The Fuse

Can We Count on Shale Oil for the Long Haul?

by Nick Cunningham | July 02, 2015

The shale revolution brought massive new supplies of oil online, dramatically reducing (although far from eliminating) U.S. oil imports in a short period of time. This led to widespread calls of America becoming an “energy superpower,” whose most urgent problem was removing export restrictions fast enough so as not to block the flood of oil spilling forth from shale regions around the country. The surge in oil production from “cowboyistan”—the oilfields in Texas and North Dakota—would shatter the influence of OPEC.

Every President since the Arab oil embargo in 1973 has been kept up at night by America’s oil import dependence. Shale has upended that equation, turning what has long been an Achilles heel of national security into a strength.

At least, that’s the story that has been told countless times over the past year at least. But it is overly optimistic, and remarkably shortsighted.

That is because the odds are good that U.S. shale won’t be around for the long haul. It may not even last longer than another decade or so. In its 2014 World Energy Outlook, the IEA predicted that U.S. shale will begin to decline by the mid-2020s. If such a scenario occurs, the U.S. will be right back where it started before the shale revolution: Overwhelmingly dependent on the Middle East for oil supplies.

If such a scenario occurs, the U.S. will be right back where it started before the shale revolution: Overwhelmingly dependent on the Middle East for oil supplies.

Although U.S. shale has produced a short-term glut, the supply picture starts to get pretty tight once shale begins to fizzle out. While the IEA believes that global oil production will climb from 90 million barrels per day (mbd) in 2013 up to 104 mbd by 2040, it will require a tremendous ramp-up in spending to make that happen. An estimated $900 billion per year will need to be plowed into oil production by the 2030s in order to meet projected demand, the IEA argues.

That figure is large by any measure, but what makes it troubling is the possibility that quite a bit of this investment may not take place—a possibility that the downturn in oil prices has made all the more likely. The IEA admits as much, saying that meeting global supplies over the next few decades “hinges critically on timely investments in the Middle East.” In fact, what is most worrying is the fact that the assumed 14 mbd of additional oil expected to be produced over the next few decades will have to come from a surprisingly few number of places.

It largely comes down to Brazil and the Middle East.

Brazil

Brazil is home to vast oil and gas riches, which sit just off the coast in the Atlantic Ocean. In 2007 the discovery of oil beneath a thick layer of salt underwrote a new era of prosperity for Brazil, one in which large offshore oil production would allow it to become a rising global power. Brazil’s state-owned oil company Petrobras predicted that it would be able to more than double oil production from around 2.2 mbd in 2007 to 5 mbd by 2020. This would place Brazil above Iraq’s current oil production levels.

But the optimism has largely evaporated since amidst a wide-ranging corruption scandal and the collapse in oil prices. On January 29 Petrobras slashed more than $70 billion off of its five-year capital expenditure program, a 37 percent reduction from last year’s plan. The company believes this will help it arrest its runaway debt, which stood at $132 billion at the end of 2014.

However, more modest spending will only yield lower production. Petrobras downgraded its production estimate for 2020 by a third, from 4.2 mbd to just 2.8 mbd. That is a long way from the 5 mbd that Brazil had originally expected.

Iraq

Digging deeper into the IEA’s estimate, half of what makes up the “Middle East’s” contribution to global supply growth is expected to come from Iraq, which has produced 3.6 mbd on average so far this year.

The Iraqi government outlined ambitious benchmakrs for its oil sector. In 2012 it laid out a goal of ramping up production to over 9 mbd by 2020, although few took the estimate seriously. The IEA had a more measured, though still very bullish take, with a 2012 prediction that Iraq would ramp up to 6.1 mbd by the end of the decade.

That would be a tall task for a normal oil producer, but Iraq is far from normal. Years of war have ravaged Iraq’s oil infrastructure. The longstanding political fight between Kurdistan and Baghdad has frustrated international oil companies, and the complexity of the country’s investment climate has deterred drillers, likely holding back deeper investments into “greenfield” projects, according to Patrick Osgood of the Iraq Oil Report. The IEA has since downgraded its estimate of Iraqi oil output through 2020 to just 4.7 mbd.

The emergence of ISIS over the past year has raised new questions over the future of Iraq.

Perhaps most important is the extraordinary level of violence and instability. The emergence of ISIS over the past year has raised new questions over the future of the country. The swift advance of the militant group even forced the IEA’s top economist Fatih Birol (who will take over the helm of the agency in September 2015) to begin second guessing his organization’s projections. In February 2015, Birol said the markets have a “myopic” view about what is needed to ensure long-term supplies, and cautioned that without significant investment today, supplies would not be able to keep up with demand in the next decade.

Over the longer-term, the IEA expected Iraq by itself to chip in 5 of the 14 mbd of additional oil the world must produce to meet demand by 2040. For Iraq to achieve such levels, it would need to see annual investments of $15 billion into its oil industry, investment that may not be forthcoming given the dual challenges of the fight against ISIS and low oil prices.

oil production growth iea

Birol: The appetite for investments in the Middle East is close to zero, mainly as a result of the unpredictability of the region.

“The security problems caused by Daesh (ISIS) and others are creating a major challenge for the new investments in the Middle East and if those investments are not made today we will not see that badly needed production growth around the 2020s,” Birol said at a February 2015 conference in Japan. He went on to add, “[t]he appetite for investments in the Middle East is close to zero, mainly as a result of the unpredictability of the region.”

The Paris-based energy agency is starting to sound the alarm, cautioning the world against growing complacent over what seems to currently be an era of energy abundance. U.S. Secretary of Energy Ernest Moniz raised the same point at an Atlantic Council Conference in Istanbul in 2014, arguing that energy abundance may be short-lived. “Without growth from the Middle East, around 2020 we have no chance whatsoever to meet growth and demand [for energy] with affordable prices,” he said.

Supply crunch?

Rosy projections about long-term supplies have largely hinged the successful development of major sources of oil in these two countries. That should raise red flags.

Brazil just ruled out about 1.4 mbd that the world was expecting by 2020, equivalent to more oil than is produced in Bakken shale in the United States. It now appears unlikely Brazil will be able to add anything at all to global supplies as depletion overwhelms new production. Brazil’s output has actually declined for four straight months as of June 2015.

Successive downgrades have also lowered Iraq’s expected output. Instead of adding nearly 3 mbd by 2020, any significant increase remains in doubt.

The failure of these two countries to live up to market expectations point to a tighter market in a few years’ time. With the sudden evaporation of several million barrels per day in future production, the world could see a supply crunch by the end of the decade.

Uncertainty ahead

Concerns over U.S. energy security wax and wane with oil prices.

What does that mean for the United States? Concerns over U.S. energy security wax and wane with oil prices, and the glut of oil over the past year has sparked a renewed sense of confidence in Washington over America’s position on energy.

But make no mistake, the U.S. is still a massive consumer of oil, burning through 19 mbd, or about one-fifth of total global demand. Becoming one of the world’s largest producers of oil, or even self-sufficiency in oil production, does not mean the U.S. economy would be insulated from a price spike, one that is looking increasingly likely in the years ahead.