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ab
Wealth Management Research
June 2012
Energy self-su ciency boosts US economy and manufacturing competitivenessTransport and utilities evolving to make greater use of cheap natural gas
US to end dependence on OPEC and transition to renewables
UBS research focus
North American energyindependence: reenergized
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ContentsNorth American energy
independence: reenergized
01 Editorial
02 Highlights
04 Introduction
05 Chapter 1 Americas new energy diet: lean and green
16Chapter 2 Energy supply: too much is never enough
23 Chapter 3 Americas energy opportunity
30 Conclusion
31 Appendix
35 Glossary
Please see important disclaimer on the back page.
2 2011 Outlook
Publication details
PublisherUBS Financial Services Inc.
1285 Avenue of the Americas
New York, NY 10019
This report has been prepared by
UBS Financial Services Inc. (UBS FS).
Please see important disclaimer and
disclosures at the end of the document.
This report was published on
12 June 2012.
Authors(in alphabetical order)Ron Barone (UBS Investment Research)
Jerey Birnbaum (UBS Investment Research)
Nicole Decker
Joseph Kenol
Maryam Khan
George Lambertson
David Leowitz
Kurt Reiman
Christopher Sighinol (UBS Investment Research)
Andrew Sutphin
Jon Woloshin
EditorMarcy Tolko
Desktop PublishingGeorge Stilabower
Cognizant Group Basavaraj Gudihal,
Srinivas Addugula and Virender Negi
Project ManagementPaul Leeming
North American energyindependence: reenergized
Pipes at a natural gas processing
plant in Colorado signal expansion of
infrastructure and a boon to the US
economy.
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North American energy independence: reenergized June 2012 1
Dear readers,
The surge in crude oil and gasoline prices during the rst quarter of this year angered
consumers and politicians and served as an unwelcome reminder of our dependence on
energy. With no immediate relief available, US motorists had to dig deeper into their wal-
lets. However, a positive trend emerged: the sharp decline in the price of domestically pro-
duced natural gas enabled American households and businesses to save on their electricity
and heating bills.
The same technology that has unleashed an abundance of natural gas has also unlocked
previously unrecoverable supplies of crude oil throughout North America. For the rst time in
decades, the US has actually reduced its dependence on foreign energy sources a trend that
will likely continue.
This movement toward greater energy independence and use of inexpensive natural gas will
yield numerous advantages for the US economy, particularly as it boosts domestic manu-
facturing competitiveness and slows the ow of dollars overseas to pay for imported oil.
Moreover, the enormous infrastructure development needed to adequately service this evolv-
ing energy landscape should li investment spending and hiring in the oil and gas sector and
in other peripheral industries.
US natural gas is not only cheap relative to crude oil, it is also much less expensive than elsewhere
in the world. We expect power utilities, petrochemicals companies and eventually the transporta-
tion grid to use more natural gas. As high pump prices continue to crimp consumer spending,
Americans will shi to more fuel-efcient, electric and other alternatively powered vehicles.
But while dependence on foreign oil shrinks, energy security will remain out of reach as long
as renewables comprise such a small share of US energy consumption. However, we believe
greater energy self-sufciency and more aordable fuels also set the stage for further transi-
tion to renewable fuels down the road.
This edition of UBS research focus explores North American energy independence both the
obstacles and the opportunities. In an accompanying UBS research focus recommendations
report, we outline how sectors and companies could be aected by a move toward energy
independence. In addition to identifying investment opportunities for your portfolio so you
can capitalize on this theme, we also highlight the practical benets of greater energy self-sufciency on our daily lives, so the next oil price spike doesnt cause as much pain.
Editorial
Mike Ryan, CFAChief Investment Strategist
Head, Wealth Management
Research Americas
Kurt ReimanHead, Thematic Research
Wealth Management
Research Americas
Mike Ryan
Kurt Reiman
Nicole Decker
Nicole DeckerAnalyst
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2 June 2012 Themes
North America will likely achieve energy inde-
pendence by the end of the decade. The
American energy extraction techniques of hori-
zontal drilling and hydraulic fracturing com-
bined with a structurally high relative price of
crude oil has encouraged widespread devel-
opment of Americas energy resources. Natural
gas is so oversupplied in the US that develop-ers are curtailing production, while domes-
tic oil producers are working to circumvent
infrastructure bottlenecks to transport their
supplies to reneries. As a result, natural gas
in North America costs less than a h of the
cost of oil on an energy-equivalent basis.
Over the next several years, we expect:
Americas newfound energy resources
to provide a much-needed boost to US
economic activity, as the country con-
tends with the eects of widespread debt
deleveraging. UBS economists project a
roughly 0.5 percentage point intermediate-
term boost to US real GDP. The drivers
behind this growth spurt include explora-
tion, development and infrastructure invest-
ment, direct and indirect job growth from
energy extraction, and the windfall that will
likely accrue to households and businesses
from relatively lower-cost fuels.
Relatively inexpensive natural gas to
create a competitive advantage for the
US. This is another key factor supporting
our view that the US economy will experi-
ence a manufacturing renaissance through
the repatriation, relocation and expansion of
energy-intensive industrial operations. This
trend is especially powerful for the petro-
chemical and materials sectors.
US oil consumption to continue to
decline, as the comparatively high price of
oil will likely prompt drivers to switch to more
fuel-efcient vehicles and alternative pow-
ertrains, such as hybrids and electric vehicles.
Increased use of natural gas at power
plants that have long relied on coal. Naturalgas will also nd its way into the transpor-
tation fuel mix through use of compressed
natural gas and other natural gas technolo-
gies in eet vehicles, as well as through the
wall outlet for plug-in electric cars.
Demand for renewables to hinge on
government subsidies, which may come
under pressure in an age of heightened
austerity.
Intense pressure on the global energy
industry to keep pace with demand. The
Energy Information Administration projects a
58% increase in energy demand by 2035 on
account of rising consumption in emerging
market countries. Despite an increase in the
use of renewables, fossil fuels still account
for over 80% of the global energy mix; and
energy producers must race to even more
remote locations to secure supplies. In the
case of oil, many of these supplies are in the
hands of national oil companies, which evenfurther hinders supply security for countries
dependent on oil imports.
The US to eventually wean itself o
OPEC imports, through a combination of
lower oil demand, greater domestic pro-
duction and additional Canadian imports.
Not only will North America achieve greater
self-sufciency and energy independence,
North American energy
independence: reenergized
Highlights
2 June 2012 UBS research focus
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Reengergized
Energy June 2012 3 North American energy independence: reenergized June 2012 3
conict in the Middle East, will also encourage ashi away from imported oil from the region.
