Oil Kingdom

Reading the newspapers these days, you’d think that the much-hyped impending American energy boom is about to make Saudi Arabia and the rest of OPEC irrelevant. Recent projections by the International Energy Agency (IEA), for example, have the United States surpassing Saudi Arabia as the world’s top crude oil producer by 2020, a development that would appear to call into question the kingdom’s role as the world’s strategic energy provider. But such projections — based, at least in part, on the rapid discovery and development of unconventional hydrocarbon resources in the United States — are far from ironclad. Indeed, they are built around numerous variables that could change over time, and which hardly foretell the end of Saudi Arabian energy dominance. Just as the “peak oil” debate falsely predicted that worldwide oil production had reached — or very nearly reached — its peak overall production, the shale oil debate is steering public opinion to the opposite extreme.

Even the IEA acknowledges that both future sources of additional crude oil and price remain big unknowns. As the IEA’s chief economist, Fatih Birol, noted in November 2012, “light, tight oil reserves are poorly known… If no new resources are discovered around the world and plus, if the prices are not as high as today, then we may see Saudi Arabia coming back and being the first producer again.” The U.S. Energy Information Administration, meanwhile, predicts that U.S. crude oil production will peak in 2020, placing the United States 47 percent below the IEA’s projections.

Thanks in no small part to new hydraulic fracturing and horizontal drilling technologies, “tight,” unconventional oil trapped in rock and sand beds is becoming more and more accessible. These improved production methods are having a major impact on the U.S. energy supply, contributing to a 43 percent increase in U.S. oil production since 2008.

Many questions remain unanswered about the U.S. unconventional oil story that could have long-term, transformative effects on global oil markets. For example, global demand would have to decline substantially — especially in emerging Asia — in order for U.S. supplies to become omnipotent. The impact of the U.S. unconventional story hasn’t depressed oil prices, which have been fairly resilient to date. Moreover, the IEA’s expectation that North America will become a net oil exporter by around 2030 depends on how much crude oil is produced not just in the United States but also in Canada and Mexico. Under the IEA’s highly optimistic forecast, the United States might surpass Saudi Arabia in liquids — though not crude oil — production for a brief period. Even then, an increase in self-sufficiency won’t necessarily eliminate America’s need for imports. OPEC’s reaction and member cohesion will impact the way global markets respond to U.S. developments. Technological diffusion can also influence the rate of non-OPEC oil supply.

Demand will ultimately determine America’s appetite for oil and energy at large. In order for the country to become less reliant on imports, demand will have to continue to decline due to efficiency gains. To date, however, there is little indication that this is happening. Middle East oil exports to America, especially from Saudi Arabia, were higher in 2012 than at any time since U.S. tight oil production began its upward trajectory in 2009. Perhaps more importantly for American consumers, unconventional oil might not necessarily lead to lower prices at the pump. Besides supply and demand dynamics, oil prices are also determined by global geopolitical events.

Yet another reason to be skeptical of the projected impact of unconventional oil in the United States is the sharp decline rate of shale oil fields. More than 80 percent of American tight oil production comes from two sources: the Bakken formation in North Dakota and Montana and the Eagle Ford formation in southern Texas. But decline from a typical Bakken well is steep, with production slumping to one fifth of its original rate within 24 months. The Eagle Ford wells, meanwhile, could reach the end of their economically useful life within four years. As a result, oil guru and hedge fund manager Andy Hall recently predicted that U.S. shale discoveries will boost production only temporarily and that oil prices will remain high.

Saudi Arabia’s role as the most reliable global oil supplier, meanwhile, is unquestionable. The kingdom has repeatedly helped to stabilize the global oil market and keep prices down by increasing its own production — first in mid-2011 to offset supply shortfalls from Libya and again in early 2012 in response to tensions between the United States and Iran. At that time, Saudi Arabia increased oil production to a 30-year high of 10 million barrels per day. This followed earlier efforts to offset supply shortages during the Gulf wars in 1991 and 2003, and the 2002-2003 Venezuelan general strike. Currently, Saudi Arabia has a total capacity of 12.5 million barrels per day, and between 2.5 and 3.5 bpd in spare capacity to meet global energy and supply shortage needs. Saudi Arabia accounts for over 50 percent of global spare production capacity. In other words, U.S. shale oil is far from displacing Saudi Arabia’s role as the world’s de facto strategic petroleum reserve.