America needs a new energy policy to secure future, sustainable prosperity, now
Frontispiece: Now that the myth of energy dominance by shale oil is well and truly dispelled, the United States needs a new energy policy to support America’s future economic growth. If that energy is to be secure, clean, and affordable, it will mean drastically less consumption of coal, oil (particularly foreign), and with time natural gas. Although the transition will take decades, the fossil natural resources of the US are finite and can only offer a limited runway, so the country needs to act now, before it’s too late.
US Shale oil myth busted, foreign imports growing
Figure 1: Production, consumption, net imports, import source and price of oil in the United States. (Source: EIA, Yahoo Finance, Capriole Energy).
In previous articles, most recently one describing the implied full-cycle breakevens of US E&P independent oil and gas companies, I have demonstrated that about half of US oil needs prices greater than $55/bo (WTI) to be developed and produced economically. More like $75 is needed to make the majority profitable. Rather than fall due to operational efficiency gains, this breakeven price may well rise due to the higher cost of capital provided to US E&Ps by now gun-shy investors and creditors. Last year’s proclamation that the US had become a “net energy exporter” was based on petroleum products (including crude oil), not crude oil only. Never mind “energy dominance”, America has remained a net importer of crude oil, even at the peak of US field production in 2019. This is partly due to the lighter quality of crudes from shale and tight formations; US refineries, built and configured for a slate of heavier crudes, need to offset indigenous oil with foreign heavy oil imports. Moreover, these foreign imports tend to have lower acquisition costs for refiners, further increasing the crack spread or margin.
America’s oil habit
Most of the US’s imported oil comes from neighbors Canada and Mexico (Figure 1). Shale oil has reduced America’s dependency on foreign oil other than from its neighbors. However, the recent returning demand for oil as activity increases again after the initial COVID-19 shutdown has been met with more imports from Saudi Arabia, with import levels not seen since August 2016.
Figure 2: US jobs, petroleum consumption and the stock market are back to within 10% of the pre-shutdown levels. (Source: Data: US Bureau of Labor Statistics, EIA, Yahoo Finance and Apple Mobility; Graphic: Capriole Energy).
If demand continues to grow back to pre-COVID-19 levels (Figure 2), and US production continues to decline because of much-reduced drilling as a response to continued sub-$40 prices and lack of investment and continued credit, then foreign oil contribution will continue to grow. America has not beaten its habit for OPEC oil and remains highly dependent on neighbors Canada and to a lesser extent Mexico. There’s little geopolitical concern about Canada or Mexico, indeed there is an opportunity for a combined energy transition policy within North American trade, but dependency on OPEC oil and the associated geopolitical risks has long been a concern for those worried about market manipulation (price shocks in both directions!) and the human and fiscal cost of US political and military involvement in the Middle East.
There are solutions available to policymakers to deal with energy security concerns and offer price support to US oil producers. For example, a buffering if not isolation of the US (or North America) from OPEC oil by using quotas, or some form of tariff or a tax on refineries acquisition costs, could provide stability in the US oil market, at least for the foreseeable future. In such a circumstance, where refiners are encouraged to “buy (North) American oil first” it is likely that the price of oil will increase and such a price differential will also increase the proportion of oil resources that are economic to develop and produce. However, such measures are unlikely to be made in the months running up to the election, as they would also increase gasoline pump prices. That wouldn’t be a popular outcome amongst voters particularly while Americans continue to endure the tragedies and misfortunes of COVID-19.
Figure 3: Energy Consumption per Capita in 2019 (Source: Data: bp Statistical Review of World Energy 2020; Graphic: Capriole Energy)
Figure 4: US petroleum consumption of petroleum products refined from a barrel of oil (Source: EIA).
But the problem is much worse than this short term outlook. America is one of the highest consumers of energy in the world on a per capita basis (Figure 2). Specifically, with respect to oil, the US has 5% of the world’s population but consumes 20% of the world’s oil. A little under half of that oil is converted into gasoline and about 27% to diesel to fuel the 284 million vehicles on American roads (Figure 4). Said another way American vehicular mobility costs about 14 million barrels of oil per day or an average a US vehicle consumes 18 barrels of oil each year. While some countries around the world appear to be taking the opportunity to change mobility habits and hence reduce diesel and gasoline consumption (and in turn reduce GHG and other pollutive emissions), US consumption of gasoline and diesel appears to be steadily growing back to levels last seen before the coronavirus pandemic (Figure 5). Although at the time of writing the pandemic is re-escalating across many US states, it’s not clear how this will affect fuel consumption, particularly during vacation times. The exception to this is of course jet fuel, consumption of which is drastically reduced compared to 2019 levels. Both business and leisure travelers are shunning flights, and even driving instead or in the case of business people, staying at home.
