America’s Day of Reckoning Is Sooner Than You Think

Photo credit: Flickr/Paul Lowry 

Each new oil well drilled in America takes us one step closer to a day few expected we'd ever see. This day, however, isn't our energy independence day. That's a bit further off into the future if we ever do get to see that day. No, the day I'm talking about is our day of reckoning. That's the day where surging light crude oil production has so flooded American markets that it sinks the domestic price of oil to the point where producers have no choice but to stop drilling.

What's the problem?
Up until just a few years ago domestically produced oil, which is benchmark priced to West Texas Intermediate or WTI, had traded on par with the globally benchmarked Brent crude price. But that relationship broke in January 2011 and as the following slide from a recent investor presentation by Pioneer Natural Resources (NYSE: PXD  ) points out, the discount has been fairly steep at times.

Source: Pioneer Natural Resources Investor Presentation (link opens a PDF

While the discount has been moderating someone of late, it's likely to reverse course very soon. Surging light crude oil production from emerging shale plays in the Permian Basin in Texas and the Niobrara in Colorado are joining the growing production from the Eagle Ford Shale of Texas and North Dakota's Bakken Shale. As this next slide notes, production has gone from less than 6 million barrels per day in 2011 to about 8 million barrels per day this year with even more growth on the way.

Source: Pioneer Natural Resources Investor Presentation

This growth, which is centered around light crude oil, has the potential to overwhelm American refineries. We could soon be faced with a reality where America is saturated with oil that our refineries aren't equipped to refine. It's a shift no one saw coming as the bulk of the refinery investments over the years have been focused on increasing the capacity to refine heavier Canadian crude oil in anticipation of increased output from the oil sands.

What happens when that happens
When the price of American crude oil trades at a sustained discount to the global benchmark, oil producers won't be able to earn an economic return from drilling. This will force producers to idle rigs, which puts millions of jobs at risk. The industry currently supports 9.8 million jobs and is on pace to fuel the creation of another 1.7 million new jobs in the years ahead. That won't happen if the industry's growth is halted.

Further, as drilling activity winds down so will the tax revenue it produces. Currently, the industry puts $85 million per day into Uncle Sam's coffers. Some of those funds will instead go back overseas as we'll have no choice but to increase foreign oil imports. That will have an impact on the U.S. trade deficit, which has been closing in recent years but will widen again as America will be forced to import more foreign oil.

We need to do something other than open up the floodgates of exports
Needless to say, if America doesn't do something soon it will cut off what's fueling our economic recovery. But simply ending our four decade ban on crude oil exports isn't the best solution. Instead, a much more measured approach needs to be taken.

Recently, the Obama administration took a measured step to ease the onslaught of production by allowing an ultralight oil called condensate to be exported after it has been minimally refined. So far, Pioneer Natural Resources and Enterprise Products Partners (NYSE: EPD  ) are the only two companies approved to export condensates. The key here, however, is that this fuel needs to be processed, which is turning it from a raw crude oil into a refined petroleum product, which are OK to export.

Photo credit: Flickr/Woody Hibbard 

Still, that doesn't help to stop the oncoming flood of light crude oil. While the refining industry is investing to increase its capacity to handle light crude, production will soon outpace that expanded capacity. But instead of opting for the easy solution of ending the export ban, a more holistic approach should be taken to find a solution that's good for everyone. We need to make sure that all Americans benefit from our vast oil riches, not just oil producers and investors. Further, the fact that shale wells decline very rapidly means that this boom has a limited shelf life so we need to make sure we don't run out of oil and face an even deeper dependence on foreign oil on the other side of the boom.

Final thoughts
The time before America becomes flooded with cheap crude oil is slowly running out. Doing nothing means America's energy boom likely ends in a bust. Meanwhile, opening up the floodgate of exports means other nations benefit our cheap oil and their citizens will get to enjoy lower gas prices while oil producers reap the windfall of profits. Bottom line here is that we need to find a middle ground and we need to find it fast. 

