What Does Energy Independence Actually Mean?

Economic Perspective of the Week — Week 12, 2022

Energy 101 — Part 1

CARTOON ON THE WEEK:

QUOTE OF THE WEEK:

“The three options are a prolonged war; a peace settlement; or a coup in Russia. Expect the first, work for the second, and hope for the third.”

• Gideon Rachman, Chief Foreign Affairs at Financial Times

What is Energy Independence Anyways?

Hello…Happy Friday….did you miss me? 😊

There has been a ton of news happening over the last month and frankly, I have been overloaded with what to actually write about.

Paralysis by analysis I guess you would say.

It seems information today becomes old in just a matter of hours or days.

I save information from a Monday and it’s irrelevant by Friday.

This makes it difficult to add any real value to you when information and news flow is constantly changing at a rapid pace.

I was stuck on what to write about until I saw this earlier today…

Now, this is not a big deal, but the comment below by the blond lady is….

Or comments like this that I see almost daily…

Or this….

It just seems our basic understanding of the energy complex here in the US and around the world is lacking.

People focus on the news bite or the keywords like “energy independence” or “Keystone Pipeline” to understand the very complex topic of energy.

Do you think the person making that comment knows what LNG stands for?

I doubt it.

So I decided to take the plunge into explaining energy..

Let’s call it Energy 101

Over the next few weeks, we will learn about the energy complex together.

My hope is to make this easy (less than a 10 min read) and to display a lot of pictures

(pictures speak 1,000 words).

This topic is also very relevant to what is going on with Russia and Ukraine.

And frankly, we ALL feel it at the pump or in our electric bill.

So what is energy?

Energy is the ability to do work.

It has been our ability to manipulate energy by different means.

The manipulation of energy is what started the industrial revolution.

While there are many different types and forms of energy, we are going to focus mainly on hydrocarbon energy which generates electricity, transportation, industrial machinery, residential homes, and commercial buildings.

Specifically, oil and natural gas.

Where do oil and natural gas come from?

Your answer to me. “The ground stupid….”

If you said this, congrats…You are right…but I am not stupid 😊

To be clear, natural gas is NOT the gas you use at the gas pump to fill your car tank.

Natural gas is mainly Methane and is just a different form of energy.

Yes, that is the same Methane we hear about in cow farts.

We also have ethane, propane, butane, and helium along with a few other gases inside the natural gas we get from the ground.

And with this gas, we use it mainly to power electricity plants along with industrial products like fertilizers, plastics, and chemicals along with many other raw material inputs.

The gas you burn in your car is made from oil through the refinery process, which we will discuss in the coming weeks.

The oil that comes out of the ground can come in many different forms.

But as a preview, the graph below shows what we can get from a barrel of crude oil and how this crude oil is refined to make its end products.

Depending on how that barrel of crude is refined, you can get asphalt, WD40, waxes for surfing, or polishes for your shoes, or gas you buy at the pump, or diesel at the pump, or hundreds of billions of different chemicals.

In fact, I think we would all be amazed, shocked, and saddened by how much stuff in our daily life is made from natural gas and crude oil.

When we see a drilling rig like the one below, they are mainly looking for oil deposits.

Or if the rig looks like the one below here, then it’s natural gas deposits.

The process of extracting oil and gas and getting it to the end consumer is broken up into three areas:

• Upstream
• Midstream
• Downstream

The upstream is where all the money is usually made. Think of the Rockefellers of the world.

The process to extract oil or gas upstream is somewhat similar.

But after the extraction, the midstream and downstream are very different.

Oil is a global market. It’s a global market because it’s easy to transport.

In 2014, it cost only $5 per BILLION barrels of oil to ship it anywhere in the world.

As a result, oil is controlled by the world market and what happens around the world.

So even if we in theory produced ALL of our oil and refined it and used it here only, we would still be tied to the world market, which sets the price of crude globally.

And usually, that price is set by the oil cost curve and storage capacity.

What is the oil cost curve?

How much does it cost to extract oil from the ground in different areas?

(In the chart above, NOC is National Oil Companies while IOC is an independent oil company. Also, this chart is from 2014, so the cost curve may have changed since then.)

If we know production from these different areas around the world and have an idea of world demand, we can quickly come to some type of base case oil price for the world market.

So when oil demand dropped off a cliff in 2020 due to COVID, even Saudi Arabia was running out of storage. There was nowhere to put it. As a result, for a brief moment, oil prices went negative for the first time in history.

We will take a much deeper dive into this subject in the next few weeks.

I think it’s super important for everyone to understand how oil went from negative dollars to over $100 per barrel in less than a year.

It’s a complex topic and has nothing to do with politics, the president, congress, or anyone else in power. If you think it does, you are giving these people a ton more credit than what they deserve.

Natural Gas

Natural Gas, on the other hand, historically has been a domestic market.

Why?

Gas is extremely hard to transport.

Historically, it could only go where the pipeline took it.

When wells were originally drilled for oil, most owners burnt off the natural gas because they had no way of capturing and transporting it.

Even with the introduction of liquefied natural gas (LNG), (BINGO…HERE IS THE ANSWER FOR THE BLOND LADY ABOVE) it cost significantly more to transport to other areas in the world.

We will get into much more detail about LNG in the coming weeks.

As for now, just know that LNG is hard to do.

Projects take billions of dollars of capital to start, add a few dollars to the end consumer BTU price, and usually only get done when countries or companies sign 15–25 year contracts.

So while the headlines from Biden’s visit to Europe (beginning picture in this article) say one thing, the actions will be much different.

It is much cheaper for Germany to get their gas from Russia (ex the invasion of Ukraine issue) than it is to transport it from the US in the form of LNG.

