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Monday, October 21, 2013

Lessons from US shale boom


Posted on 20 October 2013 - 08:22pm
Tan Siok Choo

PRICES possess tremendous transformative power.

Economists and Malaysian policy makers involved in crafting Budget 2014 who doubt the validity of this proposition should look at the US shale oil and shale gas boom – a tectonic shift in America's energy supply that could impact significantly the global energy market and the Malaysian economy.

Shale oil and shale gas are embedded within rock formations underground. Through a process called hydraulic fracturing or "fracking," a mixture of water, sand and chemicals are forced underground at high pressure to break up (or fracture) the rock and release the oil and natural gas trapped within the shale layers.

Shale gas enabled the US to overtake Russia as the world's biggest natural gas producer in 2011, Kevin Logan, HSBC Chief US economist, wrote in an article. And by 2020, the US should become a net exporter of gas, Logan predicts.

More significantly, rising output of shale oil and shale gas has enabled American to cede to China last month the unwelcome status of world's biggest net oil importer, data from the US Energy Information Administration show.

This energy revolution in the US was midwifed by elevated oil prices. After hitting a record high of US$145.16 on 14 July 2008, prices of West Texas Intermediate (WTI) tumbled to a low of US$34.67 on 18 February 2009 before resuming their climb to close at US$100.81 last Friday.

Leonardo Maugeri of Harvard University and ex-head of strategy at Italian oil company, Eni, predicts the shale boom could make the US the world's largest oil producer by 2017 with one caveat – oil prices must remain at US$85 this year and US$75 through 2015.

Although Malaysia can take comfort from the high oil price needed to sustain the US shale boom, the era of peak oil prices could be over.

"In the rich world, oil demand has already peaked: it has fallen since 2005. Even allowing for all those new drivers in Beijing and Delhi, two revolutions in technology will dampen the world's thirst for the black stuff," The Economist magazine warned.

The first revolution is fracking technology while the second is automotive technology. Improvements in automotive technology include more efficient internal combustion engines, lighter and stronger materials used to make more fuel-efficient cars and the growing popularity of electric and hybrids cars, the Economist writes.

Currently, there are approximately 115 million cars in China, the world's biggest market for autos. With the number likely to accelerate rapidly – one estimate suggests there could be more than 200 million cars by 2020, Beijing has recently mandated tough fuel consumption standards for cars – from 8.2 litres per 100km in 2008 to 5 litres per 100km by 2020.

Mindful its dependence on imported energy is a potential chokepoint, China is targeting to boost by 2015 its renewables capacity by 11.4% and to reduce energy consumption per unit of gross domestic product by 16%.

And for four successive years, China has been the global leader for wind energy, the country's third largest energy source.

Against this global backdrop, the list of things to do for Malaysian policy makers includes the following:

First, a greater proportion of Petronas' surplus funds should be invested in finding new oil and gas reserves in Malaysia and overseas.

Second, to encourage energy efficiency, the oil giant should be allowed to charge industrial users, including independent power producers, the actual cost of oil supplied.

Third, continuing to rely on a depleting asset for 40% of Federal Government revenue is neither economically justifiable nor sustainable in the medium term.

This means Putrajaya shouldn't persist in deferring the implementation of the Goods and Services Tax (GST) needed to broaden its tax base.

Fourth, although Prime Minister Datuk Seri Najib Razak has taken the bold step of partially reducing the petrol subsidy, Malaysia still remains the eighth cheapest place worldwide to buy petrol.

Opposition politicians may argue cutting the petrol subsidy would unnecessarily burden the average Malaysian.

Subsidised petrol prices will encourage smuggling as well as energy profligacy. As the US experience shows, high pump prices helped prod auto manufacturers to produce more energy frugal cars.

Fifth, if oil prices are likely to experience a structural decline soon, could palm oil see a similar price trajectory?

Using palm oil for biodiesel has linked the two commodity prices.

Increasing US output of shale oil and gas holds yet another lesson for Malaysian policy makers: the importance of allowing market prices – even if they escalate to skyscraper levels – to prevail.

One asset Malaysian policy makers consistently undervalue is employees. Allowing companies multiple postponements in implementing the minimum wage and to continue hiring large numbers of unskilled foreign labour is economically nonsensical. Not only will this dampen Malaysian wages, it will lock this country even more firmly to the middle-income trap.

Opinions expressed in this article are the personal views of the writer and should not be attributed to any other organisation she is connected with. She can be contacted at siokchoo@thesundaily.com

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