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Busting the Myth of Energy Independence

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On Monday, my Foolish colleague Travis Hoium penned an article in reaction to the release of Mitt Romney's plan for "North American Energy Independence by 2020." I'm a bit more cynical than Travis about the likelihood of achieving energy independence in the next eight years, but it's a hot topic on both sides of the political aisle right now that will affect investors, so let's address it.

Though politicians' plans vary and include references to coal, natural gas, and renewables, the foundation is more or less the same across the board: Produce more oil, and we will be OK. Energy independence is an important goal, but insisting that increasing oil production is the best way to achieve it belies a fundamental misunderstanding of what it really means to be "energy independent."

Getting rid of foreign oil imports
Earlier this month, The New York Times published a now oft-cited article about how the United States has increased its dependence on Saudi Arabian oil by 20% this year. If we were energy independent, the thinking goes, this wouldn't have happened. If we were energy independent, we could avoid the Middle East, and all the political headaches that come with it, and rely solely on North America for our energy needs. According to our politicians, all we need to do is increase production at home, and increase imports from Canada and Mexico, and we're golden.

With that in mind, let's take a closer look at what the Times cites as the reason for the increase in Saudi oil imports:

"In the United States, several oil refining companies have found it necessary to buy more crude from Saudi Arabia and Kuwait to make up for declining production from Mexico and Venezuela, insufficient pipeline connections between the United States and Canadian oil sands fields, and the fallout from the 2010 BP disaster, which led to a yearlong drilling moratorium in the Gulf of Mexico."

Well, that's weird. It looks like, outside of Venezuela, the problems that have forced the increase in Saudi imports are North American ones. One of the major issues with an oil-focused plan for North American energy independence is that it is based on at least three assumptions about the future that cannot possibly be guaranteed.

Assumption No. 1: Everything is fine in Canada
Canada has vast oil resources, and analysts project that production there will increase significantly over the next decade. The problem is that Canada's oil is one of the most contentious resources ever. The current opposition to working in Alberta's bitumen oil sands makes the American fracking controversy look like a schoolyard tiff.

Enbridge (NYSE: ENB  ) , the Canadian pipeline company that's responsible for transporting about 70% of Canadian oil exports into the U.S., virtually needs special permission just to tie its shoes right now, let alone building and expanding its pipeline network. After a dooming investigative report into its 2010 oil spill in Michigan, followed almost immediately by another pipeline spill, Enbridge is facing such strong opposition to a key oil-sands pipeline that some Canadian leaders now think the once "can't-miss" project won't ever be built. And it's not just Enbridge -- Kinder Morgan (NYSE: KMI  ) and TransCanada (NYSE: TRP  ) are facing the same hurdles. Opposition to midstream infrastructure, which is already desperately lacking in North America, may ultimately trap much of this new North American oil at its source.

Even if we assume that every single project necessary to increase oil sands production and transport it to the United States is eventually approved and constructed, and that is a bold assumption, we must understand that between public opposition and increasing regulatory oversight, it will not be cheap and it will not happen overnight.

Assumption No. 2: Everything is fine in Mexico
To put it simply, Mexico's oil industry is a giant disaster. How can we expect "North American Energy Independence by 2020" when Mexico's production has declined 25% since 2004? Some analysts predict that if Pemex, the country's national oil company, doesn't get its act together, it will become a net importer of oil by 2020. The very same year, the entire continent is supposed to reach its goal of energy independence.

Pemex has had a monopoly on the Mexican oil industry since 1938. The country's constitution forbids production-sharing agreements with foreign oil companies, which is why ExxonMobil (NYSE: XOM  ) and the rest of Big Oil don't bother doing serious business there. The only agreements that are allowed are service contracts, which pay a set fee per barrel and forbid any company other than Pemex from owning the crude that is produced.

There is a growing consensus that Pemex needs to open its doors to foreign expertise to increase oil production, but change is painfully slow in coming. In an effort to test this idea of openness, this past June the government offered to allow foreign companies the right to bid for the operational control, but not ownership, of seven separate oil fields across the country.

But the auctions were only moderately successful, as Pemex failed to award two offshore fields to foreign operators. All the bids for one field were too expensive and thus rejected, and there were no bids for the other field. There is increasing skepticism that while the Mexican government may want to open up the industry, Pemex is quite content to continue to run its own show.

Regardless, until there is a significant change in Mexican energy-production policy, it seems foolish to rely on the country for an increase in imports.

Assumption No. 3: Nothing bad will ever happen
The Deepwater Horizon disaster was an extreme oil spill, and many argue that the government response to the spill was extreme as well -- a yearlong moratorium that continues to affect production numbers today.

