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Tuesday, November 20 2018

By Angelos Angelou, Founder & CEO, AngelouEconomics, AngelouEconomics.com

Fossil fuels—love them or hate them, they’re the backbone upon which modern civilization was built. They’ve made nations. They’ve sparked wars. And, most importantly, they’ve provided the key ingredient for the most rapid and sustained economic expansion in human history.

Yes, it’s true that fossil fuels—coal, oil, and natural gas—are by their nature finite resources. It’s also true that their use releases climate-impacting carbon emissions into the atmosphere. These considerations, as well as the rise of a new generation of renewable energy technologies, all but guarantee that fossil fuels will largely go by the wayside at some point in the future. Maybe it will be in our lifetime. Maybe it will be in our children’s lifetime, or their children’s. Given the constantly evolving trends, tech, and geopolitics influencing the global energy sector, it’s hard to make long-term prognostications with any certainty.

What is certain is that, barring a miraculous breakthrough in fusion, fossil fuels are not going anywhere anytime soon. Saying that the global economy is still hooked on oil is an understatement. As recently as 2017, 80 percent of all energy consumed in the United States was carbon-based and similar consumption patterns are observable worldwide. What’s more, the U.S. Energy Information Administration expects that oil and natural gas consumption will increase +0.7 percent and +1.4 percent respectively per year through 2040. Coal consumption, despite its various headwinds, will remain constant.

It’s important to note that this growth in fossil fuel consumption is not being driven by the United States, or by any of the world's developed economies; OECD energy consumption is only expected to increase over nine percent over the next two decades. Instead, the majority of new energy consumption will originate from the world’s major developing and transitioning economies: India, China, and Nigeria, among others. As these most populous regions of the world race to catch up economically with the West, the spike in demand will send global energy consumption to never-before-seen highs. And the United States, well on its way to becoming a net energy exporter, stands poised to house a thriving fossil fuels sector for decades to come.

To truly understand how the U.S. went from gas-starved rationing in the 1970s to the energy-rich country it is today, you need look no further than the shale revolution. Indeed, the word ‘revolution’ might be underselling things a bit. As recently as 2007, the U.S. produced some 20 billion cubic feet of natural gas, only six percent of which was shale-based. Ten years later, shale gas production accounts for more than 60 percent of the now 28 billion cubic feet of natural gas produced annually.
 
In fairness to our forebears, it’s not as though they didn’t understand the potential of shale oil and gas reserves. Shale gas extraction has been happening in some form since at least 1825, and hydraulic fracturing—fracking—was invented in the 1940s. It wasn’t until a bold, late 1990s move by oil baron George Mitchell, though, that shale extraction really found its stride. Desperate to keep his company’s north Texas fields productive, he pioneered the coupling of fracking with horizontal drilling that proved shale extraction could be economically viable for a large-scale, long-term operation. Mr. Mitchell sold his company in 2002 for $3.5 billion. The U.S. oil and gas industry hasn’t looked back since.

As with any (relatively) new industry, shale extraction is still benefiting from rapid technological improvements that both reduce per-barrel costs and, crucially from a PR perspective, lessen the environmental impact of fracking operations. In 2013, for instance, the Houston-based Apache Corp. pioneered the use of 100 percent natural gas powered engines for their fracking operations, a move that significantly reduced operating costs while simultaneously cutting greenhouse gas emissions.

Improvements in drilling technology have reduced the average time and energy required to exploit new wells. Other efforts have focused on reducing the use of water (the ‘hydraulic’ in hydraulic fracturing) in the extraction process. Some techniques explored by various companies include the use of brine water or replacing water with pressurized natural gas. Other companies are eschewing liquids altogether. Last year, Canadian-based RocketFrac Services unveiled a promising new method for fracturing shale with the strategic placement and subsequent detonation of solid rocket fuel.

Notable cost savings have also come by increasing the efficiency of already operating wells. BP, in particular, has invested heavily in IT solutions for their shale operations in East Texas, Louisiana, and Arkansas. Key to these investments are the employment of “smart” wells that automatically identify and report faulty components or other issues dragging down output. Contractors are then summoned to conduct repairs with a simple app that has been compared to Uber. Finally, the company is employing augmented reality headsets (think Pokemon Go) to guide workers through the vast oil fields and document repairs.

