How The U.S. Energy Boom Is Transforming Geopolitics

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All through the years of the great recession, during the bombed out aftermath of 2008’s financial crisis that saw jobs, wages, and growth recover at a frustratingly slow pace, something unusual began to happen in states like North Dakota and Pennsylvania: oil and gas production began to grow and then accelerate – beginning from low, inconsequential levels. Improbably, the State of North Dakota now produces more oil than former OPEC state Indonesia. And Pennsylvania’s natural gas production has grown so quickly, volumes have risen over twelve-fold in just the past 48 months, that were the Keystone State a country, it would now rank as the 10th largest producer in the world.

But the momentous changes in America’s energy profile don’t end there. The great recession and the oil shock of 2008 triggered long-cycle changes in the way Americans actually use oil: walkable neighborhoods, electric vehicles, and train travel have all become popular as US drivers throttled back their gasoline consumption. The result is that for every three barrels of new, homemade oil coming out of plays in Texas, North Dakota, Colorado and Oklahoma, Americans have walked away from 2 barrels of their previous, sky-high oil demand. The result is a profound change in America’s energy balance sheet. And the spread—the difference between the energy America consumes and the energy it still has to import—has shrunk to a tiny version of its former self. These days there is a 10% difference in that spread; as recently as 2005 the difference was a steep 30%. The implications, for the US trade deficit, economy, interest rates, and the US Dollar are broad and already spreading. And the geo-political ripple effects of America’s shrinking energy spread, the recent volatility in oil prices notwithstanding, are starting to steamroll forward.

Since President Obama came to office, US energy production has increased by over 13 quadrillion BTU from 2009 through 2014—the largest five year advance in half a century. The President is no oil and gas man, to be sure. But the unabated drill, drill, drill frenzy in the US since 2009 punctures dearly held political beliefs on both the right and the left, about our President’s perspective on the use, retrieving, and future of fossil fuels.

In early 2012, President Obama made it clear that, in pursuit of solving, America’s energy difficulties he would continue to aggressively pursue every energy source possible: wind, solar, nuclear, efficiency programs and yes, oil and gas. “We can’t have an energy strategy for the last century that traps us in the past. We need an energy strategy for the future – an all-of-the-above strategy for the 21st century that develops every source of American-made energy,” said the President. Second, the President has repeatedly stated his goal, from his 2010 State of the Union Speech, to double America’s exports. That goal has nearly been met – US exports are up from $1.6 trillion in 2009 to $2.3 trillion in 2014—and energy exports have formed a nice little piece of that puzzle, at about 7.5% of the total. But there’s more. Because in a flurry of federal level approvals from the Department of Energy (DOE) and the Federal Energy Regulatory Commission (FERC) this Spring and Summer, the President’s administration is now set to deliver its fossil fuel coup-de-grace: a wave of new LNG (liquefied natural gas) export terminals to be built between now and 2020 that will export as much as 10% of US daily natural gas production. Eclipsing Russia in 2009 as the largest natural gas producer globally the US is now on the threshold of sending that gas out into the world: a new, LNG exporting giant. Intriguingly, both the President and the Administration have been quiet on this major policy shift, avoiding any self-congratulatory announcements or press briefings. Instead, louder reactions have come from Congress, where there are legitimate concerns a huge upswing in LNG exports could increase natural gas prices for Americans, here at home. This was exactly the experience in Australia, where a significant LNG export program is also underway. Indeed, various industries in the US that also thrive on exceedingly cheap natural gas, like the chemicals industry, have also voiced alarm to the administration about the torrid pace of 2014’s LNG export approvals.

The re-emergence of the US as a commodity producing and exporting power comes amidst a surprising and dramatic fall, in just the past few months, in the price of oil. Oil’s wild ride this Autumn serves to remind that those countries which would develop significant energy export capacity must be prepared to see their economies knocked around, from time to time, by price volatility. Few, if any, oil market observers predicted the 50% decline, which has left a heated conversation in its wake about the cause: supply or demand. Mark Lewis, former head of energy research with Deutsche Bank in London and now at Kepler Cheuvreux in Paris, remarks the decline “has been so steep and fast it’s barely given anyone time to properly analyze it. And it does make you wonder if (on the demand side) Asia and China are much weaker than anyone knows.”

“It does make you wonder if (on the demand side) Asia and China are much weaker than anyone knows.”

