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 (PXD 1.18%) 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 (EPD 0.56%) 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.
