The downside of oil independence

Posted by Jeff Rubin on December 2nd, 2014 under SmallerWorldTags: , , ,  • 9 Comments

What a difference a couple decades can make. OPEC’s decision to maintain production has rocked the TSX, sending energy companies as well as governments scrambling to figure out what to do in a new world order where oil prices might continue to slide. Rewind to the energy crisis in the 1970s and a decision by OPEC to keep pumping oil would have been cheered by investors not to mention motorists and the rest of the economy.

For decades, oil-consuming countries in the West have yearned to wean ourselves from our dependence on OPEC and, more to the point, its power to send prices spiking with the turn of a few spigots. Ironically, now that we no longer rely directly on the cartel for fuel the way we once did, suddenly we wouldn’t mind if they behaved exactly as we once feared.

So what’s changed? For North America, quite simply, it’s energy independence. Long the holy grail of US energy ambitions (and, by extension, many Canadian ones as well), the shale revolution has essentially made it a reality. Not long ago it wasn’t that uncommon to see a US president fly to Saudi Arabia to plead for more production and relief from the economic yoke of high oil prices. These days, we’d be more likely to see President Obama or Prime Minister Harper making the trip to lobby for the opposite on behalf of North America’s oil producers.

One’s take on oil prices, like so much else, is a matter of perspective. Once upon a time, we used to see OPEC from the point of view of oil consumers. As production has gone up around North America—in Alberta, Saskatchewan, North Dakota, Texas and elsewhere—our frame of reference has changed. Burgeoning oil production in Canada and the US means high oil prices are no longer the economic bugaboo they once were.

On the surface, decreasing our reliance on imports from Saudi Arabia and the rest of OPEC might seem like a resounding win, but a closer look shows a situation that’s not nearly that black and white. Instead of relying on OPEC to supply our oil needs, we now find ourselves counting on expensive domestic crude. It’s a spot that’s not as secure as we may have once hoped. Relying on high cost oil means oil prices must remain high to keep everything on track. Take them away and it’s not long before the cracks begin to show.

Once again, the irony of the situation is hard to miss. The whole idea behind energy independence was to insulate our economies from OPEC’s ability to manufacture the same high prices that our own domestic oil industries now require. As for consumers, it bears asking whether they’re really any better off paying high prices for oil that’s pumped close to home versus crude that’s imported from overseas. Aside from the odd Tesla owner, most North American drivers wouldn’t mind seeing OPEC pump as much oil as it can to drive prices even lower.

No doubt that Saudi Arabia would be fine with regaining its former dominance over the global oil market, but for the moment such thinking isn’t really what matters. The Saudis aren’t the ones in trouble right now. Saudi production costs are a fraction of those from the new supply sources that are driving the gains in North American oil production. Why should the onus be on the low cost producer to cut supply? If crude prices keep sliding, market forces will dictate which oil production will be shuttered and which will keep flowing.

What does that mean for North American energy producers? It’s not hard to guess. Lower oil prices mean more projects in Alberta’s oil sands will be scaled back or shelved entirely. The benchmark price of oil sands crude, Western Canada Select, has now dipped below $50 a barrel. At that price, not only are plans to double output from the oil sands no longer commercially viable, but current production levels also come into question. Energy giants such as Shell, Statoil, and Total SA have already cancelled plans for multi-billion dollar projects in northern Alberta and if prices keep falling don’t be surprised if you hear that existing production starts getting pulled out of the market as well. If West Texas Intermediate drops another $10 or so, the profitability of US shale plays will start to look similarly marginal.

With OPEC maintaining the status quo, North America’s high cost oil producers can either choose to cut output or face even lower prices. Either way the outlook isn’t bright. For the last few years, energy independence seemed like a pretty good deal. What we’re on the verge of discovering is that much of the production that makes it possible isn’t viable in a world of falling oil prices.

  • Larry C

    Energy independence still exists, at a price. If oil is $70 a barrel or higher, North American supply kicks in. We’ve created a price ceiling that means we won’t be held hostage by OPEC and our economies won’t have to endure $100+ oil again. The strongest North American suppliers will survive, the weak will die but the oil isn’t going anywhere.

  • Steve

    Jeff, I’m having a difficult time reconciling your statement regarding the reality of North American energy independence (“So what’s changed? For North America, quite simply, it’s energy independence. Long the holy grail of US energy ambitions (and, by extension, many Canadian ones as well), the shale revolution has essentially made it a reality.”) with the data.
    The US, for example, is no where near energy independence when it must continue to import oil to meet its demands. While shale production has narrowed the gap between supply and demand, it is nowhere close to zeroing out and allowing one to speak of energy independence.
    In fact, if one considers the Ponzi nature of shale production and its likely near-term peak, the idea of energy independence can be viewed as a convenient but faulty narrative that has little hope of ever being reality–unless of course demand absolutely craters.

  • Daniel Pedersen

    I find it tragic when small thinking sells books, garners TV interviews and newspaper articles. The truth is that by way of both efficiency and technology the world will be awash with oil for a long time to come. On the US gaining oil independence this can only be a positive for both the consumer (globally) and in diverting funds away from the middle east. Jeff is a classic chicken little thinker, oil prices are high and OMG its the end of the world as we know it, oil prices falls and OMG the TSX market is over and done with. Silly and ridiculous are just a few words that come to mind.

  • jim patterson

    Domestic crude is pricey now but over time further innovation will lessen the price somewhat

  • Instincts

    One way of looking at it I suppose, to make oneself feel better about oneself’s plummeting oil stocks. But the reality is that OPEC need only to jack up and maintain production to shut-down the more expensive non-conventional producers. OPEC is simply reminding non-OPEC who still holds the power. What happens among the non-OPEC producers after the fallout, OPEC could care less, other than to realize that its highly reduced the competition.

  • Instincts

    Really? And just what ‘innovation’ will make extracting northern Alberta oil sands less costly? Majically osmotically removing it? Teleportation? Resorting to the I-word is so typical of most economists. Nice to see more domestic fossil hydrocarbons stay right where they are.

  • The Truth

    Hey Jeff, where is this $200 per barrel oil you used to speak of on BNN ?? (silence and crickets).. I used to get a good laugh out of watching you on BNN and made a lot of money investing opposite of your views. I think the Toronto Maple Leafs have a better chance at winning a Stanley cup than anything you profess coming to friution. Please come back to BNN Jeff, I miss the easy profits you were providing…Hahahahahahahahahaha….

  • MB

    Maintaining production will be possible only as long as the geological limits allow it.

  • Moe

    What happens when the supply of low-hanging fruit dwindles? Prices will rise to reflect the economics of the more expensive sources. Is OPEC just forcing the more expensive production company valuations down? Are they seeing their own future shift from producer to owner? Why wouldn’t they reap the profits of higher global oil prices as their supplies decline in a typical ‘cash cow’ marketing strategy? Seems like there’s more going on in this dynamic than is being talked about. As someone pointed out, the oil will still be in the ground, and the price of extraction will only increase, so what is the manoeuvre in creating this delay?