Fossil fuels will not go the way of the dinosaur
anytime soon, however. The US must continue
to pursue eorts to develop technology and
increase the availability of renewables in the
nations fuel mix to ensure maximum energy
security. True energy independence means con-
sumers can no longer be held hostage to either
the fuel suppliers or the supplies. To truly break
free of its tried-and-no-longer-true energy-
inefcient ways and means, the nation mustembrace renewable fuels the next step on the
path to complete independence.
but we expect the US will also become a netexporter of natural gas later this decade.
A lower structural trade decit to result
from a moderation in oil imports and an
acceleration in natural gas exports. Some of
the US dollars previously shipped overseas for
imported oil will now be spent on domesti-
cally produced energy or be freed up for
other spending because of inexpensive natu-
ral gas and expected efciency gains.
The trends we discuss in this report are pri-marily a function of market-based incentives
to change behavior. Energy policy, especially
eorts to reduce harmful pollutants, lower
greenhouse gas emissions and raise fuel ef-
ciency, will also spur changes in the fuel mix
away from oil and coal and toward natural gas.
Geopolitical events, especially the potential for
North American energy independence: reenergized June 2012 3
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4 June 2012 UBSresearch focus
The North American energy landscape has
been irreversibly transformed. Whereas US oil
and gas production once lay at the fringe of
the energy discussion, it now takes its place
right at the center. For the rst time in over a
decade, US energy production is rising thanks
to the formerly untapped potential of shale oil
and gas reserves.
New drilling techniques are behind a spec-
tacular rise in onshore activity all around the
US. The advent of horizontal drilling and
hydraulic fracturing has heralded a modern-
day gold rush of sorts. The number of hori-
zontal rigs at work in the US illustrates the
point. According to Baker Hughes, there
are 1,177 horizontal rigs currently working
onshore in the US. At the beginning of the
last decade, there were 48.
The shale revolution began with natural gas
early in the last decade. Where shale gas pro-
duction accounted for just 2% of the total US
natural gas production in the early 2000s, it
now represents more than 30%. The US had
been preparing to import more natural gas,
building several new port facilities along the
coasts. Now it looks as though the direction of
natural gas will reverse as the US transitions to
an exporter of natural gas.
For how long has US dependence on oil sup-plies from the Middle East been an American
pet peeve? The US is on track to eliminate
Introduction
Kurt Reiman, Head, Thematic Research Wealth Management Research; Nicole Decker, Analyst
imports from the Middle East by the end of
this decade. Oil production in the US has
risen by over 1 million barrels per day (b/d)
in the last ve years virtually all of this
from onshore production in the lower 48.
Surprisingly, North Dakota is now second on
the list of top oil producing states behind
Texas but ahead of Alaska.
All of this is good news for the US. But like any
story about energy, this one has its fair share
of caveats. Environmental concerns are chief
among them, but they are all surmountable.
America also heavily relies on fossil fuels. That
said, abundant supplies of shale gas now chal-
lenge the coal industry and raise the economic
bar for renewable technologies.
America is now reenergized. It is a story worth
following.
Due to the technical aspects of this
story, weve provided an informative
glossary of terms used in this report
starting on page 35.
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North American energy independence: reenergized June 2012 5
Addicted to oil
Since the early 1950s, the US has had to
increasingly rely on imports to meet its steadily
growing appetite for energy (see Fig. 1.1).
Nowhere has this been truer than in transpor-
tation: Although the US is mostly self-sufcient
in the energy used to power industrial, com-
mercial and electricity generation facilities,
Americas transportation network is over-
whelmingly dependent on imported oil to
shuttle around suburban commuters, fuel
larger cars and accommodate more drivers
and airline passengers.1 The reason: The vast
majority of US energy imports are in the form
of crude oil, and the nations vehicle eet is
almost entirely dependent on oil for power
(see Fig. 1.2 and Fig. 1.3).
Americas oil addiction has yielded numerous
disadvantages over the years. Most painfully,
Americans must once again contend with
higher prices at the pump an unwelcome
Americas new energy diet:
lean and greenAmericas newfound abundance of oil and natural gas comes amid
sharply higher global energy demand and structurally elevated oil
prices. As a result, important shifts are under way to diversify the US
fuel mix and improve e ciency. As transport becomes leaner, oil
consumption will decline. Meanwhile, eet vehicles will steadily use
more natural gas, as will power plants. Together with increased use
of renewables, the US is moving along the path to greater energysecurity and self-su ciency.
Kurt Reiman, Head, Thematic Research Wealth Management Research; Nicole Decker, Analyst
Note: Primary energy includes fossil fuels, nuclear electric power, and renewables.
Source: Energy Information Administration, UBS
Production
Consumption Net imports
Fig. 1.1: US energy deficit beginning to shrink
US primary energy balance, in quadrillion British thermal units (Btu)
100
80
20
0
20
40
60
120
1950 1960 1970 1980 1990 2000 2010
Source: Census Bureau, UBS
30
25
20
15
10
5
0
5
35
2000199019801970 2010
Other
PetroleumCoal
Natural gas
Fig. 1.2: Energy imports primarily in the form of petroleum
Net imports of various fuel types, in quadrillion Btu
Chapter 1
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6 June 2012 UBSresearch focus
burden when households are trying to burno mountains of debt accumulated during
the real estate boom (see Fig. 1.4). With plen-
tiful domestic reserves of cheap natural gas
and now-viable sources of oil, Americas reli-
ance on imported oil, especially from volatile
sources, seems all the more absurd. Therefore,
Americas energy challenge is to use this new-
found oil and natural gas as an opportunity to
achieve greater energy self-sufciency.
A conuence of powerful forces
But how? Many believe that the US can onlyachieve energy independence through a coher-
ent mix of energy policies and regulations. We
disagree. Although policies are important for
changing behavior and moving the country in
a new direction (see box on page 15),we think
economic and market-driven forces are the
primary catalysts behind America further capi-
talizing on its domestic energy resources. In
addition to economics and policies, geopoliti-
cal forces will also play an important role.
Economic and market-driven forces
Continued worldwide growth in energy
demand will deepen ongoing supply chal-
lenges. Rising emerging market oil consump-
tion, together with declining output growth,
has kept the oil price elevated. This dynamic,
which we expect will persist, bolsters the
development of costlier crude oil reserves to
meet rising global demand (see Fig. 1.5).
Onshore US energy reserves are transform-
ing the domestic energy industry. NorthAmerican energy resource discoveries and
advances in drilling technology, spurred by
structurally higher oil prices, have yielded
economically viable domestic and regional
supplies of oil and natural gas to meet a
larger share of the US long-term energy
needs.
Development of domestic energy reserves
creates jobs directly, but the deployment of
30
25
20
15
10
5
0
40
35
TransportationIndustrialCommercialResidential Electric power
Note: Electricity retail sales to ultimate customers reported by electric utilities and other energy
service providers. Total electricity system energy losses are calculated as primary energy
consumed by the electric power sector minus the energy content of electricity retail sales.