The cumulative, industry-wide effect of these technological strides has been the significant reduction of the break-even costs for shale extraction. Pinpointing exact cost figures is difficult—operating expenses are highly variable and often proprietary—but all signs point to an industry that is far more efficient than it was a decade ago. Case in point, BP reported that their shale operations have turned a profit for the first time, driven in no small part by a 50 percent reduction in well downtime for repairs. Likewise, the World Bank reported that the breakeven price for oil shale extraction (typically harder to make profitable than natural gas) has dropped 42 percent over the past five years to less than $40 per barrel. In other words, the stage is set for America to become a leading player in the 21st century marketplace.

Of course, having a booming energy sector is a positive in and of itself. Energy independence has long been a sought-after goal by politicians and businesses leaders alike. But surging exports and corporate bottom lines only tell half of the story of the shale revolution. The other half, a tale of economic development, of new jobs and new hope, is the one of far more interest to the average American.

One of the reasons the modern oil and gas industry has proven such a powerful economic development tool is that it is not tied to the coasts. Instead of clustering in a few major hubs in a few of America’s largest cities, as seen with key industries like tech and finance, the locations of fossil fuel operations are determined by a different set of factors—factors that are millions of years in the making. The good news is that the dinosaurs were quite egalitarian in their choice of graveyards. At least 32 of the lower 48 states have some shale oil and gas reserves, meaning that communities with zero chance of landing Amazon’s HQ2 can nevertheless benefit in what will continue to be one of the most important engines of the global economy.

It should be stated up front that relying solely on fossil fuel extraction for economic development can be a risky proposition. Though the roughly +14 percent employment growth seen in the oil and gas sector between 2001 and 2017 is +4 points higher than U.S. employment at large, current industry employment is still down some -25 percent from the 2014 peak when increased global production caused the bottom to fall out of energy prices. Since then, both prices and employment have begun to recover, but it remains a powerful lesson on the price-sensitive (read: fickle) nature of the energy industry.

Still, fickle or not, that doesn’t change the fact that the rise of fracking has breathed new life into parts of the country not-so-affectionally referred to as flyover country. One prominent oil and gas cluster has risen in the Rust Belt, revitalizing that swath of Western Pennsylvania, West Virginia, and Ohio that was left gutted by the 1970s collapse of the U.S. steel industry. Similarly, oil and gas extraction has grown into one of Louisiana’s biggest employers, providing more than a quarter-million jobs across the state. So profound is the impact of the shale revolution that it is even altering the demographics of entire states. After remaining stagnant for decades, the population of North Dakota surged +18 percent between 2008 and 2016, a boom attributed almost entirely to development of the Bakken oil fields in the northwest corner of the state.

Nor are the benefits of the shale boom restricted just to extraction operations. Energy production requires robust supply chains, from the manufacturing of high-tech drill bits to the delivery of the final product, with each step requiring the creation of new, often high-paying jobs. Over half of all U.S. oil and gas processing takes place on the Gulf Coast, providing a vital economic asset for both the region and the world. These refineries are so important that, in the wake of 2017’s Hurricane Harvey, the resulting refinery shutdowns sent shockwaves through global energy markets for months. Other industry-supporting activities like equipment manufacturing and pipeline transportation crisscross the country, providing jobs for communities as varied as Casper, Wyoming and Oklahoma City, Oklahoma.

With typical wages within the industry nearly double that of the national median, it is unsurprising that many states have developed significant incentives programs to support their local oil and gas producers. Some of these programs are designed to encourage “enhanced” oil and gas extraction in existing wells that have already exhausted the productivity of traditional techniques. California has such a program, as does Oklahoma. Other states have structured their incentives so as to support the industry when global energy prices are low. Texas, for example, provides a revenue tax exemption for qualifying wells in months that prices fall below a certain point, and North Dakota implemented a similar price-based extraction tax reduction in 2016. Regardless of the form they take, these programs can provide a powerful form of stability for the industry, especially during those periods where global energy markets are less than cooperative.

