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Calls for national security to the contrary, America's
appetite for energy is stronger than its caution. In the last 15 years, the United
States has steadily increased its dependence
on imported crude oil by some 60%. Part of the reason is declining
production, as displayed in the chart below.
Declining production has been matched by the
country's declining reserves. A decline that comes against the backdrop of
increasingly extraordinary efforts to turn things around, including deep-sea
drilling far off the coast in the Gulf of Mexico.
Put simply,regardless of America’s
strategic concerns over energy security, any large increase in domestic
production or reserves is unlikely.
To a superpower that imports nearly 70% of its
oil, it's more than a mental exercise to evaluate the reliability of
itssources. Any economic or geopolitical risk with the potential to disrupt supplies
could have a destabilizing and even devastating impact on investment markets
and the economy. In the pie chart here we’veseparated the countries
exporting crude oil to the United
States into three categories: friendly,
potentially hostile/hostile, and unsure/neutral.
 
Those countries portrayed in black and gray
are the allies, countries thathaveusually shown a willingness to work in
concert with the United States on numerous issues. These countries are Canada
(geographic proximity), Mexico (geographic proximity), Nigeria (much improved
relations over the past 15 years) and Iraq (very close ties with the United
States, for obvious reasons).
Countries
depicted in shades of red are countries that are either openly hostile or
have previously been hostile with the United
States: Venezuela
(Hugo Chavez… say no more), Algeria
(issues remaining from Algerian Civil War), Angola
(U.S.-funded anti-government rebels), Russia
(lingering Cold War effects) and Ecuador
(thenew president is a friend of Chavez). We list Saudi
Arabia as a wildcard, with the potential to
go either way.
Adding up the numbers, a bit less than half of
U.S.
imports are from countries that are either politically unfriendly or have the
potential to be. Now let's take a closer look at the “allies” of America,
since even they have problems providing a stable stream of oil.
The Allies, Such As They
Are
In the last 15 years, Canada
has taken honors as one of the top crude oil exporters to the United
States. However, conventional reserves of
crude oil in Canada are
in decline, and the only reserves that Canada
has in abundance are the oil sands, which are expensive and difficult to
extract.
Furthermore, Canada
already consumes 90% of the crude oil it produces, and this number is
growing. Finally, the Canadian dollar currently puts a great hamper on the
growth of Canadian exploration companies: they have to pay their costs in
Canadian dollars, but sell their commodities in American dollars, an
unfavorable arbitrage.
Mexico
has less of a currency conundrum than the Canadian exploration companies, but
they face a much larger problem – their reserves are dropping quickly,
with little ability to replace them. For example, production at Cantarell,
one of the world’s largest oil fields, is conservatively estimated to
fall to half of its 2003 peak by the end of 2008.
This problem is exacerbated by Mexico's
increasing domestic consumption. Its population already consumes 60% of its
crude. Mexico,
and its rapidly dwindling resources, could become a net importer of crude oil
in the near future. (Jeffery Brown’s Export Land Model estimates that
this reversal will occur no later than 2014… six short years from now.)
Nigeria,
the African continent's largest oil exporter, has impressive oil reserves.
Unfortunately, the country is marred by not only the misappropriation of oil
funds but also the ethnic clashes between the Ibo, Housa and Yoruba tribes.
The multinational oil companies are either stuck in the middle or
contributing to the mess, depending on your point of view. Ongoing supply
unrest mean that Nigeria
is less than a reliable source of crude.
Iraq
containslargeknown fields, and the potential for more large fields yet to be
discovered. As long as the United
States maintains a strong presence in the area, it
should continue to provide a steady supply to the United
States. A long-term presence, however, is
very much in doubt. And, should
the U.S. leave, the
direction of Iraq’s
flow of oil could change overnight. So, a big question mark here.
The Axis
Countries such as Angola,
Algeria and Ecuador
are obviously willing to sell to America
now – as they need the money they’ll sell to the highest bidder.