Source: Energy Information Administration, UBS
Nuclear
Petroleum
Electricity retail sales
Renewables Electricity system
energy losses
Coal
Natural gas
Fig. 1.3: Petroleum powers transportation and little elseEnergy consumption by major sector and fuel source, in quadrillion Btu, 2011
Note: Inflation-adjusted US city average retail price.
Source: Energy Information Administration, UBS
Fig. 1.4: Gasoline prices near generational highs
Real motor gasoline prices, in US dollars per gallon including taxes
4.5
4.0
2.5
2.0
1.5
1.0
0.5
0
3.0
3.5
5.0
1976 1980 1984 1988 1992 1996 2000 2004 2008 2012
Source: UBS
059 12011010090807060 120+
Cost of a marginal barrel of oil, in US dollars
Deepwater
Conventional
Oil sands
LNG & Gas-to-liquids
US shale oil
Unconventional gas/heavy oil
Fig. 1.5: Oil thirst prompts costlier reserve development
Oil production, in million barrels of oil equivalent per day, 2012
50
40
30
20
10
0
60
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North American energy independence: reenergized June 2012 7
Americas new energy diet: lean and green
relatively inexpensive natural gas (see Fig.1.6) oers a potential cost advantage to US
industrial and manufacturing businesses,
which would also indirectly support job
creation.
Not only is the US dependent on foreign
energy imports, Americans also have a rela-
tively higher dependence on energy in their
daily lives than people in other developed
countries.2 Continuing to improve energy
efciency in transportation, business and
household consumption is perhaps impera-tive in a debt-constrained economic envi-
ronment as a way of controlling costs and
maximizing income and productivity.
Policy forces
Deleveraging of balance sheets in the US,
and the resulting slow-growth environment,
shis the discussion toward policies that
promote jobs and investment in the natu-
ral resources sector, as well as policies that
appropriately weigh both the costs and ben-
ets of environmental concerns.
Central banks are likely to keep monetary
policy accommodative for as long as pos-
sible during this era of deleveraging, which,
all else being equal, could bolster the price
of oil and other commodities. In addition to
supporting the development of unconven-
tional reserves in North America, structurally
high oil prices promote enhanced efciency
measures and advances in renewables
technology.
The US has shouldered a gaping trade decit
for decades the principal components of
which are decits with China and oil-export-
ing countries (see Fig. 1.7). To the extent that
a persistent and large trade decit is seen as a
weakness, policymakers may support eorts
to bring the trade decit closer to balance
through reduced imports of crude oil and
exports of natural gas.
Source: Energy Information Administration, UBS
West Texas Intermediate crude oil
Henry Hub natural gas
20
15
0
5
10
25
Fig. 1.6: Natural gas inexpensive relative to oil
Natural gas and crude oil prices, in US dollars per million Btu
1997 2000 2003 2006 2009 2012
Source: Bureau of Economic Statistics, UBS
China goods trade balance
Oil trade balance US goods balance
1
2
7
5
6
4
3
0
20021999 2005 2008 2011
Fig. 1.7: US trade deficit remains uncomfortably wide
US trade deficit and its constituents as a share of US GDP, in %
Source: BP Statistical Review of World Energy 2011, UBS
0
20
15
10
25
5
France
Canada
Germany
Japan
India
Russia
US
China
Brazil
Fig. 1.8: Substantial energy demand growth in China and India
Share of global primary energy demand for selected countries, in %
1990 2010
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8 June 2012 UBSresearch focus
Chapter 1
Geopolitical forces A geopolitically sensitive period highlights
the need for greater energy self sufciency
(see the July 2010 UBS research focus,
Geopolitics: the blind side). Geopolitical
instability and concerns about supply inter-
ruptions, particularly in the Middle East,
have added to the price pressure and vola-
tility in oil markets, which are likely to per-
sist.3 Although there is no practical way to
completely insulate the country from these
shocks, since oil prices are set in global mar-kets, reduced dependency on volatile supplies
would likely soen the economic impact if
crisis erupts. Therefore, North America has an
incentive to become energy independent and
bring new reserves onboard.
The US faces structural competition for
energy resources from fast-growing, highly
populated emerging market countries, espe-
cially China and India (see Fig. 1.8). Both the
Energy has been plentiful and cheap for so
long, especially compared to human eort,
that we now take it for granted. Not only do
we use it in ways that are highly inefcient,
we assume that producers will supply more
of it consistently over time to meet our needs.
However, there are no guarantees that future
energy supplies will be available in sufcient
quantities and at an aordable price. Aer all,
only about 13% of global energy consump-
tion in 2010 was renewable, according to
ExxonMobil (see Fig. 1.9).4
The amount of energy the world consumes
today is simply staggering. Putting this amount
of energy in a way that can be easily grasped
is a difcult exercise. But perhaps the following
examples can help:
To show just how far society has departed
from early civilization, we calculated how
long it would take for people to generate
the equivalent of todays annual energy con-
sumption. Scientists have estimated that the
average person produces energy at a sus-
A growing global appetite for energy
Biomass/Waste 9.1%
Hydropower 2.3%
Wind/Solar/Geothermal/Other 1.3%
Source: ExxonMobil, UBS
Fig. 1.9: A small slice of energy demand is renewable
Renewable energy share of global final energy consumption, in %, 2010
Nuclear 5.5%
Fossil fuels 81.8%
Renewables 12.7%
12.7%
8 June 2012 UBS research focus
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North American energy independence: reenergized June 2012 9
Americas new energy diet: lean and green
North American energy independence: reenergized June 2012 9
tained rate of one-tenth of a horsepower.5
We estimate that it would take the worlds
4.3 billion working-age people almost 250
years to produce the amount of energy con-
sumed globally in just one year.
Global consumption of fossil fuels (coal,
natural gas and crude oil) is equivalent to
approximately 210 million barrels of oil per
day.6 It would require the daily oil produc-
tion of 19 Saudi Arabias the worlds larg-
est oil producer just to reach one day of
the worlds oil demand.
The Alaska National Wildlife Refuge (ANWR)
holds 10.4 billion barrels of oil (the midpoint
estimate of recoverable oil reserves).7 This
resource would be depleted in just over a
month and a half by the worlds energy
demand. In other words, if taken in isola-
tion, the global energy industry would needto discover a eld the size of ANWR every
50 days just to meet the worlds energy
needs as expressed in oil terms.