It is even more extreme to assume that something that terrible won't happen again. And if it does, we have no way of knowing what the American, Canadian, or Mexican government reaction will be at the time. Certainly, there is a good chance this hypothetical spill will affect the very oil production that we will be relying on for our "energy independence."

And where in the world would we turn to make up the difference?

The global marketplace
Even if we were to accept these three assumptions, there is still no getting around the fact that oil trades on the global market and is affected by everything from production in other countries to speculation on Wall Street to economic news to geopolitical events, and even the weather. No matter how much oil we pump out of North American soil, what happens in the Middle East and around the world will affect the price of oil in the United States.

And that price of oil is crucial to North American oil production. The methods we use to produce energy domestically are expensive, and despite technological advancements, production costs, at least in the Canadian oil sands, are rising.

Complete reliance on domestic production necessitates a sustained high oil price per barrel, and though that presents some pretty compelling opportunities for investors -- check out our free report on three outstanding examples -- it is ultimately something that is impossible to predict, much less guarantee, as Morgan Housel astutely pointed out last month.

Foolish takeaway
Pledging energy independence by 2020 is a goal based largely on increasing oil production, which is in itself built on too many assumptions to ensure a completely successful outcome right now. Increasing oil production increases our dependency on oil, as well as the likelihood that we will continue to turn to foreign sources in the future.

Fool contributor Aimee Duffy holds no position in any company mentioned. Check out his holdings and a short bio. If you have the energy, check out what she's keeping an eye on by following her on Twitter, where she goes by @TMFDuffy.

Motley Fool newsletter services have recommended buying shares of Kinder Morgan. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 28, 2012, at 11:13 PM, DrGoldin wrote:

    What a refreshing article! Not every day that you see someone break down political propaganda and subject it to cold dispassionate analysis.

  • Report this Comment On August 29, 2012, at 12:34 AM, predfern wrote:

    The 800 lb gorilla in the room is the green river formation out west. There are 3 trillion barrels of oil there of which the Rand study says about 1.5 trillion are recoverable. True it is a little harder to extract than the tar sands in Canada but DOE says that Shell's freeze method is a promising technology. It is just a question of will. We are also the Saudi Arabia of coal. Idaho National Laboratory recenty completed a feasibility study on converting natural gas and coal into gasoline. They find it is very feasible ($1.60 to $1.70 per gallon). Wyoming is now building synthetic fuel plants to convert their natural gas and coal into gasoline. A Wyoming newspaper article said that you could take $34 of natural gas and turn it into $140 of gasoline. This is a nice profit, even after expenses. Yes we could become energy independent very quickly.

  • Report this Comment On August 29, 2012, at 8:10 AM, SCDividends wrote:

    Our present government is blocking direct pipe lines to the US making it harder and more costly to transport Oil to the US from Canada. Canada is now getting ready to export their oil to Asia through pipelines to the west coast. KMI and Transcanada. are getting ready to add larger pipelines to the west coast. Asia gains are our loss.

  • Report this Comment On August 29, 2012, at 9:03 AM, jwill53 wrote:

    There is another aspect of the domestic oil argument that is not talked about very openly. The mere threat, and subsequent actions to realize, of producing more oil domestically will force the Middle Eastern/African/SA oil producers to drop their prices and increase production in order to protect and maintain their stream of oil profits. Unfortunately, this becomes a double-edged sword, as the foreign producers drop their prices, resulting in downward pressure on domestically produced oil prices in order to remain competitive.

    This is a very short synopsis of this part of the energy independence issue.

    With that said, I can only see more domestically (to include Canada) produced oil as being beneficial moving forward.

  • Report this Comment On August 29, 2012, at 11:19 AM, claude043 wrote:

    This focus on supply is fine although it lack essential numbers to make it convincing. Now, equally important is the story about the changing picture on the demand side, both in US demand and in global demand.

    Now we need a second article about changing demand in all categories of energy use. Then we might be able to see whether there is any prospect of an "independence" cross-over point out there in the future somewhere.

  • Report this Comment On August 29, 2012, at 12:19 PM, EGTalbot wrote:

    If we actually care about energy independence long-term, we'll focus on renewables. But the short term conversation is still one worth having.

    The idea of anything approaching energy independence by 2020 is absurdity, and while the above commenter is correct that it is a matter of will, that's like saying a 3 foot tall person playing in the NBA is just a matter of height. The current state of our nation - both parties of govt AND the inability of the population itself to overcome divisions - means that the necessary will is not and will not be there.

    We can reduce regulations and accept more environmental damage in the hopes that we'll achieve it, but we won't.

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