And with Germany still having the majority of its energy coming from Russian Natural Gas, the only way they can change this quickly is to find gas themselves (unlikely) or pay a significant premium to steal contracted gas that was designed to go somewhere else.

We will get into much more specifics in a week or two.

So for now, just know we get many different products from the ground by drilling oil and natural gas and the end product usage is beyond our wildest dreams.\

Brief History

The first well was drilled by Colonel Drake in Pennsylvania in 1859.

Petroleum (oil) was used to make kerosene, which was then used in lamps.

Kerosene worked a lot better than coal and whale oil, which were the main sources of light prior to kerosene..

By the early 20th century, oil emerged as a preferred energy source with the invention of the electric light bulb and the automobile.

By 1919, gasoline sales exceeded those of kerosene.

Throughout the 1900s, the use of oil and gas skyrocketed and made many people rich.

In the early days, oil was easy to get out of the ground through conventional wells.

As Stanford Bernstein reported said in 2014:

“In a conventional well, you would drill to the desired pay zone and then the driller would use explosives to create fractures in the rock and pump water and sand into it in order to stimulate the well and cause the oil or gas to flow to the surface.”

This process is outlined well in this scene below from the movie “There Will Be Blood”.

https://www.youtube.com/watch?v=GKJAH-XBNNs&t=91s

But these easy wells did not last and quickly disappeared, along with the ability for the United States to produce its own energy.

Throughout the second half of the 20th century, the US was an oil and gas importer…

Bring on the Shale Revolution and Fracking

Shale has transformed the world of energy.

With the invention of shale drilling (or Fracking for short), drillers were now able to drill horizontally and “frack” at multistage, which creates very productive wells which turn into very profitable wells.

Fracking is the process by which water, sand, and chemicals are injected at very high-pressure underground to crack open the rock layers and release oil and gas trapped inside.

Shale drilling is the combination of “fracking” and horizontal drilling.

Unlike the first well ever drilled by Colonel Drake, which went a little over 100 feet straight down into the ground, most shale wells go 5,000 feet or more below ground and can take over a month to drill.

Once they reach the desired level, they turn it sideways and place a “perforating gun” at the tip, which contains explosive charges. They may go horizontal for a mile or two before reaching desired areas.

Once they get to the desired area, they pump the water, chemicals, and sand under extreme pressure to free the oil and gas, which then flows to the surface.

A typical well can produce gas for 20–40 years. Usually, oil wells have a much smaller life span.

This technology has been huge for the production of both oil and natural gas here in the United States.

While oil production has increased, it has been the natural gas that skyrocketed higher.

Oil in blue, natural gas in orange

By 2014, six total shale complexes produced over 80% of the new gas volume in the US:

• Marcellus in Pennsylvania,
• Barnett near Dallas Texas,
• Eagle Ford in south Texas,
• Haynesville in Louisiana,
• Woodford in Oklahoma, and
• Fayetteville in Arkansas.

Through the technology of fracking and shale drilling, the United States quickly became one of the biggest producers of natural gas in the world.

With the production of shale drilling, the United States became energy independent.

So what does United States Energy Independence Actually Mean?

First and foremost, we have to outline what importer versus exporter means.

You are a net importer if you import (bring in) more than you export (sell out to other countries).

When we talk about energy independence, it means we are a net exporter of energy….ALL ENERGY!!

That is the key….energy is not just oil or gas at the pump…Energy is made up of crude oil, refined petroleum products, natural gas, coal, renewables, and other liquids.

If we added up all our energy production and then subtracted our energy consumption and get a positive number, we are energy independent.

Historically the US imported natural gas, mainly through pipelines from Canada.

Before shale, we had Liquefied Natural Gas (LNG) Terminals here in the US, but those were used for IMPORTS not EXPORTS.

But with the Shale revolution, the US became a net exporter of natural gas in 2016–2018 time frame and is now one of the biggest, if not the biggest, producers of natural gas in the world.

In the coal market, the US has been a net exporter of coal for a very long time (green line below).

But coal has been displaced around the world by natural gas because of shale and fracking.

You can see the BIG drop in coal production and consumption here in the US since the mid 2000s because of the transition of electric companies to move from coal to the cheaper natural gas.

The combination of the two above makes us “energy independent”. This is because we export more coal and natural gas than we import crude.

Energy Independence does not mean we do not import crude or gas you use at the pump.

In fact, in 2021, the United States imported about 6.11 million barrels per day of crude oil from 73 countries!!!

We exported about 2.98 million barrels per day of crude oil.

To make it more complicated, if we look at Petroleum ( a very broad term and definition) which includes crude oil, hydrocarbon gas liquids, and refined products like gasoline and diesel fuel you use for your car, we were a net exporter.

We imported about 8.47 million barrels per day of petroleum while we exported 8.63 million barrels per day of petroleum per the EIA.

This made us energy independent by 0.16 million barrels per day of petroleum.

So next time someone says we were energy independent, please first ask them what is their definition of energy independence?

If they are able to answer, then ask them the definition of Petroleum and LNG.

I seriously doubt anyone could really answer these questions.

And if they cannot, you know their viewpoint and opinion on the matter is worth as much as a Russian Rubble 😊

In the next few weeks, we will attempt to answer the question,

“If we can drill for our own oil and refine our own oil, why do we have so many exports?”

In the meantime,

Please continue to pray for all those affected by the stupid war going on in Ukraine.

I know you have many options to read on a daily basis. I feel blessed if you spent the time to read this today. Thank you from the bottom of my heart.

Comments and feedback are always welcomed……

Have a wonderful weekend!!!

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