Putting Out Market Fires With North American Oil

Putting Out Market Fires With North American Oil

Recent turmoil and violence in Iraq are raising concerns of even higher gas prices at the start of the summer driving season. U.S. futures contracts for July delivery have risen above $106 for a barrel of crude oil. Though Iraq's oil production has yet to be affected, fears over escalating fighting spreading to southern Iraq, and the possible disruption to supply chains, are pushing futures prices higher.

Iraq produced 3,058 barrels of oil a day last year, and passed Iran as the second largest OPEC producer of crude oil in late 2012. Though Iraq has the fifth largest proven reserves in the world, lack of proper infrastructure and continued political uncertainty have held back development-even with substantial recent international investment. If the current crisis continues, companies may rethink their stakes in Iraq and pull out of the country or shelve future development plans.

While the price of gas has remained elevated for the past three and a half years, price volatility has been historically low. While high-cost energy slows economic growth, stable prices make planning for the future easier, for both individuals and businesses.

The most important contribution to oil's price stability has been the substantial increase in U.S. production. U.S. crude oil production has risen 50 percent since 2008, to 7,443 thousand barrels a day. This increase has been driven by advances in drilling technology. Hydraulic fracturing has opened up previously-known reserves that were either inaccessible or too cost-prohibitive for drilling.

While there have been many major unexpected events over the past few years with the potential to disrupt oil supplies, none have equaled the scale of the September 11 terrorist attacks or Hurricane Katrina. Yet sanctions against Iran, civil war in Libya, and general unrest in the Middle East have all had minimal effects on price volatility-thanks to the U.S. energy renaissance.

Ben Montalbano, the director of research and operations for Energy Policy Research Foundation, Inc. (EPRINC), told me, "Without the increase in U.S. oil production over the past few years, OPEC's excess capacity would be at or near zero. We lost 1 million barrels from Libya, and another 1 to 1.5 million barrel due to Iranian sanctions. Oil prices would likely be $20 to $40 dollars per barrel higher than they are now."

On June 3, the 30-day historical volatility of Brent crude fell to its lowest levels since the contract opened for trading 26 years ago.

This EIA chart shows the increasingly-low volatility in Brent crude oil prices since the end of the recession.

Iraq does not have the refining capacity necessary to handle the amount of heavy crude it produces. A disruption in Iraq's production would substantially affect its heavy crude oil exports. This is the type of oil found in Canada's tar sands. Unfortunately, the least costly route to bring this Canadian oil to market, the Keystone XL pipeline, requires approval from the executive branch of the U.S. government.

The first application for the Keystone XL pipeline was submitted to the U.S. State Department by TransCanada Corporation 5 years and 9 months ago. In that time, the entire pipeline could have been built three separate times. Despite the State Department findings that Keystone XL would have no significant effect on greenhouse gas emissions, President Obama continues to postpone making a decision on the economically beneficial pipeline.

Last month the State Department issued a new report concluding that transportation of oil would be far safer by pipeline than by rail. Pipelines are the ideal method of transporting oil, because they are immobile, buried underground, and do not come into contact with other vehicles or people. If Keystone XL were not approved, and the oil were shipped to the United States by rail, the State Department estimates that an additional 28 people would die and189 people would be injured per year.

When I asked Montalbano to help me make sense of the Keystone XL delay, he said, "It seems silly to effectively prevent Canada from shipping additional oil to the United States given that the U.S. remains a net oil importer, that global crude oil transportation has the potential to be a volatile affair, and that there is growing scrutiny of crude by rail shipments. This is just one example of the inconsistencies and lack of certainty that jeopardizes the full potential of North American energy production. We need to create a more predictable, rational regulatory regime."

Another example of the inconsistencies and lack of certainty Montalbano mentions is the onerous permitting process required for energy exploration on federal lands.

Even with a decreased workload, the time it takes the Bureau of Land Management to process a completed application to drill on federal lands has risen from 39 days in 2005 to 95 days. This regulatory red tape creates strong disincentives for energy exploration. In North Dakota, securing a permit only takes 10 days. Is it any wonder North Dakota's GDP grew by 9.7 percent in 2013 while overall U.S. GDP fell by 1 percent in the first quarter of this year?

Recent events in Iraq show the importance of North American oil to world markets. The technological innovations that spurred increased oil production reduce energy price volatility help the world's economy to grow, and improve America's international standing. Congress and President Obama should enhance this advantage by approving Keystone XL and speeding up energy permits.

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