Despite the already enormous appetite for
energy, most forecasts call for a sustained
increase in worldwide energy demand over
at least the next decade. The US Energy
Information Administration (EIA) projects
global primary energy demand will growSource: Energy Information Administration, UBS
800
700
600500
400
300
200
100
0
1990 2000 2008 2015 2020 2025 2030 2035
OECD
Non-OECD
Fig. 1.10: An insatiable appetite for energy
Global primary energy consumption, in quadrillion Btu
53% between 2008 and 2035.8 Importantly,
the appetite for energy among developed
countries is poised to level o while energy
demand in emerging markets will likely grow
strongly alongside rising incomes and growing
populations. The question is more about just
how fast energy demand will grow in emerg-
ing markets. For now, the EIA expects energy
demand within Organisation for Economic
Co-operation and Development (OECD)
countries to expand by only 18%, whereas
consumption is forecast to grow 85% in non-
OECD countries (see Fig. 1.10).
US and China will seek to secure energyresources from overseas, and also look to
develop domestic resources, whether they
be renewable or traditional fuels. Since both
are so heavily dependent on foreign suppli-
ers, greater energy security for both nations
would not only limit the potential for geo-
political conict, but could pave the way
for more stable global economic growth. In
fact, Chinas thirst for energy could present
an opportunity for cooperation if US compa-
nies were able to license their shale oil andgas extraction technology to enable Chinas
domestic production.
US energy independence?
Has Americas energy decit grown so large
that US energy independence is simply out
of reach? Probably, but another strain of this
theme North American independence
seems attainable. The path involves some com-
bination of the following:
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10 June 2012 UBSresearch focus
Chapter 1
Reduced crude oil consumption throughthe development of substitute vehicle pow-
ertrains and fuels, improved automotive ef-
ciency and less overall demand
Increased domestic production of crude oil
and natural gas
Improved infrastructure for the transport and
use of North American natural gas and crude
oil in the form of reneries, pipelines and lling
stations, as well as changes and improvements
to electricity generation and distribution, suchas the build-out of smart grids
Increased use of renewable fuels through
technological advances and cost reductions
Before diving into the supply side of the
energy equation, we will rst take a look at
how demand shis can enhance US energy
self-sufciency.
A leaner, greener path lies ahead
US demand is likely to remain anemic over the
next several years, thanks to a protracted phase
of domestic debt deleveraging, slowing popu-
lation growth, improved auto fuel efciency,
increasingly efcient industrial operations, and
structurally high oil and gasoline prices (see Fig.1.11). In fact, aer years atop the global energy
consumption charts, the US slipped to second
place in 2010, with China overtaking the number
one spot (see Fig. 1.12).
Weaker US energy demand growth makes North
American energy independence all the more
possible, while strong emerging market demand
makes it all the more necessary. In our view, the
demand channels that will have the greatest
eect on improving US energy security are
Energy substitution from both oil and coalto natural gas, as well as from fossil fuels to
renewables
Energy efciency
Energy substitution: oil to natural gas
The transportation sector oers the greatest
potential for oil-to-natural-gas substitution.
Although low natural gas prices and high gaso-
line prices make this an obvious candidate for
switching, relatively few customers have made
the transition (see Fig. 1.13). While competi-
tive on the basis of price, natural gas demand
within the transportation grid is unlikely to take
o without distribution networks, refueling
facilities and vehicle engine retrots.
Fig. 1.12: China surpasses US as worlds largest energy buyer
Source: BP Statistical Review of World Energy 2011, UBS
Primary energy consumption, in quadrillion Btu
100
80
60
40
20
0
120
US
China
1965 1980 1995 2010
Fig. 1.11: Much less growth in US energy demand than in the past
Note: Shaded area indicates EIA forecasts.
Source: Energy Information Administration, UBS
10-year change in US primary energy consumption, in %
50
40
30
20
10
0
10
60
10-year change
Historical average
1960 1990 20001970 1980 2010 2020 2030
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North American energy independence: reenergized June 2012 11
Americas new energy diet: lean and green
Geopolitical
instability and
concerns about
supply interrup-
tions, particular-
ly in the Middle
East, have addedto the price pres-
sure and volatil-
ity in oil markets,
which are likely
to persist.
For now, most of the oil-to-natural-gas vehicle con-version activity is taking place among companies and
municipalities that can refuel vehicle eets at a central
location. Still, the cost to convert a garbage truck or
a bus to run on natural gas is high, and the payback
period might run up to seven years at todays prices.
The federal government proposed oering tax credits
for eet vehicle conversion in the Natural Gas Act of
2011, which the Senate has not yet approved.
We expect the trend to cleaner-burning, lower-
cost natural-gas-powered vehicles to continue.
Infrastructure development will bring wideracceptance. In anticipation of a more compre-
hensive refueling network, some car manu-
facturers have begun to roll out vehicles that
run on natural gas. The economics are better
on new cars. While they cost more than their
gasoline-powered counterparts, the dierence
in price, about USD 5,000, is less than it would
cost to retrot an older vehicle.
Looking ahead to the potential oil demand
impact, if 10% of the nations car and truck
eet is converted to run on natural gas, we esti-
mate this could reduce oil consumption by one
million barrels per day (b/d), or 5%, based on
average 2011 US oil demand.
As we wrote in The Decade Aheadin February2011, one of the virtues of electric cars is that
they can tap into a much more diversied fuel
mix, including natural gas, and some are even
able to run on conventional gasoline. It remains
to be seen if the electric vehicles will coexist
with natural-gas-powered cars, or whether one
will win out. In these early days, we expect car
companies to continue rolling out models in
both formats, as each appears to be growing in
acceptance among consumers.
Energy substitution: coal to natural gasUS natural gas use has been growing steadily
in electric power generation (see Fig. 1.14).
This increased demand comes at the expense
of coal, another domestic fuel source (see Fig.
1.15). The drivers of new demand for natural
gas in the utility industry will be a conuence of
economic and political forces.
As prices have declined, natural gas has
become more cost-eective to burn than coal.
Because coal tends to compete with natural
gas as the marginal fuel to produce electric-
ity, run-times at coal plants have declined in
favor of more cost-eective natural-gas-red
generation.
Fig. 1.13: Alternative vehicles a small share of US fleet
Source: Alternative Fuels and Advanced Vehicles Data Center,
Bureau of Transportation Statistics, UBS
Alternatively powered light vehicles by fuel source, in % of total
0.4
0.3
0.2
0.1
0
0.5
Liquefied petroleum gases
Liquefied natural gas
85% ethanol (E85)Compressed natural gas
Electricity
Other
1996 1998 2000 2002 2004 2006 2008 2010
Source: Energy Information Administration, UBS
Residential
Industrial
Commercial
Electric power Transportation
6
4
2
0
810
12
200019901980197019601950 2010
Fig. 1.14: Power generation a growing consumer of natural gas
US natural gas consumption by sector, in trillion cubic feet
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12 June 2012 UBSresearch focus
Chapter 1
This shi, commonly called coal-to-gas switch-ing, has hurt coal demand in the US, particu-
larly in the Eastern US. Generally, coal-red
plants in the East consume Appalachian
coal, which is more expensive than other
coals. Burning coal for power generation has
become uneconomic versus natural gas at
many plants in the Eastern US. In the Western
US, power generation plants tend to burn
Powder River Basin (PRB) coal, which is lower
quality but less expensive and, as a result,
more competitive with natural gas. Assuming
xed prices (including delivery costs) of USD83 and USD 35 a ton for Appalachian and PRB
coal, respectively, we estimate that gas-red
plants will continue to win market share at
the expense of coal plants when gas prices are
below USD 4.50 per million British thermal unit
(mmbtu), whereas PRB coal-red plants can
remain competitive as long as gas prices stay
above USD 3.00/mmbtu.
