On Tuesday, March 17, Dan Eberhart delivered a keynote address to the Economic Club of Pittsburgh’s weekly luncheon where he spoke to the outlook of the energy market and its impact on the local economy and community. Eberhart is the CEO of Canary, LLC, the largest independently owned oilfield service company in North America, and an expert consultant in energy and business issues. The keynote was entitled “Oil Dominoes; How the Marcellus can help beat OPEC at its own game,” where he focused on the shift in global power that occurs with the shift in oil prices and the role that the Marcellus shale, located throughout Pennsylvania, has played in that shift.
I heard an interesting story about your governor recently. You probably know what I’m talking about: that last month, Tom Wolf suggested that many of the state’s woes – including a budget shortfall, struggling schools, and aging infrastructure — resulted from Pennsylvania having what he called generally low self-esteem
Republicans were pretty quick to jump on the Democrat’s remarks, criticizing him for what they thought was an insult to their hard-working constituents
At the same time, Wolf’s supporters raced to his defense, saying he was merely calling out Pennsylvania’s elected leaders.
Within days, Wolf had backtracked.
It’s not low self-esteem that’s Pennsylvania’s problem, he explained. Instead, it’s more like an excess of modesty.
Now, I’m not here to become part of a political debate. Especially in a place other than where I live.
Pennsylvania’s place in the energy sector
It’s just that, from my point of view, some pretty remarkable things have happened in the energy sector here in the Commonwealth.
My company, Canary, provides drilling and production services for oil and gas companies across the United States. As Canary CEO, I’ve seen — and been fortunate to participate in — some very meaningful industry achievements over the past several years. That includes, of course, the astonishing growth in American oil and gas production from our nation’s shale fields.
And on the natural gas side, there’s no bigger story than the development of the Marcellus Shale, which, I’m sure you know, underlies most of Pennsylvania and parts of Ohio, New York, and West Virginia.
According to geologists at Penn State, the Marcellus could hold up to 500 trillion cubic feet of natural gas. That would make the Marcellus the second largest natural gas field in the world.
Not the second largest just shale gas field. Second overall.
In the simplest of terms, the Marcellus is an energy powerhouse. The natural gas produced here is transforming the domestic market and has global implications, as well.
Doing the Marcellus math
Over the seven years that hydraulic fracturing – aka fracking — has been used to coax energy from the Marcellus’ tight rock, production in the region has grown 13-fold. Today, the Marcellus Shale accounts for about 37 percent of US shale gas production. But do the math, and you’ll see that’s still just a drop in the bucket compared to technically recoverable reserves.
The Marcellus is also an important economic engine for western Pennsylvania. The markers of its success are seen in everything from job growth to increased tax revenues.
According to investment advisors Raymond James, 90 percent of Pennsylvania’s job gains between 2005 and 2012 came from oil and gas. A 2013 report by the Manhattan Institute found that Pennsylvanian counties with more than 200 wells drilled saw per-capita incomes rise 19 percent.
What’s more, Marcellus production is altering the traditional dynamics in the natural gas industry.
For one thing, for years, natural gas used in the Northeast has had to travel from the US Gulf Coast or western Canada. But now, with the Marcellus literally right next door, a major is shift is underway. The role of Gulf gas and foreign imports is considerably diminished.
There’s no point in being modest about those facts and figures, is there?
But let’s look back even further at Pennsylvania’s place in the oil and gas industry.
Rockefeller creates, Marcellus transforms
Well over a century before the Marcellus helped transform the modern energy sector, wildcatter John D. Rockefeller launched it. And that took place very near those same western Pennsylvania Marcellus shale fields that are so active right now.
A towering figure in the history of American commerce, Rockefeller was a man who was seldom accused of either low self-esteem or modesty. He once boasted that God had directly giving him the riches he enjoyed.
Of course, not only did Rockefeller’s Standard Oil Company revolutionize the industry, it monopolized it. Eventually, the monolith was broken up, but out of the break up emerged the Seven Sisters — seven oil companies that, by the 1960s, controlled most of the world’s oil reserves.
OPEC to America fracking: Drop dead
Today, the world’s oil reserves are controlled by another monopoly, one that’s not subject to any manner of anti-trust legislation.
I’m speaking, of course, about the cartel known as OPEC, the Organization of Petroleum Exporting Countries.
While the Marcellus has become the American epicenter for natural gas production, the amount of oil produced there has also grown considerably over the last decade, tripling since 2005. When you add those barrels to the record-setting output from tight oil formations like the Eagle Ford in Texas and Bakken in North Dakota, it’s easy to see how the US has passed both Russia and Saudi Arabia as the world’s largest oil producer.
