What the Frack?

On January 17th of this year, the Annual Energy Outlook for 2017 (AEO 2017) was published by the Energy Information Agency, part of the U.S. Government.[1] The AEO examines U.S. domestic energy production and consumption, with extrapolations[2] into the future. Information from the AEO 2017 provides information and insights relevant to business management. This post focuses on petroleum and natural gas production through hydraulic fracture and directional drilling techniques (“fracking”).

America and Petroleum

The graphic labeled “Energy Consumption” is from the AEO 2017. The brown line indicates that petroleum and related liquids fuels about 35% of America’s energy current energy consumption.[3] Further, it indicates little change in annual petroleum consumption over the next 24 years, given the assumptions used to extrapolate the AEO’s “reference case”.

Over the past several decades, the U.S. has consistently consumed considerably more petroleum than it has produced. The difference has been imported, much of it from the Middle East. Since imports must be paid for, petroleum imports have resulted in a substantial drag on the U.S. economy. Further, securing continuing petroleum supplies from overseas has been a major determinant of U.S. foreign policy.

The graphic labeled “Net Energy Trade” illustrates that, in the years around 2006 – 2008, the U.S. imported amounts of petroleum equivalent to over 25% of its entire annual energy consumption, net of any petroleum exports!

Then something dramatic happened. U.S. domestic production increased rapidly from about 2010, resulting in a major decline in global petroleum prices. Accordingly, retail gasoline prices declined by about half during the last six months of 2014, resulting in boost to the U.S. economy that, in my opinion, triggered in the end of the Great Recession. Think of it this way: when a boatload of crude oil arrived in 2013 at $100+ per barrel, the U.S. shipped a boatload of greenbacks overseas in payment. By 2015, the price of crude was less than $50 per barrel and the number of boatloads imported dropped sharply. So, the U.S. shipped many fewer greenbacks overseas in payment. The rest stayed at home, within the U.S. economy. Since we are talking about millions of barrels every day, the difference really matters.

The Fracking Revolution

Fracking – petroleum and natural gas production by directional drilling plus hydraulic fracturing – is a truly remarkable technological innovation. Look again at the graph labeled “Energy Consumption”. Notice the rapid increase in natural gas consumption from 2010. That too is due to fracking. As a fuel, natural gas is complementary to petroleum. Petroleum fuels primarily transportation. Natural gas fuels mostly stationary consumption, including industrial uses, commercial and residential heating, and especially electric power generation.  

Natural gas is difficult and expensive to transport, other than by pipeline. Fortunately, the U.S. already had a domestic pipeline network in place as the huge increase in natural gas production due to fracking became available. Prior to the advent of “fracking”, global natural gas prices generally followed petroleum (crude oil) prices. The increase in natural gas supply in the U.S. resulted in natural gas prices that are not pegged to petroleum, and that are considerably lower than natural gas prices elsewhere.

Implications, Domestic and International

>> Energy Independence: Due to increased U.S. domestic production of petroleum and natural gas, the AEO 2017 projects that U.S energy exports will exceed imports by 2026, using “reference case” assumptions. That means that, if necessary, U.S. energy production would be sufficient to satisfy America’s energy requirements, without relying on OPEC or anybody else.

>> Industrial Economics: U.S. domestic prices for natural gas are substantially lower than elsewhere in the world. This provides U.S. industry with two competitive advantages in global trade. First, energy costs are low. Second, many important petrochemicals can be produced from natural gas, resulting in lower raw materials cost for many products.

>> Petroleum and Natural Gas Reserves: Fracking is used in geological formations that are different from those where conventional petroleum and natural gas production methods are used. That means energy production becomes possible in geographic areas where it is otherwise infeasible. It also means that the world’s potential reserves of petroleum and natural gas have increased substantially.

>> International Development: Fracking technology can and will be applied in other countries. Correspondingly, many nations that lack conventional petroleum or natural gas production may be able to become producers, thus reducing dependence on foreign sources and gaining a degree of freedom from global energy prices.

>> Cleaner Fuels: Petroleum produced by fracking is generally light and sweet. That means it is easy to refine, with few byproducts such as sulfur or heavy metals. Refining light, sweet crudes is relatively energy efficient. Accordingly, less carbon dioxide is produced when light, sweet crude is produced and consumed. Natural gas is even cleaner.

There is a lot more information worth discussing in the AEO 2017. Look for more posts on other AEO 2017 in the future.

Chuck - Blue SweaterThoughtful comments and experience reports are always appreciated.

…  Chuck Harrington (Chuck@JeraSustainableDevelopment.com)

This blog and associated website (www.JeraSustainableDevelopment.com) are intended as a resource for smaller manufacturers in the pursuit of Sustainability. While editorial focus is on smaller manufacturers, all interested readers are welcome.

[1] The AEO 2017 is available for free download on the Energy Information Agency’s website, www.eia.gov

[2] I use “extrapolations” rather than “forecasts” to emphasize that the AEO is projecting present and recent past information into the future based on certain assumptions. The “reference case” refers to a “business as usual” set of assumptions that do not anticipate government policy changes or technological innovations, other than those already in place.

[3] Note: U.S. annual primary energy consumption is about 100 quadrillion BTUs.


Competitiveness and the Trade Deficit

U.S. International Trade in 2014

“For 2014, the goods and services deficit was $ 505.0 billion, up $ 28.7 billion from $ 476.4 billion in 2013.”

“The 2014 increases in the goods and services deficit reflected an increase in the goods deficit of $ 35.2 billion (5.0%) to $ 736.8 billion and an increase in the services surplus of $ 6.5 billion (2.9%) to $ 231.8 billion.” [1]

Capture - Trade Deficit 3 These two charts present the same data two different ways. As you can see from the upper chart, export of goods from the U.S. continues to grow. Imports of goods, however, are growing faster, even though imports of petroleum (crude oil) are declining.

