The price for energy independence

Move over OPEC, North America is about to become a net exporter of oil. At least that’s the supposed good news from the International Energy Agency’s latest outlook. According to the IEA, the drilling boom for shale oil is putting US production on track to pass Saudi Arabia. North of the border, output from Alberta’s oil sands is expected to notch a similarly grand expansion.

Notions of energy independence, however far fetched they may seem today, play well to the IEA’s target audience, which is largely American. Irrespective of the political rhetoric we endured from both presidential candidates, energy independence isn’t really the issue confronting the US economy or American motorists. The real problem is the price of oil—not its country of origin.

It doesn’t really matter whether the US drills for its own oil, gets it from Canada, or ships it in from Venezuela or the Middle East. Hostile or friendly, no foreign supplier has turned off the spigot. At least not since the last OPEC oil shock three decades ago. The problem for oil consumers right now isn’t the availability of the fuel, but the price needed to get it out of the ground. Unfortunately, that’s already more than we can afford.

Brent, the de facto world oil price, is hovering near $110 a barrel precisely because of our growing dependence on the very unconventional sources of supply being championed in the IEA report. Energy independence isn’t going to change the reality of triple-digit oil prices. On the contrary, oil prices will have to climb much higher for the IEA’s forecast to come true. If that’s the case, does energy independence actually have any value for oil consumers?

The IEA pretends that its prediction for a huge increase in unconventional oil supply can occur with only a modest increase in oil prices. Such unbridled optimism is belied by what’s going on in the industry. Getting oil out of the ground has never been more expensive. And costs are only going up from here. Just look at the pullback in capital spending among oil sands operators. And that says nothing of the lack of pipeline routes coming out of Alberta. Does it really look like bitumen production is about to triple in the next few decades?

Good old-fashioned North American engineering know-how like horizontal drilling, fracking, or steam-assisted gravity drainage (SAGD) isn’t why we’re now tapping supply from problematic sources like the oil sands or the Bakken formation. Neither of these are new discoveries. The real heavy lifting that’s catapulted once marginal sources of supply to prominence has been done by soaring global oil prices. Without higher prices, no one would be chasing tight oil from shale formations or trying to pull tar-like bitumen out of the oil sands.

It’s no mystery how rising prices work. Just think about the simple power described by an upward sloping supply curve. The higher the price of oil, the more will be produced. This is a fundamental economic tenet that continually confounds the geologists of the peak oil movement.

In a world of $200-a-barrel oil, the IEA is probably right in believing that US production might reach 11 million barrels a day or that Canada could deliver 6 million barrels into the global market.

The problem with such a bullish outlook for supply is explained by another economic axiom—the dampening effect of a downward sloping demand curve. The higher the price of oil, the less of it our economies can afford to burn. If global economic growth is already grinding to a halt when oil prices are around $100 a barrel, what do you think would happen to economic growth—and hence global oil demand—if prices reached the levels needed to make the IEA’s supply dreams come true?

Jeff Rubin’s Smaller World