In addition to economic signals, changes
to the utility fuel mix are also policy-driven.
Environmental Protection Agency (EPA)
rules, particularly the Mercury and Air Toxics
Standards, will require coal-red power plants
to install costly environmental retrots by
2015. For some older, inefcient plants, the
useful lives and run-times of the facilities will
not be long enough to recover the costs ofthe upgrades, which will force operators to
close roughly 3% to 5% of the existing US
power supply. The gap will likely be lled by
natural gas plants, boosting its share of the
energy mix.
The EPA has also proposed new-construction
performance standards, which aim to limit
carbon-dioxide emissions from new fossil fuel
generators. While it has not been nalized,
and natural gas economics have essentially
achieved it already, the rule eectively preventsany new construction of coal-red plants.
We project coal demand to decline in the US,
albeit at a slower pace than we have seen in
the recent past. With natural gas prices argu-
ably having bottomed, the majority of the
coal-to-gas switching has already occurred.
In the future, the shi will likely be dictated
by environmental mandates and occur more
gradually.
Worldwide, coal will remain an important
energy resource for the foreseeable future, as
it plays a prominent role in meeting demand
for the emerging economies. Despite its envi-
ronmental shortcomings, coal is abundant,
aordable and safe. Therefore, in a supply-
Source: UBS
Natural gas
Coal
Wind Other
Nuclear Hydropower
30
20
10
0
40
50
60
2015
UBS forecast
201020052000 2020
Fig. 1.15: Natural gas to displace coal in power generation
Share of electric power generation capacity by fuel type, in %
Source: World Bank Commodity Price Data (Pink Sheet), UBS
Europe natural gas
US natural gas Japan liquified natural gas
1614
12
0
4
2
10
8
6
18
1980 1990 2000 2010
Fig. 1.16: US has a comparative advantage in natural gas
Natural gas prices, in US dollars per mmbtu
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North American energy independence: reenergized June 2012 13
Americas new energy diet: lean and green
constrained world, it is a necessary energysource until a viable alternative becomes avail-
able. Natural gas economics outside of North
America are far less attractive, with consumers
in Europe and Asia Pacic paying three to four
times the North American price per unit (see
Fig. 1.16). Coal demand will likely grow world-
wide through the end of this decade, though
growth in demand may be slower than in the
past due to increased use of renewables such
as wind, solar and in some regions, nuclear.
Energy substitution: from fossil fuels torenewables
When it comes to energy independence, the
key advance for renewables will be a type of
biofuel that nally succeeds in displacing crude
oil used in transportation.
Federal policy sets required levels of biofuel
to be blended into the conventional gaso-
line pool. First introduced in the 2005 Energy
Policy Act, the 2007 Energy Independence and
Security Act introduced standards for two cat-
egories of renewable transportation fuels: one
standard for the total volume of renewable
fuels, and a second standard for advanced bio-
fuels, such as cellulosic ethanol. The standard
renewable fuel, ethanol, is primarily used as a
blendstock in the national gasoline pool. It cur-
rently represents approximately 10% of the US
gasoline pool, and is now bumping up against
a blend wall, where car engines must be
altered to run on gasoline with a higher etha-
nol component.
The Environmental Protection Agency (EPA)
currently allows up to 10% ethanol, which will
cap growth in the use of ethanol in the gaso-
line pool. While the EPA has been petitioned
by the ethanol industry to raise the allowable
ethanol level to 15%, which was granted on
a limited basis for use in newer vehicles, many
retailers are unequipped to dispense the higher
blend. Most automobile manufacturers war-
ranties cover use of blends of up to 10%. For
now, we expect limited growth in the use ofstandard renewable fuels within transport.
Researchers continue to hold out hope for a
breakthrough in advanced biofuels production.
These fuels would be derived from sustain-
able feedstocks, such as low-nutrient, high-
yield crops or waste from the agricultural and
forestry industries. However, the technology
remains immature, and advanced biofuels are
not yet commercially viable.
Energy efciency: policies and fuel costs sup-port more efcient transport
According to Energy Information Agency (EIA)
data, US gasoline demand has declined by
over 500,000 b/d from peak 2007 levels (see
Fig. 1.17). Much of this decline is attributable
to a higher level of unemployment, with fewer
people driving to work, and other factors
related to soer economic activity. However,
we believe some of this demand destruction is
also attributable to higher efciency standards
and consumers growing preference for fuel
economy in the face of high and volatile gaso-
line prices.
Source: Energy Information Administration, UBS
8
7
6
10
9
2005200019951990 2010
Fig. 1.17: Steady decline in US gasoline demand
US motor gasoline supplies, in million barrels per day
Weaker US
energy demand
growth makes
North American
energy indepen-
dence all the
more possible,
while strong
emerging mar-
ket demand
makes it all the
more necessary.
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14 June 2012 UBSresearch focus
alone, if all vehicles on the road were sub-ject to 2016 standards, we estimate the rules
would reduce consumption by approximately
one million b/d, or 5%, based on 2011 US
oil demand. If the proposed rules for future
years go through, the estimated reduction in
oil consumption would rise to over two million
b/d by 2020, or nearly 11%.
All energy sources needed to meet future
demand
As global energy demand continues to grow,
the world will face ongoing energy challenges.Planning for this eventuality is therefore critical.
From a practical perspective, the only viable
way to ensure a secure and sustainable energy
future is to diversify away from what is now a
predominantly nonrenewable, hydrocarbon-
based energy supply pool.10
The US is relatively well-positioned for the
near term, thanks to new supplies of oil and
natural gas. However, now would be the
time for the US to secure its long-term energy
needs by investing in clean, aordable and
sustainable fuels. This is paramount if the US
is to make a more sustainable transition to
true energy security.
Americans love big cars and light trucks. Butwhen fuel prices are high in the US, there
is typically a shi from large, gas-guzzling
vehicles to more fuel-efcient ones. Indeed,
according to data published by The Wall Street
Journalfrom market analysis website, Motor
Intelligence.com, in the year-to-date through
May, sales of large cars in the US are down
89%, while small and midsize car sales have
risen 21% and 17%, respectively, compared
to the same period in 2011. Likewise, sales of
large sport utility vehicles (SUVs) have fallen
by 2%, while small SUV sales are up 29%.However, it remains to be seen if these trends
are permanent.
