North American’s Energy Boom (will Mexico join?)

By Maureen Crandall -- March 27, 2013

“The energy boom in North America demonstrates that competition and technology are powerful forces; indeed, markets work. When the price system is allowed to work, technology is brought to bear on supply (more) and demand (less) to the benefit of economies everywhere.”

Gone are the days of growing scarcity in the North American oil patch–and increasing petroleum imports from unstable regimes overseas.

The new consensus–that North American energy is plentiful and will remain so to at least the year 2040–is not based on hopes and hype. Over the last five years North America has experienced a true energy revolution, and it is continuing apace.

U.S. oil production is at its highest level since 1992, at over 7 million barrels per day (mmb/d), and Canada’s output exceeded 4 mmb/d at the end of last year, its highest level ever. Both are expected to continue to rise, with the U.S. topping Saudi Arabian production of over 10 mmb/d by 2020, and Canadian production rising to over 6 mmb/d.

While the U.S. will remain a net crude oil importer for now (it last was a net exporter in the mid-1940s), its dependence has already fallen by half, and most of its imports in the future will come from Canada.

The story for natural gas is even more pronounced, as production in both countries is booming, driving benchmark Henry Hub gas prices to low levels of about $3.50 per MMBtu. Facilities built to import liquefied natural gas (LNG) are now under consideration for conversion to export it. The U.S. is on its way to becoming an energy superpower, with energy supplies no longer considered limited, foreign, and finite.

In Spite of, Not Because of, Government

These supply-side developments are all home-grown by the private sector, and owe nothing to U.S. federal government policy, which in fact slowed the leasing and permitting processes on federal lands and waters in recent years rather than encouraging them.

In response to the 2008 world-oil price peak of $140 per barrel (and today’s $90), markets responded as Economics 101 would suggest. Five years later, with the successful application of advanced technologies such as hydraulic fracturing, 3-D seismic imaging, horizontal drilling, oil sands extraction, and deep-water successes, U.S. oil production is 40% higher than in 2008, while shale gas production is now 37% of U.S. gas output, up from 2% in 2000.

On the demand side, U.S. and Canadian oil consumption has been flat, in part due to the fragile macroeconomy of recent years, and is expected to remain that way. As a result, U.S. oil imports have fallen from 60% of consumption to 40%, and natural gas imports from Canada are falling under pressure from rising U.S. gas output.

U.S. Update

Our new era stimulates a collective sigh of relief, as low natural gas prices stimulate industry along with jobs creation. Yet there is a global market for LNG, and gas exports should not be prohibited by short-sighted U.S. government policy. For the first time in history, U.S. natural gas now supplies (by pipeline) about 16% of Ontario’s gas demand.

On the oil side, U.S. refining has been turned upside down, as rising inland production needs more outlets to reach refining centers on the coasts, initially built for imported crudes. The patchwork of inland pipelines is being expanded, but in the meantime over 500,000 b/d are being carried by rail and barge to refining centers.

Full pipelines and transportation bottlenecks produce gluts in areas without refineries, resulting in price discounts on both U.S. Bakken (North Dakota) and Canadian crudes. The boom in production in the lower 48 states is likely to defer interest in development in U.S. Arctic resources.

While U.S. dependence on imported oil has fallen dramatically, the United States is nonetheless likely to remain a net oil importer of more than a third of its demand, given the breadth of its land mass and the economics of pipeline versus tanker deliveries. In this regard, the U.S. is most lucky to have a prolific producer to its north looking to keep its prime oil customer.

Canadian Update

For Canada, oil production is surging, and is expected to reach 6.6 mmb/d in the future. Up to now, the U.S. was its primary customer, taking 99% of Canada’s crude and products exports of close to 3 mmb/d.

But the resurgence of U.S. oil production clouds Canada’s future export picture. Without U.S. approval of the Keystone XL pipeline – for the dealy of which the Obama administration has run out of excuses – Canadian oil exports will be forced to seek other markets, either European or Asian, and years will pass before pipeline connections are sited, approved, and built.