There is of course an immediate impulse to conclude that the US winds up a big winner as gasoline prices crumble towards two dollars a gallon. But disentangling the benefits from the losses of this price change is perhaps a little trickier now, not only for the US economy, but also for its allies and adversaries. Cambridge Energy Research Associates (IHS CERA), one of the oldest energy consultancies, for example, observed in a note released in early 2014, that the US oil and gas boom had built up such great momentum that its continuation presaged another $890 billion worth of investment over the next 12 years, boosting GDP by $94 billion, and supporting as many as 900,000 jobs between today and 2025. No surprise: the humming of industrial factories in the American Midwest the past 4-5 years has not just been due to the recovery in steel, driven by a recovery in the US automobile sector, but also the very capital intensive demand being driven by the great expansion of the US oil and gas industry.

Diego Espinosa, former Director of European Equity Research at Bernstein, and now an adjunct professor of Finance at UC San Diego and principle of Sistema Research, told Talking Points Memo in a conversation “it was and remains the gearing up phase” of this massive oil and gas expansion “that has been so incredibly capital intensive, and that has played such a large role in US capital expenditures the past few years.” Indeed, during that frustrating and subpar recovery that so many Americans grumbled about between 2010 and 2013—when many other sectors across the US economy were reluctant to invest in equipment, software, new capacity, and especially labor—it was the oil, gas industry that was hiring people and investing aggressively in new equipment.

The conventional wisdom however, typically expressed in the pages of The Economist or Foreign Policy magazine, tends to concentrate on the myriad US adversaries who will be hurt by this autumn’s oil crash. Russia and Venezuela have already been pummeled, with alarms going off in global markets about their currencies, their debt, and their capital reserves. But allies like Canada have also suffered losses, its commodity rich stock market having been hit with an initial 10% correction, along with its currency. For the United States, there will surely be job losses in the oil and gas industry, if prices stay down. The Energy Information Administration is already revising, downward, its forecast for US oil production next year, for example. Meanwhile, the Baker Hughes rig count, an industry tracker of US oil and gas drilling activity, has now fallen to a 14 month low, after its steepest monthly drop since 2009. This has raised fears in America’s oil and gas boomtowns, and the specter of the classic bust which so often follows the rush for black gold.

Make no mistake, however, it is still the case that falling gasoline prices disproportionally benefit the US economy, in a way that will drop straight to the bottom line, and boost GDP—again, if prices stay down. (Of course, if prices don’t stay down, the big boosts to GDP projected over the next calendar year will have to be pared back.) Even better, the bottom two quintiles of US income earners—who’ve been battered by higher energy prices for years—will also benefit disproportionally, as the share of their household expenditures is much more impacted by energy costs. President Obama offered one of the most lucid explanations of how the fall in the price of oil impacts a diversified economy like the US, and a more narrow, commodity-focused economy like Russia’s, when he remarked, in a December 29th interview with NPR’s Steve Inskeep, “The big advantage we have with Russia is we’ve got a dynamic, vital economy, and they don’t,” he said. “They rely on oil. We rely on oil and iPads and movies and you name it.” To the President’s point, although the US is undoubtedly undergoing an energy transformation, the country is at little risk of falling prey to a resource curse, in which the economy’s entire fortune rests on a single commodity for export.

While it’s true that a technological advance has made a new round of oil and gas production possible, America’s exceptionally good fortune appears to have almost fallen into the country’s lap. It does seem a bit randomly won: the US has barely had a discernable energy policy for decades (at least not since the Carter Administration), letting the free market, some light regulation, and, perhaps, just luck—both good and bad—guide its path forward. But despite some recent efforts, it’s not clear the shale revolution can be reproduced very easily, in other domains. In From Paris, Kepler Cheuvreux’s Mark Lewis notes a kind of “shale envy” has permeated Europe and that “an early effort to find recoverable shale oil in Poland was abandoned by several oil supermajors. And in the UK, where contingents in the government have been very gung-ho about exploiting shale resources, efforts have been abandoned but for a different reason: local opposition.” Lewis points out that one of the structural differences between the US and many parts of the world, not just Europe, is the relatively low population density in many parts of the United States. Although the State of New York recently banned fracking, it’s easy to see how the hurdles for oil extraction are just so much lower in rural Pennsylvania, or in the plains of North Dakota. Even in the 21st century, America is still benefiting from its own frontier.

