All hail the new global oil champion. The Statistical Review of World Energy 2014 released recently by BP (NYSE: BP) raised some eyebrows by reporting that the U.S. has jumped over Russia and Saudi Arabia to regain its long-held, long-lost distinction as the world’s top oil producer. According to BP, U.S. oil production was 11.6 million barrels per day (bpd) in 2014, ahead of 11.5 million bpd for Saudi Arabia and 10.8 million bpd for Russia:


However, some have claimed the change in the standings is merely a function of the way the BP Statistical Review defines oil. The BP Statistical Review defines oil as “crude oil, tight oil, oil sands and natural gas liquids,” but excludes biofuels and liquid fuels produced from coal or natural gas. Oil consumption numbers do include all liquid fuels, and as a result the consumption volume reported in the Review are always above the reported production volume.

Much of the increase in U.S. oil production over the past decade is a result of increases in tight oil production in shale formations like the Bakken and Eagle Ford, and natural gas liquids (NGL) production from shale gas drilling in places like the Marcellus Shale. The question of whether the U.S. is now the world’s oil production champ hinges on the classification of NGLs.

NGLs are longer-chain hydrocarbons like ethane, propane and butane that are typically condensed out of natural gas during processing and sold separately. A typical composition of NGLs would be:

• Ethane (two carbon atoms; 35-55% of the total)

• Propane (three carbon atoms; 20-30%)

• Normal Butane (four carbon atoms; 10-15%)

• Isobutane (four carbon atoms; 4-8%)

• Pentanes and higher hydrocarbons, also called natural gasoline (five or more carbon atoms; 10-15%).

As a byproduct of the shale gas boom, U.S. NGL production has risen to 3.3 million barrels per day, the highest level in history and an increase of about 1.5 million bpd in the past five years. U.S. oil production has increased by 4.4 million bpd in the past five years, thus just over a third of the increase in U.S. oil production by volume can be attributed to NGLs.

Some have argued that NGLs shouldn’t be counted as oil, and therefore U.S. oil production is overstated. Their argument has two main points.

The first is that the energy content of NGLs is significantly lower than that of crude oil. One gallon of crude oil has an energy content of about 138,000 British thermal units (BTU). One gallon of NGLs has an energy content of some 100,000 BTUs. Thus critics argue that at best a gallon of NGLs delivers only about 70% of the energy in a gallon of crude. And on the basis of price NGLs are worth even less, trading at less than half of the price of oil for equivalent volumes over several years.

The second objection to counting NGLs as oil is that critics argue that NGLs aren’t interchangeable with oil. Crude oil has numerous uses — as feedstock for refined fuels, for example — that can’t be readily replaced with NGLs.

Both of these points are true, but I would offer up two pieces of information in response.

The first is that last month I had the opportunity to visit Robert Zubrin at Pioneer Energy in Colorado. Robert’s team is working on a number of interesting projects. They have a 2007 Chevy Cobalt that has been run on a number of fuels, including 100% methanol, as documented here. But Robert also modified the car to run on NGLs, which requires the same sort of conversion required to run a car on propane. He says he was able to achieve fuel efficiency comparable to that of gasoline, and that the car passed all of Colorado’s emissions tests. Thus, if a gallon of NGLs can replace a gallon of gasoline then it is effectively equivalent to oil.  

My second counterpoint is that  NGLs don’t have to replace all of the functions of oil to be considered oil-equivalent, so long as they displace some of the products made from crude. Again, consider the example of gasoline. The components of NGLs with a longer molecule than butane’s can be blended directly into gasoline. Butane can be blended in quantities up to about 10% in winter (but only about 2% in summer due to its high vapor pressure). Butane can also be processed into valuable gasoline blendstocks such as alkylates. Ethane and propane can be further processed to produce petrochemicals or used directly as transportation fuel.

So, should the U.S. really be getting credit for oil production as a result of the increase in NGL production? Yes, for the most part. A barrel of NGLs can replace most of a barrel of oil. It’s much more accurate to count NGLs as oil than it is to discount them as insignificant — which is effectively what some have done.

Industry is still responding to the shale revolution, but the response takes some time. The shale oil that is being produced is too light for many U.S. refiners, so it is presently trading at a discount to lower quality international crudes. And the NGLs that are the byproduct of shale gas production have overwhelmed the market, temporarily cratering the price. Both of these situations are likely to be temporary as the market reacts to the glut of these cheap feedstocks.

If NGLs continue to sell for half the price of gasoline, we will likely see more vehicles fueled with NGLs. We are already seeing chemical manufacturers respond to cheap NGLs by building new ethylene production capacity in the U.S. (Ethylene crackers use ethane — the largest component of NGLs — in the production of ethylene, one of the most important industrial chemicals in the world.) In the long run, the extent to which NGLs are used to displace oil will depend largely on their respective economics.

Conclusions

Returning to the initial question, did the U.S. become the world’s largest oil producer in 2014? Based on the definition BP uses, it did. But based on the energy content of the produced hydrocarbons, the answer is No. Had BP counted “barrels of oil equivalent” (BOE) instead of simply “barrels,” U.S. crude oil production would have been about a million BOE per day lower, because the 3.3 million bpd of NGL production would have counted as about 2.3 million BOE per day. Production figures for Saudi Arabia and Russia would have also been adjusted downward because they extract NGLs as well, but in not nearly the same volume as the U.S.

However, if we consider all energy production — which we will in an upcoming issue — the U.S. is the undisputed champion. The U.S. is the only country in the world in the top three in the categories of oil production, natural gas production, coal production, nuclear power production and renewable energy production.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Warren’s Game of MLP Thrones   

MLPs and other midstream energy processors have continued to suffer market losses of late, as the weakest hands among their investors consider slumping energy prices and conclude that the U.S. shale boom will prove short-lived.

But behind the scenes, the savviest industry insiders continue to bet on an eventual recovery.

That’s certainly been the case with Kelcy Warren, the Energy Transfer family’s boss who has staked his flagship Energy Transfer Equity (NYSE: ETE) MLP on a bid for rival Williams (NYSE: WMB).

Until recently, Warren not only couldn’t get Williams to discuss a merger offer that carried a notional 32% premium at the time of its disclosure last month, but wasn’t even allowed to participate in the bidding process initiated by Williams in that offer’s wake. Energy Transfer was told that it could not be involved unless it agreed not to contest the pending merger between Williams and its affiliate Williams Partners (NYSE: WPZ) or other decisions of the Williams board.

But late last week informal reports filtered out that Energy Transfer was in fact allowed to sign a confidentiality agreement giving it access to Williams data on equal terms with other interested parties, without promising to tie its hands in this manner.

That, in turn, suggests that Williams may be serious about maximizing its value. Its stock now trades above what it would fetch based on the price of ETE units at the proposed exchange ratio, hinting at the market’s growing optimism that something will get done.

Continue to hold any WMB shares not sold when we recommended cutting your position in half on the day Energy Transfer’s offer leaked. As for ETE, it remains a Best Buy below $75 as the premier builder of midstream value.

This commodity slump will eventually pass, but long before it does ETE should start to profit from the latest deal struck with its affiliate Energy Transfer Partners (NYSE: ETP), which gave up open-ended incentives in yet another affiliate, Sunoco (NYSE: SUN), in exchange for short-term cash flow benefits.

Warren is a master of intramural deals transferring long-term value to ETE, which accounts for the bulk of his enormous personal fortune.

Lately he’s shoveled more of his eggs into that basket, spending $63 million on ETE units two weeks ago after buying $19 million worth from a colleague in January, and $61 million in the market near October’s lows.     

— Igor Greenwald