Energy Independence

Jim Brown
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I get a lot of questions from readers about the U.S. becoming energy independent thanks to the boom in shale oil production. Ironically if oil prices were to continue falling the U.S. would become more dependent on imports rather than less dependent.

Reader email: I appreciate your concerns about depletion of shale oil but won't there be continuous improvements and advancements in fracking and horizontal drilling technologies to "keep the party going". And if there is any political will i.e. a new administration in the fall...that sees that natural gas is our salvation and makes appropriate decisions like the XL Pipeline and calling off the EPA regulators...won't we still have a chance at energy independence for this country? LD

Good question! This is one I hear quite a bit. The term energy independence is extremely over used and misunderstood. First, the U.S. consumes around 21 mbpd of oil. We actually produce just slightly over 6 mbpd so it would take increasing our production by a factor of more than 200% to come anywhere close. The Bakken currently produces about 750,000 to 800,000 bpd. The exact numbers are difficult to find because the field spreads over multiple states and consists of multiple reservoirs. Over the next ten years some analysts believe production could increase to 1.5 mbpd. I have recently seen data that suggests this will never happen. I will show this in my shale oil report I am working on.

Everyone has heard about the Bakken, the Permian Basin, Eagle Ford, etc but the Bakken is the biggest of the bunch and most recognized by casual investors. In order for us to become "oil" independent it would require finding TEN more Bakken fields and spending the 20 years to develop them to the point where the Bakken is today. Twenty years ago the Bakken only produced about 10,000 bpd.

Over that same 20 year period global production would decline by about 80 mbpd. Since we currently only produce about 90 mbpd, including NGLs, that means we would have to completely replace our current production with new discoveries and new production. According to the IEA in their most recent report the depletion rate of existing fields is just over 4.0 mbpd per year. That means EVERY year we have to find and produce another 4.0 mbpd just to keep global production level.

In the U.S. shale oil production declines at an average rate of 35% per year for the first several years to level off at about 15% to 20% of initial flow rates. The current boom in U.S. oil production is related to the massive push to drill the shale oil fields. With 900 active rigs and an average of 3.5 weeks per well they are adding more than 1,000 wells a month at a cost of $4.5 to 7.0 million each. The initial production from those wells is barely offsetting the decline in existing wells otherwise overall production would decline.

In May of 2009 USA production was 5.364 mbpd. At the end of May 2012 production had risen to 6.227 mbpd, an increase of 863,000 bpd. Over that period more than 36,000 oil wells were drilled. That means there was a net gain of only 23.9 barrels per day per new well drilled because of the production decline in existing wells.

If you carry that to the extreme it would require 615,000 new shale wells to become oil independent. Unfortunately it would only be temporary since once the drilling boom was over the 35% depletion rate would quickly push us back into dependency again. Clearly this is just a math exercise and is not reality since it would take 615 months or 51.3 years to drill that many wells.

To briefly summarize there is no way using existing technology and known oil reserves for the U.S. to become oil independent.

Gas is another story. Given a pro energy administration we could see a dramatic increase in the switchover to gas but it would be only a drop in the bucket as far as reducing oil demand. The majority of oil in the U.S. is used for transportation as gasoline, diesel and jet fuel. The push to convert over the road trucks to use gas is gaining acceptance but the build out could take a decade or longer. Piping gas to the major truck stops would be a major undertaking. Converting the rigs (replacing) to burn gas instead of diesel is a simple and cost effective proposition over the long run but in the near term those existing trucks represent a major capital investment and they are not likely to be retired early. Converting cars to gas is not likely to really catch on in the mainstream public. The hybrid model has a much better chance.

Converting gas to liquids is a proven process but it is also expensive and environmentally unfriendly. If gas prices are going to remain low that could be an option but the plants are extremely expensive. A better use of the capital would be to create a LNG terminal and ship the gas overseas where it sells for $12 to $18 per MCF.

The XL pipeline will eventually reduce our dependency on waterborne crude imports by -9% or about 1.0 mbpd. That means fewer imports from the Middle East and Venezuela. Since the pipeline is not expected to begin operation until 2016, assuming it is approved in Q1-2013, existing global production will have declined by more than 12.0 mbpd over that period. If all of that 12.0 mbpd has not been replaced with new production the XL pipeline will instantly become our lifeline.

Will new technology come to our rescue? Never say never. For the technology to help in the near future it would need to be a concept today. Fracking is not new technology. Wells have been fracked for 50 years. The technology improved over the last two decades but it is not new. Horizontal drilling is not new. Horizontal wells have been drilled for years but the technology to accurately direct the drill bits through an opening the size of a garage door two miles underground and a mile away from the rig has improved significantly.

The problem still remains a lack of "easily produced" reserves and even with all the recently discovered shale oil fields that oil is not easily produced. FYI, the shale oil fields were not recently discovered. They were discovered decades ago but were not considered economically productive until horizontal drilling technology improvements occurred. It remains to be seen if the long term benefits of shale oil are economically viable. Very few shale oil wells have actually produced a material profit. Those in the sweet spots in the shale fields have been winners but the vast majority that missed the core areas may never produce a profit.

Can the U.S. become energy (oil) independent? Not likely. Can the U.S. produce more oil and reduce our dependency on foreign imports? Absolutely! The only way the U.S. will become independent is when we get a technology breakthrough that produces inexpensive cars that run on long life batteries with a gas sipping backup engine. Today's hybrids are heading in that direction but the short battery life, compact size and high cost make them impractical for all consumers. When global oil production begins to decline and oil prices rocket higher, those hybrids will become much more practical and the U.S. less dependent on foreign oil because of necessity rather than desire.

If global oil prices were to continue declining the rush to drill shale oil and ultra deep offshore wells would decline significantly. These efforts require oil at $85 or more to be economically productive. Every action has a reaction. Expensive oil produces more oil and competing technology. Cheap oil reduces exploration and slows down technological innovation.

Reader email: A guest on CNBC Thursday indicated he's predicating oil to drop to $60 a barrel (Brent) by the end of the year. He based his conclusions on a slowing global economy especially in US, Europe, China, and India. In your Sunday newsletter could you give us your opinion on whether we could see $60 oil or whether OPEC will start slowing production to keep prices up, if they can? Thanks DD.

I think I have answered that in the commentary above but I did not specifically address Brent prices. I believe that short of a complete meltdown in Europe the odds of $60 Brent are close to zero. Analysts are picked to appear on CNBC because their views are out of the ordinary. An analyst that claims oil prices will remain stable at $90 without any volatility will not be chosen to appear on TV. Only those that can make a rational, or sometimes irrational, argument for some extreme price swing get chosen for the three minute sound bites.

For instance, in the Facebook saga the analysts predicting an $8 to $19 price for FB got plenty of airtime but those with a price target in the $30s were bypassed because they were not edgy enough to attract the attention of viewers. This is the same with oil prices. Come up with an outside the box price estimate and you get your three minutes of fame. Bad news sells or in this case extreme news sells.

I can't believe that OPEC would allow the Brent price to dip much lower without a global economic meltdown. However, they can only impact prices in the long term as in months. They can't impact prices for next week or the next several weeks.

Send me your emails using the link below and I will be happy to answer them in the newsletter.

Jim Brown

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