Federal mandates also support more fuel-
efcient cars and trucks. Corporate Average
Fuel Economy (CAFE) standards are a sales-
weighted average fuel economy, measured
in miles per gallon (mpg), of the passenger
cars or light trucks in a car manufacturers
eet (see Fig. 1.18). Current CAFE standards
require that vehicles meet an average 29.8
mpg in 2012, rising to 34.1 mpg by 2016
(formerly 2020).9 Beyond 2016, proposed
standards would be increasingly stringent, ris-
ing to 38.8 mpg by 2020 and 49.6 by 2025.
These rules will reduce the amount of gasoline
Americans consume. In the 2012-2016 period
Note: Shaded area indicates projections.
Source: International Council on Clean Transportation
California
US
EU
Canada
Japan
Australia
South Korea
China
40
30
20
50
60
70
20202015201020052000 2025
Fig. 1.18: Countries pushing improved automotive efficiency
Miles per gallon for light-duty vehicles, normalized to US CAFE test cycle
Chapter 1
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North American energy independence: reenergized June 2012 15
Americas new energy diet: lean and green
Broadly, there are two approaches that policy-
makers can use to alter the energy mix: Make alternatives more aordable and
accessible
Discourage demand for conventional fuels
We believe the most eective energy policy is
one that borrows from both approaches, but
it needs to be carefully managed. It is unpro-
ductive and even detrimental to make one
particular resource unaordable if there is no
alternative choice, and vice versa.
Policy to increase the supply of alternativefuels and technologies
Market-driven change is inuenced by price,
which determines demand. For policymak-
ers, the temptation is to subsidize alternatives
so that they are economically competitive
with the prevailing infrastructure. Today, wind
power, solar photovoltaic and electric cars
are all subsidized and none are yet cost-com-
petitive. While the intention is to wean these
businesses o subsidies as technical progress
is made, this is easier said than done. There is
less urgency for businesses and consumers to
improve processes and lower costs so long as
they are protable. Meanwhile, the govern-
ment becomes stuck in a trap, as pulling sub-
sidies prematurely would cause prices to rise,
which would hurt consumers.
Direct government support for research is
another route, leaving it to the business com-
munity to determine how to compete in the
marketplace. However, this requires a high
level of commitment from the government,particularly since funding for these types of
projects can oen come under pressure when
there are budget cutbacks.
Policy to dampen demand for
conventional fuels
As the adage goes, The best source of new
supply is conservation. In this regard, there is
a lot of low-hanging fruit in the US.
One way to reduce energy demand is through
programs that promote energy efciency andconservation, such as the CAFE standards
discussed earlier. Energy-efcient appliances
and light bulbs are now mandated as well.
However, it is curious, especially given that
high energy costs periodically reduce house-
hold discretionary income, that forced
conservation seems to be the only proven
long-term eective way to get most Americans
to conserve.
A far more controversial policy to lower
demand is to impose taxes, fees and mandateson certain fuels. Such is the case, for instance,
with the EPAs coal mandates, which require
expensive upgrades to coal plants to avoid
costly penalties. It was also the idea behind
the recently proposed carbon dioxide cap-
and-trade system, which did not get passed
because of concerns that trading schemes can
be complex, bureaucratic tools for social engi-
neering that may also cause unintended eco-
nomic hardship.
For this reason, some policymakers favor a at
tax. Gasoline and diesel fuel taxes are a type of
at tax. Though not a popular idea, some poli-
cymakers in the US favor a higher gasoline tax
to curb demand and fund alternative research.
In Europe, consumers paid roughly USD 5.87
per gallon for gasoline in 2010, which included
USD 3.80 in taxes, versus the average price
in the US of USD 2.84/gal, which included a
combined state and federal tax of an average
USD 0.45.11 The US federal tax is only USD
0.184/gal and has not been increased since1993. The implications are obvious: US drivers
pay among the lowest taxes for the developed
world and drive cars with low fuel economy,
whereas Europeans drive smaller, more fuel-
efcient cars.
How policy can alter the energy equation
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Energy pursuits: access, technology and
knowhow
The energy industry has steadily evolved
through innovation and ingenuity. Technical
improvements have enhanced environmental
protection, and production has grown more
efcient to optimize available reserves. The
2010 BP disaster was a sober reminder of the
risks and dangers of oil and gas exploration.
However, in the early 1900s, oil gushers, such
as the famous Spindletop well in Texas, were
routine. They coated the countryside with mil-
More energy: an intense challenge
For decades, Americans have taken energy for
granted. This is changing as oil prices remain
well above historical averages, partly reecting
sti competition for supply from developing
economies.
The increase in price is an unwelcome
reminder that oil and gas resources are neither
renewable nor recyclable. For every unit of
oil and gas consumed, another unit must be
found to replace it. Not only are the quantities
already enormous, but the world consumes
more energy year aer year.
The challenges appear greatest in the oil
markets. We have heard the phrase:All the
easy oil has been found. It is true. Oil produc-
ers have had to extract resources from pro-gressively difcult-to-reach places to satisfy
rising demand. This has increased the costs
of extraction which are, in turn, passed on to
consumers. We estimate the marginal cost of
a barrel of crude has risen from USD 22 per
barrel (bbl) 12 years ago to at least USD 80/
bbl today (see Fig. 2.1).
Energy supply: too much is
never enoughRevolutionary extraction techniques will raise US oil and natural gas
production at a time when the world faces structural energy supply
challenges. Higher domestic oil production and greater imports from
Canada can help end Americas dependence on unstable suppliers.
Although America will remain dependent on fossil fuels throughout
the decade, the US will continue to pursue eorts to increase the
availability of renewables in the nations fuel mix.
Nicole Decker, Analyst
Chapter 2
Note: Marginal costs include exploration, development, production, taxes, transportation,general and administrative; and estimated gross up needed for operators to earn a 10% rateof return.
Source: UBS
50
40
30
20
10
0
60
80
70
2000 20022001 2010 2011 2012E2008 20092006 20072004 20052003
Fig. 2.1: Extracting difficulties drive up marginal cost of oil
Estimated marginal cost of worldwide oil production, in US dollars per barrel
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North American energy independence: reenergized June 2012 17
Energy supply: too much is never enough
unied voice on oil industry issues. As the USbecame a net importer of crude oil in the early
1970s, OPEC had gained a dominant position
in world oil markets and an ability to inuence
oil prices (see Fig. 2.3). Sometimes it exercised
its inuence in ways that undermined global
growth. For example, in October 1973, OPEC
initiated an embargo (to protest US and other
Western nations support of Israel during
the Yom Kippur War). In a matter of weeks,
world oil prices tripled. In 1979, the Iranian
Revolution ravaged many of Irans produc-
ing elds. Until 2008, this was the highestlevel ever for oil prices in real terms. Since that
time, the US has sought to reduce its depen-
dence on OPEC oil supplies.
