Impact of shale gas’ discovery in the US on global oil prices

Global oil prices have been hit hard because of discovery of new shale gas in the US and falling demand in the world market. This report is a study of the impact of shale gas discovery on the global oil prices and the economy.

Shale gas is defined as natural gas from shale formations. It is basically a gas found in shale rocks. The shale acts as both the source and the reservoir for the natural gas. In recent years, the shale gas has become a very important source of energy in United States with the exploration at North Dakota and Texas. In large measure this is attributable to significant advances in the use of horizontal drilling and well stimulation technologies and refinement in the cost-effectiveness of these technologies. Hydraulic fracturing is the most significant of these.Many shale gas production also take place in Canada, Europe, Asia and Australia.

Now, moving1 back to North America, due to sufficient data absentation,the exact location of potential shale gas reserves in America is still not clear. The shale gas production first started in Texas in 1990s.But as per the EIA 2012 report, US carries potential for more shale gas reserves.

As per the latest estimates, the United States of America achieved global leadership in petroleum and natural gas hydrocarbon production, beating Russia which once enjoyed the largest energy production in the world. Now, Russia fell to second position and Saudi Arabia became third largest producers. The main reason behind this change in production levels is the extensive exploration and production of shale gas in US since 2008(more than 11 quadrillion British thermal units). Despite the fall in the global oil prices, the shale production continues and has increased by over 3 quadrillion btu (1.6 billion barrels per day).

Note: Petroleum production includes crude oil, natural gas liquids, condensates, refinery processing gain, and other liquids, including biofuels. Barrels per day oil equivalent were calculated using a conversion factor of 1 barrel oil equivalent = 5.55 million British thermal units (Btu).

While massive production was undertaken in the US, hydrocarbon production fell in key areas of Russia because of weak economic growth and falling exports. In 2011, both Russia and US enjoyed equal levels of production but rising production in US and falling production in Russia resulted in US exceeding Russia in production  by almost 12 quadrillion btu. Saudi Arabia which generally controlled production levels to stabilize the world oil markets , quite shockingly refused to curb its production despite the continuously falling prices and increasing global inventories. As a result, Saudi Arabia’s total petroleum and natural gas hydrocarbon production was nearly unchanged from 2013. With the increase in U.S. production, the United States produced nearly twice the petroleum and natural gas hydrocarbons as produced by Saudi Arabia in 2014.

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Source: U.S. Energy Information Administration, Petroleum Supply Monthly

The US crude oil production rose massively from 1.2 million barrels per day to 8.7 million barrels per day (16.2% increase) in 2014. This is the highest level of increase experienced since 1990.This increase was mainly due to oil exploration in North Dakota, Texas and New Mexico.

FALLING GLOBAL GAS PRICES:

Between the years 2010-2014, prices were rising fairly.This was mainly due to rising oil consumption in China(one of the largest consumers of oil in the world) and conflicts in key oil nations like Iraq.                                                                                                                           As a result, the demand did not meet the supply or as in economics, there was a situation of excess demand with insufficient oil reserves. This led to spiking prices.

This spurred in investment by firms in US and Canada to find new sources for oil extractions and drilling in North Dakota’s shale formations and Alberta’s oil sands as they found it profitable to invest in difficult-to-extract places. As a result, supply of unconventional oil production boomed with US alone adding 4 million extra barrels of crude oil since 2008.

Till recently, US oil production boom did not have much impact on global prices because certain oil rich countries were facing geopolitical conflicts. There was a civil war in Libya and Iraq faced threats from ISIS.

However, by mid-2014, these conflicts did not matter as US shale production increased rapidly.  The demand for oil fell gradually because of economic inefficiencies and switch away to other fuels. There was a slowdown in China which is the second largest consumer of crude oil after US. Imports of crude oil by US reduced drastically because of exploration of new shale gas in the Texas and North Dakota region. Imports from OPEC have been cut in half and for the first time in 30 years, the U.S. has stopped importing crude from Nigeria.

On the supply side, the shale production increased over the years with the expected production to reach 2 million barrels a day. OPEC(Oil Petroleum Exporting Countries) failed to derail the US shale boom and Saudi Arabia set a record of about 10.3 million barrels per day in April 2014.