In natural gas, the U.S. has been the sole purchaser of Canadian gas exports, but these are dropping as U.S. gas production rises. Canada, like the U.S., is looking to develop LNG export markets. The plethora of energy in both the U.S. and the provincial Canadian land mass is likely to postpone indefinitely the development of resources in the Canadian Arctic or the Mackenzie Valley.

In fact, the Energy Information Administration sees the U.S. becoming a substantial exporter of natural gas to Canada in the future. That the U.S. would ever be a large natural gas exporter, and to Canada of all destinations, was beyond imagination only a few years ago. This is testimony to both the richness of the US Marcellus shale gas deposits and to the gas demand centers in eastern Canada.

Mexico Update

For socialized Mexico, the energy revolution has yet to take off, despite the country’s rich deposits.

With proper incentives, Mexico could become an oil and gas powerhouse. Its biggest problems are above ground, in terms of the politics and history surrounding the state oil company PEMEX. The company’s production is declining, starved as it is for capital investment; without investment, Mexico could turn into a crude oil importer.

The new government recognizes this as a “signature issue,” and the expectation is that while PEMEX will remain in the hands of the state, it will be allowed to seek development relations with interested foreign oil and gas companies to offset the declines in oil production and to develop shale oil and gas deposits, of which it has many.

The country is currently a net crude oil exporter and a net natural gas importer. Mexico presently exports over 80% of its total crude exports to the U.S., all by ship, since there are no oil pipeline connections. But it is a growing importer of gasoline and diesel, which, if it exploits its undeveloped oil resources, it could provide locally.

As to natural gas, Mexico continues to increase its pipeline gas imports from the U.S., as well as to buy LNG from a variety of other countries. Since many of Mexico’s promising undeveloped oil and gas resources lie in the north close to Texas, a Transboundary Hydrocarbon Agreement between the US and Mexico to guide development has been proposed, but as yet is unsigned.

Given the boom in U.S. oil and gas production, Mexico is unlikely to remain a strong oil exporter to the US, and will have to seek future customers elsewhere.

North America to the World

The renaissance of the North American energy sector is reshaping the world’s energy landscape with far-reaching implications for energy flows and geopolitics. For example, already oil imports from Nigeria and Venezuela to the U.S. are dropping.

Middle East oil exports are competing with Nigerian and North African crudes in Europe, which puts downward pressure on the price of Russian oil exports to Europe. Asian gas demand will be met in the future possibly by both U.S. and Canadian new LNG exports, as well as by existing suppliers and new Russian and Australian LNG shipments.

The energy boom in North America demonstrates that competition and technology are powerful forces; indeed, markets work. When the price system is allowed to work, technology is brought to bear on supply (more) and demand (less) to the benefit of economies everywhere.

In the case of the U.S., oil imports from non-North American sources have fallen precipitously, with implications for both energy import vulnerability and geopolitics. Canada and Mexico, if they are to sustain exports, prices, and returns to production, need more transport infrastructure and need to seek alternative export markets.

Moreover, if Mexico is to ensure its energy future, it will have to open oil and gas exploration/production to economic forces, which means a change in the way PEMEX operates. From a U.S. policy perspective, Washington needs to change its import-focused strategies to recognize the value of both oil and gas exports. This means approving the Keystone XL pipeline, opening federal lands, and approving LNG export plans.

At the same time, increased U.S.oil and gas production distresses fossil-fuel foes who once thought that “peak oil” and “peak gas” would result in naturally increasing prices and greater conservation. For these pressure groups, it is game-on for a carbon tax or some other way to reflect environmental externalities. The oil and gas industry, meanwhile, will factor this risk into their exploration and production budgets in a world where politics as much or more than geology drives supply and demand.

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Maureen S. Crandall, Professor of Economics in the Eisenhower School, National Defense University (Washington, DC), is author of Energy, Economics, & Politics in the Caspian Region (Praeger 2006). She was also president of the Washington Chapter of the U.S. Association for Energy Economics (2006–2007).