OPEC has moved away from the role of a car-
tel to that of the worlds swing producer.
The organizations self-appointed task is to
alter production through a quota system to
balance world oil supply and demand (see Fig.
2.4). However, the aw in OPECs stated mis-
sion is that it conicts with an economic moti-
vation to optimize the revenues generated by
its resources.
Most OPEC nations have little industry other
than oil, and are dependent upon oil revenues
lions of barrels of oil, wasting natural resourcesand causing long-lasting environmental dam-
age. The invention of the blowout preventer in
the 1920s was an important technical develop-
ment for the industry and remains so today.
Oil exploration now entails sophisticated sub-
surface imaging, elaborate calculations and
highly specialized equipment that help uncover
resources in increasingly remote and precarious
places. Still, the worlds proved oil reserves rep-
resent less than 50 years of supply, based on
current oil demand levels.
Whats more, oil reserves in most of the
Organization of the Petroleum Exporting
Countries (OPEC), as well as some other large
non-OPEC suppliers are o limits to interna-
tional exploration and production companies.
Approximately 70%-80% of current world
reserves are controlled by national oil compa-
nies or sovereign-owned companies (see Fig.
2.2). As a result, a large portion of the worlds
oil supply is tightly controlled by countries
whose interests are not necessarily aligned
with that of energy consumers.
OPEC: supply constraints
OPEC was formed in 1960 to provide a large,
Note: Excludes Canadian oil sands.
Source: BP Statistical Review of World Energy 2011, UBS
Libya3.4%
Nigeria2.7%
Venezuela15.3%
Iran9.9%
Iraq 8.3%Kuwait7.3%
UAE7.1%
Saudi Arabia19.1%
Angola1%
Algeria0.9%
Qatar1.9%
Non-OPEC22.8%
Ecuador0.4%
Fig. 2.2: OPEC holds the lions share of current world reserves
Share of total proven crude oil reserves by country, in %, 2010
Note: Shaded areas represent supply shocks.
Source: BP Statistical Review of World Energy 2011, Energy Information Administration, UBS
Inflation-adjusted crude oil price, in US dollars per barrel (rhs)
Annual change in global oil supply, in million barrels per day (lhs)
0
1
4
3
2
5
43
2
1
6
0
100
80
60
40
20
120
1970 1980 1990 2000 2010
Fig. 2.3: Supply shocks induced oil price spikes
Annual change in global oil supply Inflation-adjusted crude oil price
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where oil and gas have not been previouslyexplored for or produced. These hard-to-reach
places include Arctic regions, deep below salt
layers (subsalt) and oshore in ultra-deepwa-
ter. Just as in the past, we believe this next
generation of exploration could be crucial to
future world supplies. The difculty and high
cost of extracting this oil will likely keep global
oil prices elevated, and this oil will only be
exploited if prices are high.
Oil: ending OPEC imports
Given all the constraints on global oil produc-tion, we think Americas shale oil and gas revo-
lution is truly a game-changing development.
In particular, we think the development of this
energy resource will free the US from reliance
on OPEC crude oil by 2020 and enable the
nation to become a net exporter of natural gas
even sooner. While the decline in oil consump-
tion discussed in Chapter 1 provides the US
with some additional energy security, there are
two supply-related trends that will likely con-
tribute to independence from OPEC:
Rising US oil and natural gas production
Increased oil imports from Canada
Imports of 8.9 million b/d accounted for 59%
of the total crude that the US input into its
reneries in 2011. Of this, Canada and Mexico
to fund social and government programs. Asa result, most OPEC nations and other sover-
eign-run oil companies tend to underinvest
in their own oil industries to preserve their
resources investing only enough to support
production that will satisfy internal govern-
ment funding needs.
Failure to maintain a comfortable cushion in
spare capacity has caused the market to lose
condence that OPEC is able to raise produc-
tion to meet rising global demand. This con-
cern is exacerbated when civil unrest, such asthe uprisings in Libya and Nigeria, and poten-
tial military action, such as in Iran, threaten
to remove millions of barrels of production
and capacity from world markets. With spare
capacity already depleted at 3.1 million barrels
per day, a major event would nearly wipe out
OPECs spare production capacity.
Beyond OPEC: another technological leap
under way
Even the best oilelds can only produce for
so long. Many of the world-scale basins that
have served for decades, such as the North
Sea, are mature, and production is now taper-
ing o (see Fig. 2.5). With limited access to
new resources because of nationalization,
operators are turning to frontier regions
Chapter 2
Source: Energy Information Administration, UBS
Brent crude oil price, in US dollars per barrel (rhs)
OPEC crude oil production, in millions of barrels per day (lhs)
33
31
25
27
29
35
37
80
60
0
20
40
100
120
140
20102006200219981994
Fig. 2.4: Oil prices sensitive to OPEC production
OPEC crude oil production Brent crude oil price
Source: Energy Information Administration, UBS
3
2
1
0
6
5
4
7
200520001990 199519851980 2010
Norway
UK
Fig. 2.5: North Sea oil production in steady decline
Oil production in Norway and the UK, in thousand barrels per day
Given all the
constraints
on global oil
production, we
think Americas
shale oil andgas revolu-
tion is truly a
game-changing
development.
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North American energy independence: reenergized June 2012 19
Energy supply: too much is never enough
as exploration continues in other plays, includ-ing the Permian Basin in Texas, the Monterrey
shale in California and the Denver-Julesburg
Basin in Colorado.
We believe the Gulf of Mexico has been over-
looked as activity was halted by the drilling
moratorium following the tragic Macondo
accident in 2010. Oil production in the Gulf
of Mexico declined by 15% (234,000 b/d)
in 2011. The moratorium has been lied, as
regulators and operators have stepped up
standards to help ensure safer operations. Thepermitting process has resumed, and explora-
tion and development activity is expected to
reach pre-incident levels by the end of 2012.
Production has turned upward in 2012 to date
(see Fig. 2.8). With subsalt exploration in the
Gulf of Mexico only beginning, new supplies
from the Gulf of Mexico could surprise to the
upside, in our view.
Oil imports from Canada. Canada is already
the single-largest source of imported oil for
the US, and over 97% of Canadas exports
ow to the US (see Fig. 2.6), accounting for
nearly one-quarter of total US imports. Canada
has large deposits of heavy crude oil that are
now economically recoverable, thanks to new
technologies. According to the BP Statistical
supplied 3.3 million b/d (see Fig. 2.6).1
OPECsupplied 75% of the crude oil from outside
of North America. Among the OPEC nations,
the US imports the most from Saudi Arabia,
Venezuela and Nigeria. However, supplies from
all three of these countries have been threat-
ened by civil unrest and other geopolitical
issues, highlighting the instability of the US oil
supply base.