This, as you might imagine, has not set well with Saudi Arabia, which is OPEC’s de facto leader. The Saudis lead the world in terms of total exports of petroleum liquids. Saudi Arabia has 16 percent of the world’s proved oil reserves. It maintains the world’s largest crude oil production capacity. And, you might be interested to know, Ali al-Naimi, Saudi Arabia’s oil minister, has Pennsylvania ties. He attended Lehigh University, in fact. And he once headed Saudi Aramco, the national oil company that’s a descendent of Rockefeller’s Standard Oil.
Unfortunately, al-Naimi’s connections here don’t mean he’s a friend of Pennsylvania – or the US, for that matter.
Last November, when the world was struggling with an oversupply of oil amid weakening demand, al-Naimi is the person who strong-armed the other OPEC member nations at their Vienna meeting into accepting lower oil prices per barrel, rather than cutting production. Threatened by the flood of American oil eroding their market share, this was a swift and decisive scheme to accomplish two things: first, rout marginal US shale producers who require higher oil prices if their projects are to remain viable, and second, reduce production from others.
By keeping their output targets in place, OPEC sent global oil prices into a freefall.
The cartel wouldn’t cut production even if oil falls to $20 a barrel, al-Naimi said later. The kingdom may even bolster output if non-OPEC nations do so, he added.
Now, that’s the sign of healthy self-esteem, right there.
Shale strains felt in Pennsylvania
Since June of last year, the price of a barrel of West Texas Intermediate crude oil has lost about half its value. Obviously, when the price of oil dips below a certain point, it makes it unprofitable to drill, and harder to get money for operations. Although North America’s shale oil production costs vary considerably from basin to basin, for some operators low prices have led to idled rigs, lost jobs, and shrinking capital budgets.
The US rig count has been on a multi-month dive, reaching a low not seen since 2010. In December and January alone, about 300 US rigs went offline. Some analysts think that as many as 550 drilling rigs will be sitting on the sidelines for the near future. In recent months, more than $150 billion worth of new energy projects have been scuttled or put on hold.
While natural gas is somewhat insulated from changes in oil pricing, the effect of OPEC’s move has been felt by producers of Pennsylvania Grade crude oil, which is also known as PennGrade. PennGrade is the paraffin-rich petroleum produced here and in Ohio. West Virginia, and New York, and its price has plummeted, too. During February, PennGrade was running in the $47 to $52 range. That’s the lowest PennGrade’s been in almost five years, and a far cry from the $100 per barrel mark reached three times last year.
But it’s not just PennGrade producers who are feeling the pinch. As low crude prices have made some of Pennsylvania’s shallow oil wells uneconomic, the number of applications for new drilling permits has also shrunk. That’s a problems for refineries that process PennGrade crude and need a certain level of raw material to maintain capacity.
OPEC’s history of market manipulation
Of course, this isn’t the first instance of OPEC playing dice with the universe. The cartel has used its energy to manipulate the market multiple times.
In 1986, for example, Saudi Arabia manufactured an American oil bust by flooding the market just as US production was increasing. In less than four months, oil prices plunged 67 percent, to just above $10 a barrel. It took nearly 25 years for American production to rebound.
A decade earlier, in 1973, OPEC used oil to draw the world into Middle East conflict. The Arab Oil Embargo gave rise to long lines of cars circling futilely around gas stations whose tanks were empty. At least this time, there’s been no pain at the pump. Drivers in the US are enjoying the lowest fuel prices in years, although with Pennsylvania’s high gasoline taxes, you might not be getting the same break that other Americans are.
This time, OPEC’s gamble – aimed at quelling the rush of oil from fracking while preserving its own market share – seems to be paying off. In addition to the loss of rigs and other reductions at US producers, demand for OPEC crude is already on the rise. This shows the developing battle royale between OPEC & U.S. producers heating up.
Pains felt ‘round the world
But the US is hardly the only country affected by Saudi Arabia’s contrivances. Even some of its OPEC brethren are experiencing lower oil price pains, especially those whose state budgets rely heavily on oil revenues.
Estimates by EIA suggest that the price decline will cost all 12 OPEC members a total of $257 billion in lost revenue this year. Member countries most exposed to lower oil prices will be hurt the most. That would include Iran, which needs a break-even price of $143 per barrel to balance its budget, and cash-strapped Venezuela, which teeters on the brink of default.
Even before the OPEC decision, Iran was reeling from sanctions over its nuclear program. Not only did export revenue decline 30 percent, but the nation’s oil and gas fields were virtually closed to investment. As a result, Iran’s access to technology that could boost output and offset its high break-even price was severely limited.
Venezuela is an interesting case, of course. The nation is one of the world’s largest oil exporters, but even before the price of oil started to slide, it was in dire financial straits. Inflation is a staggering 60 percent and the economy is rapidly headed for recession. Because of fuel subsidies, Venezuela enjoys some of the world’s cheapest gas. Cutting subsidies would help the economy, but the government refuses to do so. Analysts today say that Venezuela has a 93 percent chance of defaulting on its debt over the next five years.