The lower chart expresses the same data as the ratio of imports to exports. For example, “150%” means that $1.50 worth of goods are imported into the U.S. for every $1.00 worth of goods exported from the U.S.


The Trade Deficit – So What?

Last year, the U.S. exported $ 736.8 billion worth of goods less than it imported. That’s a net of $ 736.8 billion worth of the U.S. domestic market for goods that U.S. producers did not supply.

But wait, it gets worse. Petroleum is “goods” and the U.S. imports a lot of petroleum. However, in 2014, U.S. domestic production of petroleum soared and the global price of petroleum dropped. The deficit in petroleum products decreased by $ 43.7 billion, compared to the 2013 figures. Factoring out the petroleum reveals that the deficit in manufactured goods increased by $ 76.8 billion (a whopping 17.2%) to $ 524.2 billion![2]

So what? A net of $ 524.2 billion worth of the U.S. domestic market for manufactured goods was lost to overseas producers last year. Robert Scott of the Economic Policy Institute writes: “Growing trade deficits in manufactured products have been a primary driver in the displacement of U.S. manufacturing jobs since 2000. Trade deficits in manufactured products, which have increased over the past five years, remain a substantial threat to the recovery of U.S. manufacturing employment and production.” [3]

Ambushed by the Obvious?

Trade deficit in manufactured products? The first thing that comes to mind is China. And the U.S. trade deficit with China is huge – last year, the U.S, imported $3.76 worth of goods from China for every $1.00 worth of goods the U.S. exported to China. Yeah, low labor costs, unfair this, unfair that – all probably true.

Capture - Trade Deficit Table

But wait, the U.S. is running trades deficits in goods with a lot of other countries too. The European Union shipped $1.51 worth of goods to the U.S. for every $1.00 worth the U.S. shipped to them. Germany alone shipped $1.67 worth of goods to the U.S. for every $1.00 worth that the U.S. shipped to them. The dollar value of goods imported from Japan last year were almost exactly twice the value of the goods shipped from the U.S. to Japan. Don’t be ambushed by the obvious — the problem isn’t just China, and it isn’t just labor costs.

U.S. manufacturing, as an industry, obviously has a competitiveness problem. But it isn’t a simple, “one fix cures all” sort of problem. After all, U.S. producers did export over $ 1.6 Trillion dollars worth of goods in 2014. And certain sectors, notably transportation, primary metals and fabricated metal products, did quite well.

Government policy changes can certainly help. [5] But, there is also a lot that individual firms can do to help themselves. Pareto’s law does apply. About 20% of the firms in any given sector are going to make about 80% of the profits – domestically and globally.

The Performance Curve

Take the manufacturing facilities in the United States and measure the performance of each. Then rank them, from best performing to worst performing: Capture - The Performance Curve

“Performance” refers to the ability to compete. The relative performance of manufacturing firms roughly follows Pareto’s principle: the familiar 80 / 20 rule. The performance of the best firms is as different from that of the rest as the performance of the best professional athletes is, compared to everybody else.

Viewing manufacturing performance in this way helps explain why so many manufacturing firms are fighting for survival, while a few others prosper. The high performing firms on the left side of the Performance Curve are different in kind from those on the right. It isn’t simply a matter of degree.

This difference in kind reflects the passing of a paradigm. The Industrial Era paradigm — the system of thinking that the Industrial Era embodied – is in the throes of being replaced. Manufacturers who embrace new ways of thinking can improve their performance and move toward the left side of the Performance Curve. [6] Those that don’t change can expect to continue to be squeezed toward the right.

Chuck - Sedona 2014Thoughtful comments and experience reports are always appreciated.

…  Chuck Harrington (Chuck@JeraSustainableDevelopment.com)

P.S: Contact me when your organization is serious about thriving in the globalized 21st century … CH

This blog and associated website (www.JeraSustainableDevelopment.com) are intended as a resource for smaller manufacturers in the pursuit of Sustainability. While editorial focus is on smaller manufacturers, all interested readers are welcome. New blog posts are published weekly.

[1] Source: U.S. International Trade in Goods and Services December 2014, U.S. Census Bureau Press release 5 February 2015. http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf

[2] Balance of Trade, Petroleum’s contribution data source: https://www.census.gov/foreign-trade/Press-Release/current_press_release/exh9.pdf

[3] Source: http://www.epi.org/publication/increased-u-s-trade-deficit-in-2014-warns-against-signing-trade-deal-without-currency-manipulation-protections/

[4] CY Trade Deficit (Goods) data source:  https://www.census.gov/foreign-trade/balance/c0004.html. Note:  International trade figures sometimes combine goods and services. Some report on a calendar year basis, others report on a government fiscal year. In international trade, manufactured goods constitute about 85% of trade in goods.

[5] The Information Technology and Innovation Foundation has much to say on government’s role. Start with A. Nager and R. Atkinson, The Myth of America’s Manufacturing Renaissance: The Real State of U.S. Manufacturing, Information Technology and Innovation Foundation, 12 January 2015   http://www.itif.org/publications/myth-america-smanufacturing-renaissance-real-state-us-manufacturing (Note: The Information Technology and Innovation Foundation is a non-partisan think-tank in Washington D.C.)

[6] Improving your firm’s competitive position is a primary theme to many of the essays posted to this blog. One good place to start is with Three Modes of Innovation, http://jerasustainabledevelopment.com/2014/11/29/three-modes-of-innovation/