So what does all of it mean, all of the jobs, and incentives, and technology, and uncertainty? What is the current state of U.S. oil and national gas, and more importantly, where is going? To answer the first question bluntly, the shale revolution has made the U.S. a global energy powerhouse. U.S. natural gas production has ranked number one in the world for nearly a decade now, when it surpassed Russia in 2009. And, if preliminary data from the EIA is to be trusted, the U.S. also took the top spot in crude oil production earlier this year. This achievement is unambiguously attributable to shale oil production, specifically that of West Texas’ Permian Basin.

Looking ahead, the recent recovery of energy prices has ensured the profitability of shale oil and gas production, and thus ensured that the U.S. will remain a global player for the foreseeable future. According to the EIA, U.S. natural gas will dominate 75 percent of the global market by 2022, and OPEC has likewise forecasted that non-OPEC oil production will surge +16 percent by 2023 due to U.S. shale oil extraction. That begs the question as to what the U.S. will due with all of that new oil and gas. With domestic refineries already more or less operating at full capacity, there is really only one viable answer: export it. Except that’s where things get tricky.

As mentioned previously, the lion’s share of new energy consumption will be driven by developing economies, with China naturally being the most voracious. China already accounts for one-fifth of U.S. oil exports and also consumes a non-trivial share of liquid natural gas (LNG) exports. The problem is that, as anyone with even the thinnest knowledge of geopolitical economics is aware, trade relations between the U.S. and China haven’t exactly been stellar as of late. China’s plan to implement 10 percent tariffs on U.S. oil and LNG imports thus comes as less than welcome news for domestic producers.

While the immediate effects of such tariffs would be minimal, the long-term prospects are more alarming. The higher costs associated with tariffs could impact the negotiation of long-term LNG contracts, which could in turn reduce incentives to develop new shale wells. In a similar vein, an ongoing trade spat could encourage China to look increasingly to Africa for abundant and affordable oil. It is unlikely that reduced demand from China will cripple U.S. oil and LNG producers; the global energy market is a big and diverse place and someone somewhere will be willing to buy. At the same time, these deteriorating relations with China seem to represent little more than another layer of uncertainty for an industry already subject to abrupt and violent swings of fortune.

And what about coal, that black sheep of the U.S. energy industry? It’s no secret that times have been hard for domestic coal producers. Between added regulatory hurdles and increased competition (most of which is perversely coming in the form of U.S. LNG), the industry has consistently shed jobs for decades, even as gas, oil, and renewables experienced significant employment growth. Moving ahead, stagnant consumption rates are unlikely to bring about any meaningful reversal of these trends.

But none of that necessarily signals the final death knell of the U.S. coal industry. Even as domestic consumers continue to shift away from coal for a variety of market, regulatory, and environmental reasons, many foreign consumers are showing potential. In 2017 alone, U.S. coal exports jumped +61 percent, and exports to Asia more than doubled. As these emerging economies continue to develop, they should prove a reliable market for the coal that is mined. It’s not like domestic consumption is completely off the table, either. Entering operation in 2011, the Dry Forks power plant in Gillette, Wyoming is a shining example that coal plants deliberately designed for environmental compliance (as opposed to the overhaul of existing plants) can sustain clean and economically viable operations. Likewise, the carbon sequestration technology being field tested at the plant holds much promise for solving the greenhouse gas problems that have long dogged coal power.

Still, in many regards, it’s clear that the era of coal is over. The shale revolution has simply shifted too many paradigms, and there’s no going back. The upside is that, on the aggregate, U.S. energy producers are in a more dominant position than they’ve been in decades. Even better, they should be able to maintain this position for decades to come. Thus, as oil and gas production rises to record highs, and brings employment with it, fossil fuels will continue to play an essential role in shaping the 21st century U.S. economy.

Bio: AngelouEconomics is a leading Corporate Site Location and Economic Development Consultancy. The firm has provided site location services to clients with over $5 billion worth of data center projects and developed over 400 economic development strategic plans for U.S. and international clients. To learn more, visit www.AngelouEconomics.com or email: Angelos@AngelouEconomics.com, (512-658-8400 cell).

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