Figure 5: Post-COVID-19 rebound of petroleum consumption and fuel type in 2020 compared to 2019. (Source: Data: EIA; Graphics: Capriole Energy)
Forecasting future US oil demand
Figure 6: Three models of projected oil consumption in the United States.
So America’s voracious demand for oil shows no real signs of substantial abatement, and unless there is a change of administration in the White House in November, it also appears unlikely that policymakers will take a longer-term view of the enormous risk that the US is facing with this dependency on oil. To illustrate the risk, let me depict the fundamentals of the demand-supply problem. Firstly, a thought experiment on demand forecasts (Figure 6). In Figure 6 I have illustrated three cases estimated as top-down calculations to predict America’s future demands due to its oil dependency. In the most optimistic version, the Energy Transition Case (ETC) I assume that peak oil demand in the US was last year and that there is a rebound into 2022. After that, I assume that there is a suite of measures applied to reduce oil consumption such as substitution (e.g. hybrid and electric vehicles), efficiency (e.g. incentives against SUVs and light trucks), and habits (e.g. commuting regulations). Although confident that technology is available or will be available, I appreciate that changing American culture to adopt the technologies will be an enormous adaptive challenge. In the second model, the Flat Model, I assume the same partial bounce back, and then for simplicity, I keep consumption flat out until 2050. In the highest case, which I suspect might be conservative in its estimation of the possible largest demand scenario, I have consumption not only rebounding but achieving a new rounded peak around 2030, before going into a decline, albeit slower than the ETC case. The bottom line here is that unless there is a transformational intervention to drastically reduce consumption, the US’s oil budget for the next 30 years is more than 200 billion barrels.
Figure 7: Projected US oil demand compared to sources of reserves (2019) and estimated fiscal breakeven prices for those resources (Source: bp Statistical Review of World Energy 2020 and various for breakeven prices; Graphic: Capriole Energy).
Meeting the demand
Figure 7 compares the 2050 US demand budget to current oil reserves around the world. I think there are several important takeaways from this comparison. First and foremost, the unlikelihood that the US can meet its oil budget with US oil production, even in the ET case, is underscored. The US, consuming 20% of the world’s oil, has 4% of the world’s reserves. This should not be confused with “resources” such as the USGS’s conclusion that the Permian basin holds 46 billion barrels of “technically recoverable resources”. The performance of the US shale oil industry in the last decade culiminating in its current meltdown demonstrates that that oil resource is unlikely move into economically recoverable reserves.
The US demand budget could, in principle, be met by North American resources, assuming that export issues in Canada can be solved. Meeting the US demand with indigenous and neighboring resources will be a whole lot easier if action is taken to reduce demand. When full fiscal costs are taken into account, then it is fair to say that there is no such thing as “cheap oil”, not much anyway. The rising technical costs of extracting more challenging reserves and the rising costs of capital for non-OPEC producers mean that breakevens there are really well above $50/bo. For OPEC countries, where economies are largely, if not solely dependent on oil, prices of $80/bo (Brent) are needed for states like Saudi Arabia to make ends meet. Prices lower than these breakeven prices come about because of supply being perceived as greater than demand and are made possible only because the producers borrow to “subsidize” the development and production that would be otherwise uneconomic. While OPEC countries, with plentiful reserves and a particular oil dependency of their own, will want to oil demand to be sustained if not grow to allow them to produce at the required high prices. In a global version of the ETC for the US in Figure 6, where the world needs around 700 billion barrels to 2050 the lesser demand will probably bias the price downwards to levels that would make North American resources uneconomic. I believe that this market vulnerability, as well as the political risks of dependency on OPEC oil, underscores the benefit of buffering if not isolating the North American oil market, as described above. Said another way, the first thing to be re-shored in a new American economy with increased manufacturing and infrastructure development is energy.