In an editorial co-authored by Tom Rdige & I, outside of OPEC, Russia is coming up a big loser. Revenue related to the sale of oil and natural gas accounts for about half the country’s budget, and Moscow loses about $2 billion in revenues for every dollar decline in the price of oil. As expected, Russia has cut its growth forecast for 2015. The World Bank is even less optimistic, projecting that the Russian economy will shrink by at least 0.7 percent this year if oil prices remain where they are.
Ironically, even though recession is likely, Russia refuses to cut production; worried that would decrease its market share and invite competition.
Looking toward Africa, lower oil prices are especially hurting the resource-rich nation of Nigeria, the continent’s biggest oil producer. Although Nigeria is experiencing growth in other areas of the economy, energy sales account for up to 80 percent of all government revenue. You can imagine what a 50 percent reduction in oil prices means for the country’s coffers.
And then there’s Syria and Iraq. On top of low oil prices, ISIS, or Islamic State, is pirating oil wells and making about $3 million a day by undercutting prices on the black market.
Who’s winning with lower oil prices
There are some winners emerging from the low price scenario, however.
Take China, for example, which has overtaken the US as the largest consumer of energy and is set to become the world’s largest net importer of oil. Lower prices mean a boost to its slowing economy. And they help the nation have more leverage over key supplier Russia, which desperately needs to keep its customers happy and preserve all the energy income it can. As long as crude prices stay low, China has an upper hand in its negotiations for Russian oil.
Or consider India, which imports 75 percent of its oil. Falling prices are helping to ease a current account deficit. If prices stay low, the cost of India’s fuel subsidies could decrease by $2.5 billion this year alone.
Energy alters geopolitic
Of course, it’s not just economics that ebb and flow with the tide of oil and gas.
Geopolitical goals and alliances also come into play. In fact, energy has been called the world’s most important geopolitical commodity.
For example, if not for surging US oil production, America and our allies would never have been able to impose those tough sanctions on Iran. Because we no longer needed their oil exports, we could play hardball on the nuclear turf without worrying about them cutting off our energy supplies.
Marcellus shale gas is also expected to have a hand in helping America’s allies wrest themselves from unfriendly energy vendors.
Last fall, the government approved plans to ship liquefied natural gas from the Marcellus to Japan and India through the Cove Point plant in the Chesapeake Bay. This will give the Japanese market a new source of natural gas not linked to the global price of oil, but rather to the more stable domestic market in the US. And it will help India diversify away from coal while assuring a steady energy supply. Other countries like Ukraine, which have to rely on natural gas from volatile Russia, may be next in line for Marcellus production. So not only is the Marcellus a good news story for the US, it’s helping balance power throughout the world.
For Marcellus, a bright future
Is there any sign that Marcellus will peak soon?
If the folks at the research firm Morningstar are right, the answer is Not at all.
They predict that Marcellus will be the biggest driver of US gas production over the next few years, satisfying an increasingly vigorous market. Natural gas is becoming more and more important in the global energy mix, forecast to grow from 21 percent to 25 percent by 2035. That makes it the only fossil fuel whose share is expected to increase.
Bringing this discussion to the doorstep, the analysts at IHS Global Insight say that increased development of the Marcellus is expected to contribute $42.4 billion annually to Pennsylvania’s economy by 2035—up from just $7.1 billion in 2010. They also believe that sustained low oil prices may increase interest in the Marcellus and result in more rigs and services coming to the area.
Admittedly, natural gas prices are low in the Marcellus, especially in the northern regions. But so are production costs. Even in the short time since fracking cracked the Marcellus, gas operators have used technology to lower costs at the wellhead, improving efficiency. Today, natural gas production in the Marcellus is among the lowest-cost in the US, with breakeven levels in certain liquids-rich areas below $1 per thousand cubic feet.
Low prices have also prompted some operators to shift their drilling to the wet gas part of the Marcellus. That allows them to produce natural gas liquids like ethane, butane, and propane, which are some of the prized building blocks used in the petrochemical industry.
And, as I mentioned earlier, there’s a staggering amount of natural gas yet to be extracted from the Marcellus to keep up with that demand. In fact, at current production rates, the resource potential is between 30 and 75 years. That’s a long horizon for pumping out energy, promoting job growth, adding to the Commonwealth’s budget, and outlasting OPEC’s antics.
If I can return to your new governor, when Mr. Wolf was asked how he felt about New York state’s decision to ban fracking, he said he wanted to have his cake and eat it, too. Clearly, the Marcellus fulfills that desire, with icing on top. And it gives Pennsylvanians something to be proud of well into the future.
