In an exclusive interview with Oilprice.com publisher James Stafford, energy security expert Michael Levi, the David M. Rubenstein Senior Fellow for Energy and the Environment and Director of the Program on Energy Security and Climate Change at the Council on Foreign Relations (CFR), discusses:
- Why oil price stability is still all about the Middle East
- Why the oil and gas industry is heading towards transformation
- Why oil prices could drop substantially
- Why the US shale boom is real
- Why the shale oil boom won’t lead to major US foreign policy changes
- Why Keystone XL is pretty much non-essential
- Why we won’t see any radical change in renewables in the next five years
- The best way to achieve meaningful results on climate change
What follows are excerpts from a longer interview:
James Stafford: The UK-based think tank Chatham House has published a new report seeking to demonstrate how the oil and gas industry is under significant pressure that will lead to a transformation. How do you see a potential transformation of the industry taking shape?
Michael Levi: I think it is important to start with a distinction, particularly one that is important in the US: the oil and gas sectors, to some extent, are becoming two genuinely separate sectors, rather than one integrated one.
In the past, most natural gas was produced as associated gas together with oil, and that made oil and gas as a single entity very clear, something that made a lot of sense. Now you have a lot of non-associated gas; gas being produced separately, often by companies that do not engage in much oil production. They really have distinct challenges and opportunities, and as a result, different sets of pressures.
For the natural gas industry, at least in the US, the big challenges are low prices in the glut of gas on the market that is not being matched by demand. A big part of this is certainly idiosyncratic; there are people who are drilling to hold leases and cash flow, and they are doing that en masse, which is a problem for the whole industry.
At the same time, they have not been able to coalesce around the efforts to boost demand.
The oil world is a completely different story and you have pressures from different directions right now. On the one hand, you have a surge in opportunities for development in countries where geopolitical risks are relatively low. In the US, Canada, and Brazil you may need to still worry about regulatory changes, but you are not worried that terrorists will come and capture your workers.
At the same time, for a lot of the companies, that is not enough and they are still looking globally, and they still face challenges from nationalism and unstable regimes. On top of that, they are entering a period in which there is probably more uncertainty in prices than there has been for a long time. You have this collision of growth and supply from
outside OPEC, together with potential Iraqi growth and substantial investment from within OPEC that really opens up the possibility of a big, if temporary, price drop in the next five or so years. That complicates the outlook for companies, on top of everything else.
James Stafford: Really? You believe that prices could drop in the future?
Michael Levi: I think prices could drop substantially. If you look at the most recent IEA report or the most recent OPEC outlook, you see that if all currently planned investment goes ahead, then at prices resembling current ones, supply would greatly outstrip demand.
Either countries will pull back with production and investment in OPEC and allow supply to match demand at relatively high prices–and I think that is the most likely outcome–or they will not be able to decide who has to pull back, and there will be an excess of supply on the market that pushes prices down quickly. That is self-correcting, because low prices cannot sustain the big gains in North American production. But you can still have temporarily low prices that really shake things up for some producers, depending on the properties of their investment.
James Stafford: Speaking of the IEA report, predictions that the US could pass Saudi Arabia to become the world’s largest oil producer by 2017 have come under a lot of criticism. What do you think of the IEA’s predictive mathematics?
Michael Levi: Predictions are always wrong in one way or another, and I am not going to second-guess those who have thought to a much greater depth in these analyses. There is a range of estimates out there, but the IEA ones are relatively modest.
The bigger issue is: what are the implications? Everyone likes to talk about how their projections show that the world is being reborn anew, and will be fundamentally different from what it was in the past. There is a temptation to oversell, and I think it is reasonable that people react negatively to efforts to oversell the consequences of the changes going on in energy.
James Stafford: What are your views on the shale boom? Do you believe it can live up to the hype?
Michael Levi: It depends on what hype we are talking about. I think the shale boom is for real. I think that a lot of the criticism that we do not know long-term production rates and so on are important to look at. But even if you assume that returns on wells are substantially lower than most people think they are right now, our projected output is still quite high, because producers’ economics are dependent primarily on what happens in first few years after they drill. We know roughly what happens in the first years after producers drill.
The hype that says that this will all replace coal without any government intervention, gas prices will be $3 forever, or that we will be the dominant exporter in the world, are out of contact with reality. We have temporarily depressed prices, they will rise a bit. Hype always has the ability and the tendency to outstrip reality, but in this case, reality is pretty radical itself.
James Stafford: Could the shale boom lead to a change in US foreign policy priorities, away from the Middle East?
Michael Levi: An economic analyst will typically tell you that the US shale boom will fundamentally change US vulnerability to energy events in the Middle East. But not every policymaker listens to their economic advisors.
I do not think that US policymakers will step back and say, ‘We need to revisit our strategy in the world, because of this oil boom.’ I do think that what is happening will weigh on ongoing discussions that already exist about future US priorities.
The most obvious one is the discussion from the US Department of Defense over how much to shift from the Middle East to Asia. Within that existing debate, I have no doubt that people who want to see more of a shift will emphasize what is happening in US energy. I think it will have some influence, but ultimately, I do not see a radical change as being likely.
James Stafford: Now that Barack Obama has won a second term, what do you see happening with the Keystone XL Pipeline? Will it go ahead? Is it essential to US energy security?
Michael Levi: I made a prediction once on the Keystone XL Pipeline, so I have lost my license to make future predictions. The Keystone XL Pipeline is non-essential to US energy security; it is also not disastrous to climate change. It has been overblown by both sides in the debate. It is one pipeline that would carry a modest, but non-trivial amount of crude, and that would help create economic incentives to increase production, again, by a modest but not earth-shattering amount.
The more fundamental question is whether the US is going to let economically-rational infrastructure go ahead. I think if you replicate a pattern like the one that some would like to see for Keystone and you start blocking pipelines all over the place, then that becomes a larger economic problem.
In the end, will it make the US more secure in any meaningful way? I doubt it. Prices for Canadian oil rose more during the Libya conflict than the prices for Brent Crude, or WTI. It is hard to say that Canada gives the US potentially more security aside from in extreme circumstances.
James Stafford: One would have thought that the natural gas boom would be good for the environment, but the cheap gas prices have also hit coal prices, and we are seeing Europe sucking up unused US coal. Is this a trend we can expect to continue?
Michael Levi: I think it is a trend we can expect to continue to some extent, particularly if Europe does not make stronger moves away from coal. The state of our knowledge about global coal markets is pathetic. All we can say right now is, directionally, more gas in the US means cheaper coal, which leads to more exports, but we are still far from being able to really put quantitative meat on those bones, and making some meaningful net assessment.
James Stafford: Can the US afford to turn its back on nuclear energy?
Michael Levi: If you mean by turning its back, you mean a phasing-out of nuclear energy, I do not think that is sensible to do. Nuclear energy provides 20% of our electricity, and the marginal cost of production is extremely low for existing power plants. The real question is can the US afford to turn its back on nuclear in the future as a source of zero-carbon energy growth? The answer is: we do not know, because we do not know what the alternatives will be, or if there will be significant alternatives. So you want to keep nuclear alive as an option; that means trying to figure out ways to bring down costs, particularly financing costs. It means looking for ways to resolve, or at least partly resolve the waste questions, and it means looking for ways to potentially innovate on small modular reactors to provide a different economic model and a different construction model for nuclear power.