The Goldilocks Zone for us oil price
Figure 8: The Goldilocks zone for US oil price. Monthly oil prices are plotted against average monthly gasoline prices. (Source: EIA, Yahoo Finance, Capriole Energy).
Although there is considerable debate on the point, economists suggest that there is a sweet spot for oil prices in the US. Too “cold” or low prices means that oil companies cannot make money and that part of the economy shrinks. Too “hot” or high prices causes high pump prices for gasoline, and this undercuts consumers’ discretionary income to spend on other goods and services, as well as impacting transport of both goods and people. It is generally accepted that something around $70/bo is the sweet spot and on Figure 8 I’ve depicted a goldilocks zone of $50 to $80/bo (WTI) which corresponds to a gasoline price range of about $2 to $3/gallon. This implies that the institution managing imports and exports (if any) of oil in the US would be adjust quotas or whatever mechanism is chosen to priotize North American oil over other sources to cause the price to sit within the Goldilocks zone, with the secondary objective of price stability. At times of globally low oil price, consumers in the North American oil zone would pay more for their gallon of gas than perhaps they otherwise would, but the oil producers would be protected from market disruption. At times of world price highs, consumers would be protected with cheaper gas at the pump, while producers would only be able to benefit if there was surplus oil to export.
Breaking the habit
These measures to use North American oil first are only the first step in breaking America’s oil habit. It’s only the methadone to substitute for foreign oil that is a volatile and expensive fix. The next step involves radically reducing the addiction, and for America that means transforming transport from almost completely oil dependent to a new mobility that has different habits and relies on more sustainable and secure energy resources.
Figure 9: Vehicle miles in the US 1990 to 2018. (Source: Bureau of Transportation Statistics, Capriole Energy).
American vehicles travel an astonishing 3.2 trillion miles every year and the vast majority of that is on the highway, explaining why 70% of the 20 million barrels consumed each day in the US is related to the combustion of gasoline and diesel (Figure 9). Highway miles have increased about 1.5 times in the last three decades and except for the recession after the 2008 financial crisis and the recent constraints imposed by the COVID-19 outbreak, has shown no sign of reducing growth, let alone decline. Although fuel efficiency for internal combusion engine (ICE) vehicles has radically improved, and now hybrid and electric vehicles have entered the market, gasoline and diesel consumption have also increased in the last 3 decades, but not in the same proportion as highway miles (Figure 10).
COVID-19 has incurred both a public health crisis and an economic crisis and so far neither have been successfully managed at federal and state level. The crises have had deep impacts on Americans’ mobility habits over the last few months, but are any of these effects going to be long-lasting? Figure 11 shows the Apple Mobility data related to the COVID-19 outbreak. Before drawing any conclusions from this data, it’s worth reminding the reader that the information is gathered from iMap inquiries from iPhones (with anonymous identification, we’re assured). Therefore it may not represent very well commuters who know their routes well. Transit use (bus, metro, etc) has collapsed and not recovered a lot since the initial mid-March shutdowns. This is hardly surprising given fears of infection in closed and crowded spaces. Consequently this may account for some of the greater rebound in driving and walking as people take to their feet or their cars.
Figure 10: Petroleum products, specifically gasoline and diesel, consumed in the US, 1990 to 2020. (Source: EIA, Capriole Energy).
I have heard and seen anecdotal evidence that some businesses are going to do a lot more working from home or remotely, thus cutting down commuting. That could mean a lasting reduction in transit and highway miles, even after the pandemic is finally over. Of course the immediately available data in Figure 11 suggest any savings in highway miles have been overwhelmed by substituted transit miles and probably additional vacation or short trip miles as Americans, frustrated by the lockdowns, but unafraid of, or taking precautions to avoid, infection, got back on the roads. I also have not heard much about US cities taking action to reduce the reliance on automobiles, as has been happening in Europe. Some of that is for good reason, with lack of transit infrastructure in many American cities forcing people to drive. In summary, it looks like we’ll need to wait some time to see if there is a lasting reduction in transit use, and whether or not the substituted driving miles offset those more fuel efficient transit miles.
Figure 11: Apple Mobility data on Driving in the USA benchmarked to January 13th 2020.
