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11/13/12 – Formula for Success: Rise Early, Work Hard, Strike Oil. — J. Paul Getty

Written by Brad McMillan, CFA®, CFP® | Nov 13, 2012 1:13:00 PM

On this metric, the U.S. is poised for success. The Wall Street Journal (WSJ), New York Times (NYT), and Financial Times (FT) all have stories on the International Energy Agency’s new World Energy Outlook 2012, which reports that the U.S. will be the largest producer of oil in the world by 2020 and a net oil exporter by around 2030. The story made the front page of both the WSJ, with “US Redraws World Oil Map,” and the FT, with “US to be world’s top energy producer,” but it only made it to page B6 in the NYT. Tells you something right there.

The headline story is great and underlines the point I have been making for a while that things are changing. The oil and gas industry is creating U.S. jobs directly, and it will do so indirectly as well by providing a lower cost base for manufacturers. In fact, last week the FT reported that German industrial companies are formally warning that they expect to lose jobs because of it.

Underneath the headlines, part of the story looks even better. As much as oil production is increasing, natural gas production is increasing even more, and it will have an increasingly greater effect as more plants and generators are built or converted. The U.S. natural gas cost advantage will be even larger, and it is expected to persist over the long term.

Other parts of the story, however, don’t look so good. Analysts are warning that the long-term production of these new oil sources is not yet proven, so it is premature to start long-term plans. There’s a good discussion in “Risks cloud bright future for oil and gas” (FT, p. 4). Also, production costs for these oil sources are still higher than those elsewhere in the world, such as Saudi Arabia, so domestic production could be negatively affected if oil prices decline. Finally, although most of the U.S. crude is of fairly high quality, much of the U.S. refinery capacity will have to be refitted to handle it efficiently.

Even given the drawbacks, this remains a tremendous boost to the U.S. economy, and it will have knock-on effects well beyond the economic. For example, the U.S. Navy now spends tremendous resources keeping the Middle East oil shipping lanes open and unthreatened. As imports from the Middle East become a smaller piece of the U.S. energy pie, those resources can be committed elsewhere, or even cut. The geopolitical effects will be massive as well; Russia, for example, will lose influence as it becomes less important as an oil and gas supplier to Europe and elsewhere. In fact, today’s FT has a good article, “Shale surge poses threat to Gazprom in Europe” (p. 15), on just this topic.

Overall, this is one of those rare events, that, if it plays out as expected, has very few downsides for the U.S. There are environmental concerns, which should not be minimized, but the net effect seems to be overwhelmingly good. Nice to think about as we work through the fiscal cliff.