Stirling International

This article appears in the latest issue of IEA Energy: The Journal of the International Energy Agency.
By Michael Cohen

Five years ago no one would have been talking about the prospect of US energy independence. But this year, domestic crude oil production should rise by 10%, and within five years the United States is likely to break the record output high reached more than two decades ago, to flirt with the position of top world producer.

The prospect of energy independence is very complex, though, and depends heavily on the types of crude oil that refiners consume, the composition and level of energy demand, infrastructure constraints and oil prices.
The new volumes of production are coming mostly from shale reservoirs composed of low permeability, fine-grained rocks that formed from the compaction of silt and slightly larger sediment. The rapid increase in production from these so-called light tight oil plays has dramatic implications for world oil markets, geopolitics, the environment and the macroeconomy.

New tricks for old reservoirs

The rapid increase in tight oil production occurred in part because in many cases companies were already familiar with the resource base from previous, conventional drilling for oil or from natural gas production. Horizontal drilling and hydraulic fracturing techniques, based on lessons learned from extracting shale gas, boosted oil recovery rates. Companies have been producing from the Williston Basin, including the newly prodigious Bakken fields in North Dakota, Montana and Saskatchewan, since the 1950s. The same phenomenon is true in some Oklahoma and Texas plays.

This tight oil renaissance has wide-ranging implications. Rising oil production from the mid-continent is competing with other marginal oil prospects in North America, including the Canadian oil sands, and any sustainable price impacts will arguably have implications for OPEC output and capacity decisions. Increasing output is already reducing Gulf Coast refineries’ demand for equivalent light sweet (lower-sulphur) crudes from Africa.

Not all oil is the same

But those predicting US energy independence often confuse the country’s total crude imports with the substitutable, light component of those imports. Gulf Coast refineries’ capacity to process heavier crudes is increasing, so imports of heavier crude are unlikely to fall in the future despite greater production of light oil.

The tight oil renaissance has become a hot-button political issue. While North Dakota, epicentre of the Bakken shale, has the country’s lowest unemployment rate, companies report that one of the toughest aspects of drilling in the area is finding hotel rooms for employees. The state’s murder rate is rising, locals complain about horrendous traffic jams and there are long waiting lists for spots in day-care centres. Citizens are concerned about contamination of the water supply, and the World Bank reported this year that increased gas flaring in North Dakota lifted the United States to among the top five flaring countries in 2011.

But the biggest reason the IEA and many other analysts urge caution is how takeaway capacity from areas of the Williston Basin in North Dakota and eastern Montana could constrain growth, increasing producer reliance on more expensive modes of transport and hurting the realised price for their oil. Light tight oil is swelling inventory levels at the Cushing storage site in Oklahoma, causing a structural disconnect between the benchmark West Texas Intermediate (WTI) oil price and that of other grades. Temporary transport bottlenecks have already caused drastic discounts of the price of oil offered for sale from the Permian Basin in Texas and the Bakken play. Although takeaway capacity in the Texas plays should be ample for rising output levels, short-term bottlenecks are likely, and producers must rely on truck and rail-based modes of transit.

Texas has its advantages

Production in the less constrained Eagle Ford shale area of Texas tripled over the course of 2010. In 2011 to early 2012, it more than doubled again to exceed 400 000 barrels a day. Producers there benefit from close proximity to the Gulf Coast refining centre, high gas liquids content and significant initial oil production rates. Takeaway constraints should disappear soon because of increasing processing plant capacity and new pipeline capacity. In fact, some analysts hint that the rapidly increasing Eagle Ford volumes will most directly reduce US light sweet imports, and challenge the economics of other light tight oil plays in the mid-continent.

But while the majority of American tight oil production is economic at WTI prices even below USD 80 a barrel, new plays without ample infrastructure or where producers are less familiar with the geology are more expensive.

Furthermore, tight oil production requires extensive infrastructure to collect small volumes from dispersed wells, and it experiences steep decline rates. Drilling and completion costs sometimes reach USD 10 million per well, largely due to constrained quantities of oilfield services in the Bakken and the need for longer horizontal laterals.

Another limiting factor will be the extent of drilling that can occur without reducing the pressure in the formation, with concomitant effects on already-producing wells.

Much opportunity but also limits

Analysts maintain that if the Bakken can support multiple wells, then future exploration and development would shift to new prospective areas such as Three Forks formation and could result in even higher output.

The Eagle Ford and Bakken plays, along with shale plays in Colorado, New Mexico, California and the Midwest, are making the United States the single largest contributor to non-OPEC supply growth in 2012, and without a doubt, it will remain the top contributor for the next five years. Tight oil production growth will ease oil market fundamentals in the short and medium term, while spurring economic growth and reducing oil imports. But many constraints, current and future, will maintain US interdependency with world oil markets.

Michael Cohen oversees short- and medium-term non-OPEC supply forecasts and writes the monthly Oil Market Report's supply section. Prior to joining the IEA in 2011, he worked in the US Energy Information Administration and Energy Department's Policy and International Affairs office.

Article by: www.iea.org