The iMaps data doesn’t cover aviation, but we need look no further than the jet fuel consumption data to see the COVID-19 impact on air travel habits (Figure 5). I think it’s fair to say that we have learned a lot about video-communication over the last few months to see that we don’t need to travel for meetings and conferences. I have successfully conducted several different types of business meeting, including a board meeting, on Zoom and Microsoft Teams. This week I am participating in an online conference with geothermal energy as the subject matter. It seems to me that COVID-19 has taught us that a lot of the business travel we did before was inefficient if not unnecessary, so I think it’s reasonable to assume that it won’t return to pre-COVID-19 levels. How vacation travel is ultimately going to be affected is also very difficult to predict. One uncertain factor is whether or not air travel will be as affordable as it was pre-COVID. For example, a consolidated airline industry may be able to charge higher prices.
So in summary it appears difficult to predict how COVID-19 will ultimately affect US mobility habits, but it clearly represents a disruption in which policymakers and businesses can find opportunity to take measures for an improved living environment in the future, particularly it seems for Americans in the large metropolitan areas.
Consumer choice, energy substitution, and efficiency
Figure 12: Production Share and Fuel Economy by Vehicle Type in the US (Source EPA
Decreasing the miles traveled by Americans is one way of reducing demand on oil. The other method is to change the vehicle of choice, particularly towards hybrids (PHEVs) and fully electric vehicles (EVs). Unfortunately, larger less fuel-efficient vehicles have been capturing more market share in the US, not less over the last few decades (Figure 12). So fuel efficiency improvements of ICE vehicles are being offset by consumers choosing to drive larger cars, trucks, and SUVs. Figure 13 illustrates another interesting dynamic: with one very notable exception, American manufacturers lag severely behind foreign makers in producing fuel-efficient vehicles. I presume that this is because non-US manufacturers are having to design ICE vehicles for sale in countries with stricter fuel economy (= emissions) regulations than the US. The notable exception is of course Tesla, widely regarded as the world’s leading EV maker. In Figure 13 Tesla is given its own scale on the graph in terms of fuel economy. The electric motor is just so much more efficient, with less waste in unused heat than an ICE in converting energy to miles on the road. Hence there are several measures that policymakers could enact to reverse the growing demand for oil in this space.
Being a Tesla Model 3 owner since March 2019 I can attest to the simple “kitchen table” economics. I have spent more than 80% less on fuel (gas or electricity) owning an EV compared to my previous ICE car. Maintenance costs are lower too, as the electric motors in the Model 3 require no maintenance and any corrective actions I’ve taken so far have been under warranty. There many other things of wonder about the Model 3, but its breakthrough on energy efficiency is amazing and is a role model for the future re-engineering of other energy sinks such as buildings.
Figure 13: Changes in Estimated Real-World Fuel Economy and CO2 for Large Manufacturers (Source: EPA).
In the shorter term, there is a huge need for a measure to bias consumers towards vehicles with higher fuel efficiencies. That could take the form of additional levies on pump prices for gasoline and diesel, with the revenue from these levies used to fund incentives (such as tax rebates) for consumers to purchase the most efficient vehicles, particularly the increasing range of PHEVs available on the market now, to close any current price gap between hybrids and their ICE counterparts. As explained above, in kitchen table economic terms, if purchase cost outlays are the same, then the superior operating costs of the hybrid or EV should make the decision easy for consumers.
Figure 12: A thought experiment assuming a decline then gradual build of highway miles in the US. These miles are increasing driven in electrified vehicles to reach 42% in 2050, with electricity needed calculated as 35kWh/100 miles and then correlated to the amount of natural gas needed to generate that electricity.
For the longer term, it’s clear that US car manufacturers need to be incentivized to do more on ICE fuel efficiency and manufacture of hybrids and EVs. This could fit well with an approach to rejuvenating manufacturing jobs in the US, with government incentivized investment in the appropriate technologies. There is a particular opportunity for breakthroughs in fuel (and emissions) efficiency for larger vehicles such as 18-wheeler trucks. In this vehicle sector, there is still huge room for improvement, although some European companies are already making progress on electric and hydrogen-driven trucks and buses.