Securing America’s Future Energy (SAFE) in Washington DC, a policy organization which keeps a close eye on many of these energy trends, publishes an Oil Security Index that quantifies and tracks the ups and downs of energy security across many nations, including the United States. The country currently sitting at the top of SAFE’s most secure ranking is Japan. That may sound surprising: Japan has few if any domestic fossil fuel resources, she is dependent on the import of coal and natural gas to fund its powergrid (especially in the wake of Fukushima) and of course, the country also has to import oil. And yet, Japan has so ruthlessly pounded away at energy efficiency for such a long period of time that its very low oil-intensity earns top marks. Where does the US compare? The US has been rising of late in SAFE’s index. The increase in US production is, of course, playing a big role. But it’s the decline in US consumption of oil that’s helped out the US the most. Data on vehicle miles traveled (VMT), maintained by the Department of Transportation, topped out in the US around 2008, and has since then flatlined.

Accordingly, the US now occupies the 5th best position in SAFE’s security index. Domestic supply is rising, imports of oil are falling, and the US is becoming more efficient, with its oil intensity measure improving nicely. The one, sticky, problematic vulnerability the US still faces however is oil use in transportation. Essentially, its enormous fleet of 250 million cars and trucks. dependent on oil. Sam Ori, Executive Vice President at SAFE, points out that although the difference between American oil consumption and production continues to shrink, the U.S. transportation system remains deeply undiversified, with a kind of bedrock dependency on oil. “The real issue for the United States—and other countries as well—is our dependence on oil to power mobility. Even as we are importing less oil, our dependence has not changed appreciably. Today, we rely on petroleum fuels to power 92 percent of mobility. It was 95 percent in the 1970s, and it will still be 90 percent in 2030 according to the Department of Energy. The lack of fuel diversity in transportation evidenced by those figures is what has historically made our economy vulnerable to wild oil price swings, and it is what continues to make us vulnerable today.”

Regardless of whether oil prices stay down at current lower levels, or go back up again, America’s global energy presence is clearly in expansion, as the volumes of new oil and gas start to find their way out into the world. That’s been true of US coal exports for a long time. In fact, during China’s coal supercycle American exports of coal tripled from the years 2000-2008. But now the US is using its industrial capacity to refine oil into products and has once again pulled off another tripling of diesel, gasoline, and bunker fuel exports. Just ten years ago the US was exporting 4 quadrillion BTU of energy annually. Now its up to 12 quadrillion BTU. But US exports of LNG could supercharge this trend, and could add at least another 3 or as much as 5 more quadrillion BTU of annual energy exports. Politically speaking, the coming wave of LNG exports, in which LNG export infrastructure is being approved and under construction in Texas, Louisiana, and Maryland, is entirely a result of approvals at the federal level and thus confounds any typical liberal or conservative expectations of the President. Cheuvreux’s Lewis agrees that while Obama has placated his constituency on the Keystone pipeline (so far), much of the new volumes of oil and gas “are really the result of the unique state control over natural resources in the US” that the coming wave of LNG is pretty much entirely due to administration discretion.

This commodity export supertrend is also unfolding at a time when the US Dollar is hitting 11 year highs. Currency devaluation in Japan, a European central bank fighting deflation, and weakness in emerging markets admittedly are already dollar supportive. But it is fairly predictable that when countries increase exports the currency’s tendency is to strengthen. The resurrection of the US Dollar as rising currency could affect another key rate that drives the global economy: the yield on US Treasury Bonds. Already low, the world’s bond and credit markets take their signal from US rates. A United States consuming less energy, producing more energy, at a time of weakness in the global economy drives the dollar higher. The promise of increased energy exports threaten to drive the dollar higher still. And that in turn tightens monetary conditions at home, thus pushing the prospect of Federal Reserve (the FED) rate hikes back even further. Sistema’s Espinosa believes the FED, which has been trying, or suggesting, it would normalize interest rates for some time now, “is about to have to contend with a strong dollar problem that many market participants, including the FED, may not have foreseen.”