OPEC is absolutely terrified of this game-changer
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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 July 20, 2014, at 9:53 AM, ahabthearab wrote:

    Oh please why don't you feed me anther bulshit story so the oil companies can screw me more at the pump. How about telling the public it takes more to refine diesel fuel thats why it cost more.

  • Report this Comment On July 20, 2014, at 10:29 AM, bigoilbob wrote:

    This is a dogs breakfast of mumbo jumbo comments. As a liberal petroleum engineer, I believe that this cries out for a free market solution, without any rent seeking give aways from relaxed enforcement of world class environmental, safety, and health compliance. Refinery investments, drilling activity, this will all sort out. And (again, as a liberal) lose the export ban. Every barrel burned will replace a dirtier one.

    Finally, mandate oil pipelines from local off loading facilities to the existing KXL pipelines in North Dakota. No more oil trains. And stop ANY post completion, non emergent (and accelerating cash flows is NOT an emergency) flaring. Building THOSE pipelines would create MORE jobs than the earth poisoning KXL Canada line.

  • Report this Comment On July 20, 2014, at 10:47 AM, dadx wrote:

    uh-huh, i've been hearing this same bs since the early 70's. nothing has changed except for the price of a by-product that costs nothing to make

  • Report this Comment On July 20, 2014, at 10:53 AM, True411 wrote:

    This article is complete nonsense.

    Oil producers can make a profit off shale oil at $80 to $85 per barrel. There's absolutely zero risk that they won't make a profit unless the world's supply drops below that point. That isn't going to happen.

    Since the US still imports more oil than we produce, there's also zero risk that our refineries will see a glut of domestic oil any time soon - we will simply cut back on imports to process cheaper domestic oil.

    Finally, there is enough oil in shale and tar sands to last more than 100 years at current rates of production.

  • Report this Comment On July 20, 2014, at 11:10 AM, dallas75216 wrote:

    I long ago gave up on the integrity of big oil. They have a monopoly no one can take on. Price fixing is de rigueur among them.

    I don't know what games they play with commodities prices but it is succeeding.

    Cheap oil from abroad ?? really at 100 a barrel? Gasoline prices approaching $4 per gallon?

    How much does it cost to pump oil from established Texas wells? Electricity and an occasional pump replacement and maybe some roustabouts mowing grass.

    As for natural gas, Scotland is spending 500 million to process USA natural gas. Texas A&M built a pilot plant to convert natural gas to Gasoline at the cost of 50 per barrel for natural gasoline. gee 50 cents a gallon , that will go nowhere.

    I expect electricity for electric cars will go to gasoline equivalent cost at charging stations or with utility companies putting meters on electric cars and charging gasoline equivalent prices.

    It already has happened at Walgreen's charging stations.

    Never give a sucker an even break.

  • Report this Comment On July 20, 2014, at 11:28 AM, wildpig wrote:

    typical motley fool nonsense.

  • Report this Comment On July 20, 2014, at 11:51 AM, OneHundredxFifty wrote:

    "we'll have no choice but to increase foreign oil imports."

    This statement is patently false. We have a whole host of alternatives.

    - Add light crude refining capacity here at home. Given the generous tax breaks that oil companies receive this is a very reasonable requirement and there are a whole host of carrots and sticks that could be offered to assure they do it.

    - Beef up the CAFE voluntary standards so that they are real standards to reduce domestic consumption. These worked well in the 70's and 80's. Combined with Alaskan pipeline oil, this led to the Reagan era of low oil prices.

    - EV and pluggable hybrid growth may occur quickly enough so that as production falls off, so does demand and foreign imports continue to fall.

    If the reduced use scenario is followed we would add jobs for engineers and labor to make a new breed of auto. In the likely event that the world followed us we would further improve the balance of trade exporting the best of a new breed of vehicles.

    It is clear that Tesla aims to become the world cost and volume leader in Lithium Ion battery production - http://www.teslamotors.com/sites/default/files/blog_attachme... And while they only fess up to planning one Giga factory by 2020, they are actually doing the permitting groundwork for 5. Recently Musk was quoted as saying "We're probably going to do two or maybe three states all the way to creating a foundation and completing the plans and getting approvals and everything," This of course suggests positioning themselves to build multiple similar factories.

