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Ten Reasons To Be Concerned About U.S. Energy Independence

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U.S. energy independence must be about to happen. The International Energy Agency just devoted its World Energy Outlook 2012 to telling us so. America will become the largest producer of oil and other liquid fuels on Earth by 2020; it will be entirely self-sufficient by 2030; and a net exporter by 2035. Boom. Epic stuff.

It would be churlish to deny that U.S. energy growth will provide major economic gains to America -- of course it will. Here’s a few hundred pages explaining exactly what they are. But this isn’t going to be a free lunch for America.

We’ll leave aside the fact that IEA forecasts have a strong track record of being universally wrong, or that a month ago they were pinning all their supply side hopes on Iraq coming good to ‘balance’ international oil markets. Minor stuff; but having just flown over the Bosphorus en route to Ankara via Istanbul, believe me, the world looks very different depending on where you’re sat. Here are 10 reasons for the U.S. to be cautious on energy supply growth, irrespective of however the IEA forecasts play out:

1) America Will Never Be The New Saudi Swing

America is never going to be in a position to produce enough liquids to perform the role of swing producer in the oil world. It might notionally overtake Saudi production by 2017, but that hardly leaves it much export margin to play with. U.S. pricing ‘power’ will purely become a function of how much collateral damage it does to other producer states, not dictating how much consumers have to pay at the pumps.

2) Global Pricing Pressures Will Always Influence US Pumps

By the same token, America can never truly escape international pricing pressures affecting broader supply-demand fundamentals. If anything, once the Obama administration gets to grips with significant infrastructure bottlenecks that have led to an inefficient domestic market, WTI benchmarks will increasingly realign with international prices. ‘What happens in the Gulf of Aden still affects what happens in the Gulf of Mexico’.

3)  Transitional Friction Will Be Profound

The fact that America has seen such rapacious supply side activity averaging over 500,000b/d in the past four years was good news for President Obama’s re-election, but it’s deeply concerning for traditional producer states. America has played fast and loose with international oil market stability of late, first in Libya, and then in Iran, purely on the back of new oil gains. Assuming U.S. supply growth forces oil under three ($100/b) figures, OPEC states will be in deep political trouble. Supply side outages across producer states will be the result when instability hits.  American supply growth will not be in a credible position to settle the markets; consumers will pay a heavy transitional price. The transitional limits of ‘energy independence’ will be clear for all to see, not just in traditional producer states that needed high prices to maintain stability, but a range of new players that all required firm prices to bring difficult fields to the wellhead.

4) U.S. Policy Suffers Structural Paradox

Needless to say, this makes a total mockery of ongoing US external support for oil supplies coming from the Middle East. It makes zero sense for Washington to be paying billions in tax payers’ money maintaining the 5th Fleet in Bahrain only to watch  OPEC states internally implode from the prospect of lower oil prices driven by American supply growth. It also points to a very awkward conundrum for State Department interests in the Gulf – this is ultimately about U.S. global power, not just oil.

5) All Points On The Compass Look East

The more damaging geopolitical problem is that anywhere ‘East of Nigeria’ will be looking to China and India for security of demand and geopolitical cover. China will stake its claim to regional dominance far more aggressively and expand its influence into the Gulf. The Asian ‘pivot’ will lose its bearings, and the dollar put on borrowed time if China no longer sees fit to keep bankrolling the Fed for its own security ends. What’s worse, Washington will still be intrinsically connected to global oil prices but have zero influence in the Gulf, Caspian, Russia or East Africa to influence material outcomes. That’s on anything ranging from nuclear proliferation to delicate succession issues. China will be calling the shots, able to split the world in two by laying claim to the Middle East, the Caspian, Australasia, Russia and East Africa as vital interests.