This time there was excess supply in the market . A lot of unused oil was simply being stockpiled away for later.

The following graph shows how over the years the prices of changed. In the 20th century, prices started rising with prices  but in 2015 there is a tremendous fall in the prices .Oil prices fell quite abruptly from $110 in mid-2014 to nearly $50 which is half of what the prices originally were.

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As prices fell further, OPEC, world’s largest oil cartel, met at Vienna in November 2014 to discuss on the situation. Some countries like Iran and Venezuela favoured reduction in production so as to increase the prices but other countries like Saudi Arabia opposed to this solution. OPEC already enjoys lower cost of production. Saudi Arabia’s cost of extraction is merely a little around $5-6 per barrel and so could tolerate falling oil prices quite easily. So, it was finally decided not to curb production to stabilize the prices as they do not want to lose their already fading grip in the market. OPEC’s market share was around 60% but it fell to 40% due to increasing US production. With OPEC removing all curbs on production, prices fell further by 2% to $57 by end of 2014.

Impact on the Economy

The falling global gas prices have had different impacts on different countries.

  • The oil importers have basically benefited from the situation with countries like Japan enjoying cheap gasoline prices.
  • The oil exporters have been adversely affected by the situation like Russia(which is already facing ruble record lows),Nigeria, Iraq, Venezuela etc

The impact on specific countries is mentioned below:

  1. Russia: Russia is greatly dependent on its oil and gas production. Its oil revenues contribute about 45% of the government budget. The economy is so much dependent on its oil revenue that a one dollar fall in its prices leads to about $2billion fall in its total revenue. Because of fall in the international oil prices, Russia’s GDP is expected to shrink about 4.5% in 2015. Russia’s ruble’s international value has depreciated because of expensive imports. In order to handle the situation, Russia hiked interest rates from 10.5% to 17% in order to stop people from selling their rubles. But it would further worsen the situation in Russia slowing down their economy as increasing interest rates makes it harder for businesses to borrow and spend.
  1. Iran: Iran’s economy started to rebound after years of recession.It currently needs oil prices well worth of $100 per barrel to balance its budget.Iran needs to divert itself to other sources of government revenue if prices continue to fall further.
  2. Venezuela: Venezuela, one of the major oil producing countries, is extremely affected by the situation as the oil revenue contributes a major portion to government budget. As a result, Venezuela’s GDP is expected to shrink by 3% if prices continue to fall further.
  3. USA: US, currently enjoying world leadership from oil production, is affected both positively and negatively from global gas prices fall. On the positive side, the shale gas exploration has led to many employment opportunities benefiting about 48 states in US. It also ensures energy security in the areas, thereby ensuring economic stability in the areas. On the negative side, US oil revenues have been hit hard as the cost of drilling is huge which could not keep pace with the falling prices. Availing the opportunity of growing oil prices, The American frackers had borrowed heavily. As a result, many firms operating in the US have started withdrawing from the investment in the drilling and extraction prices.
  1. Saudi Arabia: One of the largest oil producing countries in the world, Saudi Arabia would be financially hit hard if the falling prices persists. Although they have decided not to curb the production fearing losing significant markets to Russia and the US. They have sufficient reserves to handle the situation at around $750 billion. If the oil prices continue to fall, the government may run into deficit equal to 14% of GDP.

Future behavior of the market

The future situation of global oil issue is quite uncertain. Although the situation is recovering but it is only short-term. China’s demand is improving although there is a slowdown in its economy currently. On the supply side, oil reserves in America are falling gradually. Because of falling prices, many frackers have started withdrawing from the shale gas production. Moreover, the oil demand tends to increase in the coming years as people react to falling prices by travelling more miles and demanding more cars.US can take advantage of falling oil prices to make needed energy-policy reforms such as ending wasteful fossil fuel subsidies or putting in place new efficiency measure.

But if demand remains weak and production continues to rise, then its difficult for prices to bounce back. Only time will tell what will be the future course of global oil prices and whether situation becomes better or worse.

– Mishika Jain

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