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Zero Sum: US Oil and Gas Production Boom a Promise or a Threat?

July 19, 2012

It is unclear as to whether an exponential increase in US oil and gas production will create negative as well as positive consequences, be they economic, geopolitical, or environmental.  These divisions are evident from a televised debate between a number of leading analysts last week which can be viewed at the New America Foundation.  Steve Levine nominates winners and losers from what he terms the ‘coming age of plenty’, but it seems that he misses out some key categories.

The ramifications of the production boom are termed variously as a “tipping point”, a new industrial and technological “revolution”, a tectonic shift,  a “big deal” – for the world as a whole.  The changes come from the spread of alternative supply sources triggered by high prices: deepwater, shale and tight oil and oil tar sands.

The potential implications of these changes for Australia should be further considered from economic and environmental perspectives.

Broader global impacts of increased US production include a potential shift to oil and gas exports from the US; a resurgence in energy-intensive US manufacturing, power generation and road trucking; US current account deficit reduction and $US appreciation (thereby continuation of USD as reserve currency); supply choice for Asia customers and reduction in industrial process pollution-intensity; and a re-alignment of US foreign policy to compensate for reduced import dependence and re-aligment of energy industry production based on supply diversity.  Some of these issues are covered in a presentation by Ed Morse, Head of Commodities Research at Citigroup (also a participant on the NAF panel).

A significant finding and point of convergence is that the growth in US production will result in profound consequences for other primary commodities producers.  While the focus is inevitably on the implications for oil producers (OPEC), there are ramifications for exporters of other energy commodities, given the energy market and fuels interplay.  Already, a domestic shift in the US between coal and gas is evident, with an oil/gas shift in heavy road transport also possible.  This shift is also likely to be seen in other markets.

The main economic implication for Australia is the potential for US gas exports to create ruptures in the web of international gas contracts and prices and shift demand from coal to gas.  These issues are explored in a Brookings paper on the prospects for US gas exports.

Already, reduced US gas imports have marginally loosened up Asia-Pacific gas markets through increasing options for spot price contracting and downward pressure on contracts.  However, long-term oil-indexed contracts are likely to remain dominant, with LNG markets remaining tight after 2015.  While existing Australian LNG projects are built on the premise of long-term contracts, price and term renegotiation are possibilities on increased market supply and downward price pressure.  Any future US LNG exports are likely to continue to free up options for consumers to engage in spot markets, creating marginal downward pressure on prices, and reducing the capacity for new developments to negotiate amenable off-take contracts.  Australia’s $100 Bn of approved LNG projects are already seeing significant pressure from supply competition and costs.

In turn, the gas market loosening created by new US supply and potential transfer and uptake of technology to expand alternative gas sources in other markets will increase a shift to gas from coal.  Increased gas availability will enhance a shift to gas consumption thereby marginally reducing reliance on international coal contracting (irrespective of any sectoral structural shift in key markets – e.g. China) and suppressing those prices.  New start and marginal production costs from regional mines will therefore continue to see pressure – increasingly important in light of input cost inflation for Australia resources projects.  Further, a major market uncertainty is the timing for the huge potential for shale gas production in China to be realised on the back of technology transfer from the US.

The last – and possibly most under-assessed – implication of North America oil and gas expansion is the impact on global climate change science and policy.  In aggregate, oil expansion in Canada and the US is deemed by environmentalists to be negative, particularly from tar sands.  This issue has seen significant US domestic opposition (Keystone), as has the potential negative effects of upstream production (fracking, deepwater catastrophes) and methane releases.  In Australia, some studies have shown that LNG production and use has a substantially lower greenhouse gas emissions profile than coal.  The methodologies of these analyses will likely remain a source of contention.

However, the broader technology and market ramifications resulting from the US transformation have not seen detailed consideration in international climate debate.  Transformative impacts on global upstream and downstream technological innovation and uptake, have been less appreciated.

As NAF panelists remark, the role of natural gas as an interim fuel with substantial greenhouse gas emissions benefits is not overly embraced in the European Union.  While Brookings deems US LNG exports to have ‘negligible’ impacts on the global power generation mix, it is possible that the broader impacts on gas technology uptake and development in supply and use, as well as other energy sources, is of greater importance in the medium-to-long term. And it’s not just the displacement of coal as an energy source.  The IEA notes that, through providing a near-term cost effective alternative to nuclear and renewables, there is the potential for gas to contribute an additional 320 Mt CO2e by 2035.  Thus, gas supply enhancement is likely to be a double-edged sword.

Given the salience of Australian LNG future exports in transforming regional energy markets, it is surprising that these implications have not been more overtly explored and discussed within the framework of international climate policy positions, as coal production and use has been in Australia, and oil production and export has been in OPEC.  One-sided initiatives proposed by Quatar at the margins of international discussions have been the only efforts to put gas on the agenda to date.

While Australian gas and coal projects and prices will (and already do) suffer through increased gas supply competition, it will  benefit through induced demand and may take advantage of geopolitical benefits.

A final point made by the NAF panelists is that downward price pressures may create a positive consequences for commodity producers:  they will have to undergo economic structural reforms to compensate for countervailing forces – a salient issue in Australia’s commodity-warped economy, but perhaps less pronounced than for oil-exporting countries.

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