It is also clear that investment is required in electricity infrastructure, from generation through transmission to supplying new demands like EV charging points. For example, the availability of charging points for EVs remains a concern for many motorists considering a purchase. Again, Tesla has captured a huge advantage on other EV manufacturers through the continued buildout of their charging infrastructure, making it possible to use a Tesla as a commuting car and as a long-distance road tripper. There is an opportunity for an entrepreneurial venture to start filling in the gaps for both Tesla and particularly other makes.
To estimate the potential impact of these changes to mobility I conduct another thought experiment in Figure 12, converting predicted highway miles into electric miles as opposed to ICE miles. It’s probably optimistic, suggesting 42% of highway miles are electrified by 2050. Nevertheless, it shows that such electrification would add over 500 million megawatt-hours to demand in 2050. Today’s total demand in the US is around 4 billion megawatt-hours, so 2050 vehicle electrification represents a 12.5% growth on 2019. Also noteworthy is that if generated from natural gas (more on that matter below) this would add 3.7 tcf gas consumption by 2050. America currently consumes about 31 tcf per year of natural gas and about two-thirds of that is used in electric power generation. It is very important to note that this thought experiment, even if I add in some further fuel efficiency gains for the remaining ICE vehicles, only takes out just about half of today’s oil consumption on the US highway, roughly 7 million bod. That describes a half-way point between the Flat model in Figure 6 than the Energy Transition Case. This may be enough to deliver secure, affordable mobility for the next three decades, but it may not be sufficient for the second half of the 21st century.
Sustainability matters
Figure 12: Electricity generation in the US by fuel source. (Source: EIA, Capriole Energy).
Of course, there is no point weaning America off of oil, only to build dependency on another unsustainable resource. (I use the definition of sustainable development from the Brundtland report). The good news is that America is far richer in natural gas than oil, but demand continues to grow. If the current growth in demand continues, then America will consume over 1000 trillion cubic feet (tcf) before 2050. This compares to current reserves of 531 tcf in the US, so half of that budget currently appears to be available in the US. But even natural gas is not infinite, and the same risk of rising demand versus diminishing supply will be faced within the next three decades. In addition, burning natural gas without capturing and sequestering emissions (CCS) is harmful to the environment, increasing the risks of climate change. Less harmful than burning coal and oil for sure, but also carrying a significant problem of leaking methane from wells and infrastructure, methane being 70 times more radiant forcing than CO2 shorter term in the atmosphere. Therefore for the sustainable development of energy for the US there is a need to conserve natural gas, mitigate fugitive emissions, and like oil, invest in other resources to offset natural gas, and form an energy plan for the future.
A deep dive into the future of natural gas is beyond the scope of this piece, but I offer a couple of thoughts on this matter. The growth of renewable power in the US is similar to other countries in that it has doubled in share of generated electricity in the last 5 years, but unlike some other countries still only comprises 10% of the share. That said, if that exponential growth was possible and was to continue, 40% of US electricity could be renewable by 2030, and the reliance on coal, and then natural gas, could be reduced and the future potential of those resources extended. Some, much smaller, countries are already achieving that level of renewables penetration into their grids, but the scale of US demand underscores the enormity of the renewables challenge. It is also worth pointing out that the variability of renewables like wind and solar means that without battery storage at scale, renewable electricity needs to rely on back-ups like natural gas peakers. Investment in technologies such as at-scale battery storage, baseload renewables like geothermal, and other options in an eclectic mix of possibilities remains critical.
Conclusion
The thought experiments in this piece offer me some real hope that a secure future, sustainable prosperity for the USA, largely independent of foreign fossil resources outside of North America is possible. The biggest challenge I think is a cultural one, getting Americans to favor electric and hybrid vehicles. The challenges of growing renewable energy into the energy mix are enormous too, and the need for fossil fuels to pave the way is clear. There is no off-on switch. Therefore policymakers need to be holistic or bipartisan in their approach. Extreme views such as fossil fuel dominance on one side, or prosecuting oil companies for their polluting products on the other, are equally non-sensical. American needs an integrated and collaborative strategy to combine the strengths of the rich resources and the high capabilities of all energy types and energy people, including systems design to drive efficiency into the outcome. The runway, underpinned by oil and gas, can be perhaps measured in decades, but nevertheless action needs to start now.