One of the paradoxes of energy is that nations are not necessarily made secure simply because they posses domestic resources. Energy security is determined more completely by a portfolio of both assets and capabilities brought to bear on a country’s energy challenges. Moreover, the history of achieving security exclusively through fossil fuel production, or exports, is a troubled one. That’s why Europe, and now the US and in particular China, are aggressively pursuing renewables. Solar and Wind power carry none of the exploration risk of oil, or the geo-political risk of trade. According to Bloomberg New Energy Finance, (BNEF) global investment rebounded strongly in renewables in 2014, rising 16% to $310 billion. Both China and Japan have taken leadership roles as well, in building out enormous, annual solar capacity–and each will likely have built more than 10 GW (gigawatts) of capacity just last year. But most astonishing of all is the share of new energy growth now taken up by renewables. For example, in 2013 alone, combined wind and solar power provided 12.5% of new additions to global energy use from all sources.

A diverse portfolio, therefore, of both fossil fuel capacity, increased efficiency, and the uptake of renewables is the likeliest path to energy security–and better economic strength. Will the US energy spread, now at 10%, head to zero? It may. It’s been America’s declining demand response to years of high oil prices that has helped to drive oil imports lower, which the Energy Information Administration (EIA) notes has been enormously beneficial to the US balance of trade, restraining the trade deficit from reaching even higher levels. Conversely, Russia discovered the unfortunate effects of having so little flexibility in its economy that the oil crash, which arrived immediately after it was hit with political sanctions, hit especially hard. “The sanctions regime (against Russia) shows the incredible dominance the US has over capital flows, and the reserve regime we have today is one that is dominated by the US”, says Sistema’s Espinosa. Concurrently, this may be why Russia has been so eager to beat the West in the race to supply China with natural gas, and there is talk of a second major natural gas pipeline deal to pump Siberian gas into China’s western provinces. Espinosa also observes that both China and Russia remain “trapped in the Dollar bloc, and both may try to find a way out, to create some new system for themselves.”

One country that could potentially wind up as lucky windfall recipient is China. With the US, Russia, and also Australia looking to globalize the world’s LNG market, China could play these supplies off each other, and win for itself very attractive pricing. James Blatchford, SAFE’s Director of Policy, observed that “China has sought tremendous diversity in the sources of its oil imports, and we would expect them to approach its LNG imports similarly to the extent possible.”

“They rely on oil. We rely on oil and iPads and movies and you name it.”

That said, there is currently a great deal of doubt about whether or not China can possibly uptake all the new volumes of LNG coming to market in the next five years. Leonardo Maugeri, of Harvard’s Geopolitics of Energy Project, is the latest to question the economics of various LNG projects, but acknowledges in his recent report, “Falling Short: A Reality Check for Global LNG Exports,” that “ample room for LNG imports (in China) still exists but not so huge as to justify the current rush of LNG projects.” Even so, doubters would be wise to consider the massive call on global coal that came from China between 1995 and 2005. Coal, deeply embedded into the Chinese energy mix, has made conditions literally unlivable in many large cities, not least in the nation’s capital, where the average air pollution in 2014 was 8 times that recommended by the World Health Organization, according to the South China Morning Post. Beijing’s leadership understands it needs an ever quicker, more robust way to start replacing coal and the answer is obvious: natural gas. “There is massive political will in China to do something about the air pollution,” says Mark Lewis, “and in China, political will actually has an impact.” Indeed, China, it should be noted, is currently the 9th largest global producer of natural gas, but has enormous room in its energy mix as gas currently composes only 5% of its total energy consumption. China could easily lead the world into a new age of natural gas.

So, while America’s fossil fuels renaissance certainly increases its raw power, the effects of the US energy surge are set to distribute themselves quite broadly. In the phenomenon known as encirclement, America’s impressive array of advantages–a strong currency, cheap domestic electricity and natural gas, rising income from energy exports–may trigger a global response from other nations who will look to avoid becoming overly dependent on increasing US dominance over capital flows, and soon, energy flows. It also seems inevitable that the coming wave of LNG exports will, in the decade ahead, become a major legacy of the Obama Administration. Eventually this this will likely force a change in hard beliefs about his presidency, especially as those exports enrich the US economy, and as they help re-shape the way energy is used in the world. Those who still worry about the effects of an increase in US LNG exports may want to weight such outcomes against a bigger prize: the possibility that a big increase in Asia’s natural gas consumption could finally break the continent’s dangerous decade-long love affair with coal. With that in mind, the President could stand to be less shy about his looming LNG export triumph.

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