    The point of the Giga factory is to drive down EV costs by reducing the cost of the batteries by increasing volume. http://handlemanpost.wordpress.com/2014/06/28/battery-prices...

    So I think we will have many choices other than increasing imports of foreign oil. Perhaps the middle ground that you refer to is to facilitate the transition to EVs and make sure to create the incentives needed to assure that the US becomes the world leader in both EV use, EV manufacturing and EV battery production.

    The path to doing that could be training and relocation incentives for oil field workers to move into the EV and renewable energy sectors. If we start that now, we can gracefully transition to the new Lithium Ion economy.

  • Report this Comment On July 20, 2014, at 2:00 PM, rednekkin wrote:

    Oh no, please, please whatever you do, Brer Fox, please don't throw me into that briar patch. It's just full of the highest quality/easiest to refine source of energy there is. It's been the fundamental input in all products, services and capabilities in the western world and the primary building block of our civilization for the past 150 years. Please, please, don't give me any more of that! If I have too much of the most valuable commodity on earth , there is just no way that I will figure out how to make a dollar off it. I will just be flummuxed if I am not able to be held hostage by the oil exporting despots of the world. Let's enlist our enlightened government to accelerate its efforts to constrain the production and distribution of the energy source that fueled human industrial and technology growth for the past 150 years. Government is so much smarter and better intentioned than we capitalists and has a much better idea about how to wean us off our terrible oil habit. What we should do is build more solar farms that cost twice as much to produce a unit of energy so America can be taken back to the era of outhouses, horseflies, whale oil lamps and cholera. Yeah, that's it, we need to reduce human population growth to be in touch with Mother Gaia. "This growth, which is centered around light crude oil, has the potential to overwhelm American refineries." Please, please don't make our refiners take any more of the best quality/lowest cost oil that they think they want. After having increased their plant complexity ratings, Tesoro, Valero, HollyFrontier and Marathon Petroleum will never, ever figure out how to refine easier-to-refine oil. What do you want them to do, install hydrocrackers? What do you want smaller companies to do, install toppers and splitters? All the oil inventions and innovations that will ever be made have already been made and, if they are too successful, E&P and refiners will just shut down and fire everybody. Quick, to save jobs, call President Obama and get him to stop us from producing too much light oil and shipping it around America to -- and this is truly a destructive capitalist concept -- where demand for it is highest. No way the industry can figure out what to do with cheaper oil or, like, move it from Bakken to Cushing. They're just fresh out of ideas. "We need to do something other than open up the floodgates of exports" OMG, what if America starts supplying Europe and Asia with gas and oil? They might not be hostage to despots in the Gulf and Russia. That great humanitarian Vladimir Putin might stop liking us. "Meanwhile, opening up the floodgate of exports means other nations benefit our cheap oil and their citizens will get to enjoy lower gas prices while oil producers reap the windfall of profits." Yes, lets figure out how to punish and de-profit those who have deployed billions in risk capital and produced economy-changing innovations that will return America to its former place as the world's leading economic power and benefactor. They're bad: they're rich. God forbid that we should solve our balance of payments problem by exporting gas and oil to our allies where we can get twice the price. Let's keep their economies stultified by high energy prices. Where's a world regulator when you need one?

  • Report this Comment On July 20, 2014, at 2:30 PM, Jheebo wrote:

    "Further, as drilling activity winds down so will the tax revenue it produces. Currently, the industry puts $85 million per day into Uncle Sam's coffers. Some of those funds will instead go back overseas as we'll have no choice but to increase foreign oil imports."

    Someone please explain this to me. How is tax revenue going to go overseas? And, more importantly, how is a glutted market going to mean we have to import more oil?

  • Report this Comment On July 20, 2014, at 11:26 PM, Freddyfreebe1 wrote:

    Take the lying out this country and the rich may not be so rich and normal people could afford to live in this over priced scam of a country.

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