A funny thing happened on the way to Barack Obama and Mitt Romney’s goal of greater U.S. energy independence: American industry got there first, on paper at least. Now the question is: What can go wrong?
Thanks to the hustle of innovative U.S. energy companies, the discovery of vast shale gas and oil fields, and stronger national conservation, some forecasts peg energy independence for North America at just a few years off. A Citigroup report calls the region “the new Middle East.” Pimco says the trend is a “game changer.” Bain & Co. declares it a “new paradigm.”
The knock-on effect, some believe, could be historic: millions of new jobs and the “reindustrialization of America” as companies hitch new manufacturing to cheap energy. Shell 4324.KU +3.14% and Dow Chemical, DOW -0.64% among others, are already planning new chemical plants fueled by rocketing shale output. Driven by new fields such as the Bakken in North Dakota, U.S. oil production has hit levels not seen since 1998.
So why is John Hofmeister, the former chief of U.S. operations for Shell, sounding an alarm? “Unless something seriously changes in the next five years,” he said in an interview, “we’ll be standing in gas lines because there won’t be enough oil to go around.”
The reason is that there’s still disagreement over the factors governing the growth of production from the new fields. Among those factors: the direction of global supply and demand, how price will help or hinder exploration, whether new regulation will impede development, and how long it will take to build the infrastructure needed to get more oil to market.
Mr. Hofmeister said he believes forecasts also understate the “decline” rate of shale fields. The hydrocarbons tend to flow robustly in the first months of drilling, then decline before plateauing at lower levels.
To sustain growth, companies will need to drill many wells at a rate “beyond the capacity of the industry as currently defined,” he says. “Those who ballyhoo oil shale and say that this will take care of us—no, it won’t.”
What’s more, Bakken oil currently trades at a discount to world market prices in part because of crimped infrastructure: The U.S. currently doesn’t have enough pipelines to get the oil to refineries efficiently.
So, until more pipelines are built, buyers are jerry-rigging deliveries. Delta Airlines DAL -0.97% just bought a shuttered refinery in Trainer, Pa., to make its jet fuel. Ed Bastian, the airline’s president, said Thursday he’s considering buying oil from the Bakken and then shipping it to the plant by train.
In fact, infrastructure is short across the board, from skilled manpower to storage facilities to the broader supply chain that feeds the fields. “Production is going faster than the midstream or downstream can accommodate it,” says Frank Verrastro, a former executive at Tosco and Pennzoil who is now with CSIS, a think tank in Washington. By resorting to rail, “all we’re doing is moving the bottleneck.”
By some estimates, hydraulic fracturing, the innovative but controversial drilling method by which oil and gas are freed from shale or other formations, gets too expensive if oil prices drop below about $50 a barrel. That may be another hurdle for the industry if the global economy slows sharply. Gas producers have already been hammered by plummeting prices from an oversupply of shale gas.
And regulation is another puzzle. States and communities are split over whether to allow so-called fracking in their backyard. Citizens groups have raised concerns about the safety of the procedure, about pollution controls around well sites, and about the dangers posed by drilling through water tables and aquifers. The EPA has already issued some standards for the drilling and continues to examine issues such as the discharge of waste water. It’s unclear whether any new rules would affect the speed of exploration. Environmental groups support greater federal oversight of the myriad fracking operations across the country.
But operators, such as Exxon XOM +0.16% and Devon Energy, DVN -0.35% like state control. John Richels, the CEO of Devon, which now gets some 50% of its production from shale, says states understand the local geology better than the federal government. “We’re spending a lot more time on satisfying regulatory issues,” he says. “The potential impediment [to expanded production] is the growth in that additional regulatory layer” from more federal oversight.
Either way, Washington must also marry the new hydrocarbon bonanza with its emission and renewable-energy goals. Public policy, concludes the Citigroup report, may determine whether growth from the new fields stays healthy or fizzles.
“Investors and the industry can live with regulations if they are clear and prospective, if you can price that into your investment decision,” says Howard Newman, CEO of Pine Brook, a private-equity firm and early investor in shale exploration. “What will set us back is if the environment remains uncertain and any regulatory scheme becomes retroactive.”
It’s true that greater energy independence may be just over the horizon. But this won’t be a sprint. Get ready for the long-distance hurdles.