6) America Might Lose Friends Closer To Home As Well

Well, when we say ‘split the world in two’, it’s not going to be quite that neat for the Americas. There’s no way Canada, Mexico, Colombia, Ecuador, Venezuela, Brazil or Argentina will be happy relying on a single source of supply and a single source of demand from Washington. Far from selling oil into a saturated U.S .market, they’ll redouble their efforts to export energy to Asia, a hedge that could significantly reduce Washington’s long term influence in ‘Monroe’s playground’. Brazil could end up joining OPEC; Canada will be very tetchy about Arctic developments. As for Europe, with the trans-Atlantic relationship dead, they’ll go looking for new friends to help with energy supplies. The most likely of which is China to align consumer interests on the Eurasian land mass. The Western Hemisphere shrinks; for China, the sun never sets.

7) America Will Struggle To Keep Pace

Having lost most its friends (or ‘frenemies’) as some like to put it, America has a bigger problem. Can it really follow through towards 2050 as the biggest energy player in the world? The geological data is unsure. America’s 482tcf of gas and 25.2bn barrels of oil will start to look very small, and particularly if other producers follow America down an unconventional path. That’s by no means unlikely when you consider U.S. benchmark pressures could force traditional producers to give up trying to control prices, and go for a volumes strategy instead. We’re already on the verge of that happening in the natural gas world, there’s no reason why it wouldn’t be any different for oil. 110mb/d by 2020? Probably doable in a risk free, care free world; call it ‘OPEC’s unconventional bounce’. In a race to the bottom of the barrel, the Middle East is always going to trump the U.S. mid-West.

8 ) But Fear Not, America Can End Up A Chinese Lake

If that happens, fear not, the one country that will keep investing in U.S. liquids production is China. It’s in direct Chinese interests to make sure America fulfils its oil potential to help forge a structurally cheap and abundant energy world, not to mention hedging Beijing’s supply side portfolio. China has pumped $17bn into America since 2010, $10bn into Brazil, $16bn into Venezuela, and $18bn into Canada. And that’s before you consider the prospective $15.1bn Nexen mega deal. Many think it’s farfetched, but look closely at the U.S. natural gas scene. China's not only happy ploughing money into economically disastrous dry shale plays, it’s providing supply side contracts and finance for U.S. LNG export growth. Ask Cheniere down at Sabine Pass. Cheap U.S. gas on international markets is exactly what China wants to secure preferential contracts across the board, and it’s precisely what they’re now eyeing for oil.

9) Blunt Conclusion: China Gains Most From Cheap U.S. Oil 

The core reason is China knows it gains most from a world of cheap and abundant energy. America ‘wins’ a ten to fifteen year tactical victory from enhanced liquids output, but in doing so, loses the long term battle for superpower status against China. Beijing gets to drive through its industrial revolution on the cheap, all while the economic gains for America remain marginal. Beijing leverages U.S. production gains to break the pricing game and force producers into a volumes future. Despite 80-85% import dependency, China picks up the pieces in a perennial buyer’s market. America goes home, broke.

10) Blunt Footnote: Climate Mitigation Gone, Climate Adaptation The New Game

By way of footnote, any hope of progressing climate mitigation through a US-China deal has now totally gone. This will purely be a world of climate adaptation to reduce the worst impacts of climate change. 2C stabilisation no chance; 450 parts per million by 2017, probably so. Where the relative costs fall will be down to mother nature on that one.

… Silver Linings?

But fear not, there’s a silver lining here and it’s the reasonable chance that the IEA is totally wrong. The report spends very little time looking at shale oil decline rates, some of which have dropped to around 20-40% of original production. Nor does it look at the quality of the geology that’s left in America once the juiciest plays are gone. As for political risk, that doesn't appear to exist in America, (no doubt BP could add a nice chapter for the IEA on that score). Then you get onto break even prices. The IEA genuinely seems to think we’ll only be consuming 99.7mb/d by 2035, up from around 90m/b today. If that’s so, we’ll be swimming in the stuff. Production would need to be so cheap in the U.S. it’s basically free. Rex Tillerson can forget losing his shirt from cheap shale gas; he’ll be down to his y-fronts once China has stripped America bare through relentless liquid investments.

Get the picture; energy gains are great, but everyone should be very careful what they wish for, most of all the IEA, whose political capital frankly doesn’t extent that far these days beyond Washington and Paris. And certainly not in Ankara, if the locals are much to go by…