale resources – first for gas, and then for oil. Many failed and lost their shirt in the process. A few succeeded. But the big ones, the BP’s or Exxon’s of this world, only came in once the basic technologies (such as horizontal drilling and hydraulic fracturing) had been developed – to buy them, and to apply them elsewhere.

Economics

Economists use a big name for this type of development (named, of course, after a fellow economist) and call it a “Schumpeterian” process – otherwise also known as Economics 101: Under market conditions, high prices trigger competition, and competition triggers innovation. There are victims among those agile spirits who move in first, and there is a wave of followers who come in next, catching up with the new technologies and refining them to make them more efficient, until the system turns stable again. These waves of innovation indeed are one of the most fundamental characteristics of functioning market economies.

The US is now reaping the second round effects of such a wave of innovation: after access to the massive resource base has been granted by technological improvements, and thus the boom been triggered, comes the hour of efficiency improvements.

The graph above shows how: In North Dakota, for example, the number of new wells started in 2012 grew by more than 50% and so did the state’s oil production – even though the number of rigs grew by only 10%. Producers are getting more oil out of the ground with less activity.

Perhaps the most important lesson one can ever hope to learn from this development is what it means for energy markets generally: that energy markets are governed by the very same simple principles as any other market.

There is a reason this happened in the US or Canada and not, say, in Venezuela or China – despite the fact that they sit on unconventional resources at least as plentiful as those in the US and Canada (oil sands in Venezuela, shale formations in China). This reason has nothing to do with resource endowments below ground but everything to do with competition and markets above ground. Innovation tends not to happen in economies where government control extinguishes the private reward for trial and error - in energy markets just as in any other industry.

Global Impact

Meanwhile, the developments in North America are changing energy relations for the rest of us. They are still too new to be emulated in other parts of the world, although the resource base is wide-spread. But while other places are busy trying to locate those resources (and remember, they will have to mimic the “above ground” competitive conditions as well to access them efficiently, which will take time), developments in the US are reshaping global oil markets as we used to know them.

Five years ago the US imported 2 million barrels per day of refined products (i.e. gasoline, diesel, etc.). Last year, it became the world’s biggest exporter, selling 1 million barrels per day of refined products abroad (crude oil exports are still legally constrained in the US). All told, the US still is a net oil importer and likely to remain one for years to come, but look at the graph below – I think it tells it all.

Net US oil imports peaked in 2005 and have since fallen by 36% (or 4.5 million barrels per day). Just to clarify the order of magnitude; this reduction is equal in size to Japan’s entire oil consumption last year, Japan being the third largest oil consumer on the planet.

Just a few years ago, US imports were on a par with Europe’s; now they are one third below those of the European Union.

Over that same period, Chinese net oil imports rose 84% (2.8 million barrels per day). China is well on its way to overtake the US to become the world’s largest oil importer. You can take a guess as to how long it will take for the orange and light green lines cross - it is happening right as we speak. (Believe it or not, 20 years ago, China was a net exporter of energy!).

In my view, and this is a little guesswork now the foundation of which can be found here, the US is likely to remain a modest net oil importer until about 2030. North America as a region (comprising Canada, Mexico and the US) looks set to become self-sufficient around 2020. China, on the other hand, soon the world’s biggest importer of fossil fuels (oil, gas and coal), will import almost 80% of its oil and more than 40% of its natural gas by 2030.

In this way the shale “revolution” becomes part of a much bigger development.

But what triggered it? Accident? The North American resource base? Markets? What are the implications? And - will it happen elsewhere?