But at the same time they have been ramping up their production and exports
to other countries. As time goes on, however, these countries may begin to
pick and choose to whom they sell such an increasingly precious commodity.
This trend is evident in Venezuela,
a more mature oil-producing country, which, under the leadership of Hugo
Chavez, has already begun to reduce exports to the United States.The Exxon
Mobil suit against Venezuela
is the latest, but far from the last jab in the sparring going onbetween America
and Venezuela.
The bad blood, combined with increased international competition for Venezuela's
oil increases the possibility of a Venezuelan oil embargo on exports to the United
States.
Russia
has the potential to possess one of the most abundant sources of crude oil on
the planet. But the tap-twisting that Russia
has recently pulled with its natural gas exports strongly suggests it sees
its energy as a tool for gaining geopolitical power, as the Europeans are
discovering.
The Wildcard
Even though the Saud family and the United
States have enjoyed a relatively stable relationship, rising tensions in the
region and increasing Islamic militarism could potentially trigger another
oil embargo such as in the 1970s, particularly if Israeli-Palestinian
troubles remain unresolved. We can thus see both sides of the coin. On the
one hand, Saudi Arabia
could be the American bastion of supply over the next few decades; on the other,
through its power in OPEC, it could increase the price of crude oil even
more. The overthrow of the Saud family, dourly predicted for years, would in
all likelihood be unfavorable to U.S.
oil supplies.
So What’s the
Solution?
The squeeze on supply is only getting worse as
the ascendant economies of China
and India
ramp up their demands for oil. At some tipping point, exporters unfriendly
toward the United States
will be happy to sell their oil to these growing markets. So where can the United
States expect to turn instead?
What about the former Soviet
Republic countries (the
“-stans”)? Offsetting their vast potential and anti-Russian
leanings is their geographical proximity to China,
which is increasingly eager to exert as well as secure power. In any case,
the possibility of finding a new significant reserve of light oil in most of
these countries is unlikely.
There is, however, a much better solution
– a proven and plentiful resource in an area friendly to the United
States and in geographical proximity: the heavy oil
fields in Alberta. While available in abundant supply, it
is not without its challenges. That’s because heavy oil is more
viscous, more dense (low API gravity), and often has contaminants such as
sulfur; it's usually purchased at a discount to light oil due to its
increased cost to pump and transport.
The United
States already uses heavy oil in some of its
refineries, and increasingly so:
Canada
could ramp up its heavy oil production relatively easily, since the reserves
in the country have already been proven. Transportation of this fuel is also
less of an issue since Canada is quite stable politically, and can easily
construct new pipelines or twin their existing ones (to reduce the costs) to
pump much-needed crude oil into the United States – provided the price
is right.
The Opportunity
Why is heavy oil suddenly so much more popular?
The main reason is that the demand for heavy oil from the refineries around
the world is beginning to outstrip the supply of heavy oil. BP Inc, for
example, is investing $3.8 billion to upgrade its Whiting Heavy Oil Refinery
outside Chicago, in large part to handle more
heavy oil from Canada;
and countries like China,
India, Syria
and Saudi Arabia
are also beginning to build more heavy oil refineries.
This shows that the United
States is beginning to use more heavy oil in
its refineries, and is willing to pay a premium for a source of oil in a safe
and friendly country.
So how do we profit? A logical answer would be
to buy into prospective heavy oil companies, those that are cheap producers
with good potential upside. Unfortunately, with oil prices well over $130 per
barrel, most producers come with a very high premium attached. These
companies will begin to correct once they are unable to economically replace
their current production with new reserves or when the impending American
recession gains traction.
Therefore, we should be looking for
well-cashed-up companies that can withstand difficult capital market
conditions and has their operations in a jurisdiction that stands to benefit
from America’s crude oil shortfall, and increasing reliance on heavy
oil.
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Casey Research, LLC.
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