US oil production. By the end of this decade,
the Energy Information Administration proj-
ects domestic oil production to rise to 6.7 mil-lion b/d, up 22% from 2010 levels. However,
the EIAs oil production estimates are con-
servative, in our view. Already, only a few
months aer the projections were published,
US oil production is over 6 million b/d, above
the EIAs projections for 2012 (see Fig. 2.7).
Production has risen by over 600,000 b/d in
the last year. We believe that US oil produc-
tion could rise by at least another 2 million
b/d to over 8 million b/d by 2020.
Onshore shale oil accounts for most of the
recent sharp increase in US oil production. We
estimate that production in the Eagle Ford and
in the Bakken alone has risen by over 700,000
b/d in the past three years. We believe shale
production in the US is only in the early stages
Note: Lighter shade denotes imports from OPEC.
Source: Energy Information Administration, UBS
0
20
15
10
25
5
Canada
SaudiArabia
Mexico
Venezuela
Nigeria
Iraq
Colombia
Angola
Russia
Brazil
Kuwait
Ecuador
Algeria
Fig. 2.6: Canada is the largest source of US imports
Crude oil imports to the US by country as a share of total imports, in %, 2011
Source: Energy Information Administration, UBS
Projected production
Production
4
5
6
3
0
1
2
7
2006 2008 2010 2012 2014 2016 2018 2020
Fig. 2.7: Production exceeds cautious EIA forecasts
US crude oil production and projections, in million barrels per day
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20 June 2012 UBSresearch focus
eral approval. This would be a lower proleway to bring incremental crude production
from Canada to the US.
New oil supplies from the US and Canada clear
the path to energy independence in North
America. OPEC oil exports to the US could fall
to zero by 2020 (see Fig. 2.10). There are chal-
lenges, we know; additional hurdles will arise.
But much has already been accomplished,
and only a continuation of the momentum
that has already begun is needed to achieve
independence.3
Natural gas: supply outpaces domestic
demand
Hydraullic fracturing and horizontal drilling
technology (commonly called fracking)
has resulted in such rapid growth in natu-
ral gas production that the US is experienc-
ing a supply glut, forcing natural gas prices
to low levels. (See appendix on page 31 for
a more complete discussion of shale oil and
gas techniques and environmental consider-
ations.) Shale gas production in the US grew
at an annualized rate of 32% between 2000
and 2010 (see Fig. 2.11). Most of the recent
growth comes from the newest and largest of
the US shale gas plays: the Marcellus in the US
Appalachian Basin.
Review of World Energy 2011, Canadas com-bined conventional oil and oil sands reserves
top 175 billion barrels, which places it squarely
in the top ve in the world (see Fig. 2.9). The
Canadian Association of Petroleum Producers
2011 report forecasts oil production in Canada
will rise to 4.2 million b/d by 2020, from 2.8
million b/d in 2010.2
There has been some question as to whether
new supplies from Canada will be sold to
the US. Controversy centers around the envi-
ronmental eects of oil sands production,processing and rening. In addition, ofcials
have delayed construction of the proposed
Keystone XL pipeline, an infrastructure proj-
ect that would transport additional Canadian
crude oil to the US. The project is held up
in a lengthy permitting process on concerns
about the spill risks near drinking water sup-
plies and other environmentally sensitive
areas. Absent US support, some Canadian
producers have begun to look at export
markets accessible from the Canadian West
Coast, though pipelines over the Canadian
Rockies could be difcult. However, there are
a number of smaller pipeline projects that
could connect to preexisting cross-border
infrastructure, which would boost capacity to
transport oil to the US and not require fed-
Chapter 2
Source: Energy Information Administration, UBS
0
300
200
100
400
600
500
1980 20001990 2010
Fig. 2.8: Gulf production rebounded despite disasters
Gulf of Mexico crude oil production, in million barrels
Note: Lighter shade denotes OPEC reserves. Canadian reserves include conventional oil andoil sands.
Source: BP Statistical Review of World Energy 2011, UBS
0
250
200
150
300
100
50
SaudiArabia
Venezuela
Canada
Iran
Iraq
Kuwait
UAE
Russia
Libya
Kazakhstan
Nigeria
US
Qatar
China
Brazil
Angola
Algeria
Mexico
Ecuador
Fig. 2.9: Canadian oil sands among top world reserves
Largest proven oil reserves, in billion barrels, 2010
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North American energy independence: reenergized June 2012 21
Energy supply: too much is never enough
Coal: marginalized but not going awayThe US holds estimated coal reserves that
would last upwards of 200 years, based
on current demand levels. Coal represents
approximately 20% of the energy consumed
in the US, the third-largest energy resource
behind oil and natural gas. Most of the coal
consumed in the US is used to generate
electricity. As power-generation economics
move in favor of cleaner (at least to burn) and
cheaper natural gas, coal producers are turn-
ing to export markets.
The future of coal in the US goes beyond
aordability and supply. With new competition
from natural gas, the case for coal is aord-
ability of clean supply. A major research eort
is under way to develop clean coal technology,
but thus far, the feasibility of clean coal tech-
nologies remains unproven. Given its prevalent
market share of the US energy resource base,
it will not be possible to eliminate the use of
coal any time soon. However, using less of
it marks an important step toward a cleaner
energy base.
Seeking long-term solutions
A more secure supply of oil and natural gas
is exciting and benecial for the US. And
In the early days of petroleum exploration,natural gas was not considered a useful prod-
uct and was burned o. While the US has
historically been self-sufcient in natural gas,
production had been in a gradual decline
since the mid-1970s, as elds in the Gulf of
Mexico matured. As a result, several terminals
were constructed on the US coasts to receive
imports of liqueed natural gas (LNG) (see box
on page 22). These terminals now essentially
sit idle, and some are in various stages of per-
mitting for conversion to LNG export terminals.
By the EIAs projections, the US will be a netexporter of LNG by 2016.
The EIA estimates technically recoverable shale
gas reserves in the US at 482 trillion cubic feet
(tcf). Total gas reserves in the US would sup-
port current demand for 100 years. US natural
gas production is projected by the EIA to rise
to 25.8 quadrillion Btu by 2020, up 17% from
2010 (see Fig. 2.11). More likely, natural gas
production growth will be dictated by demand
growth and exports for the foreseeable
future. As vast supplies lie in wait, the industry
could accommodate a signicant increase in
demand. Importantly, we believe supplies are
adequate to hold prices well below those seen
in LNG-dependent markets elsewhere.
Source: Energy Information Administration, UBS
Rise indomestic
oil production
Increase inCanadian
imports
Offset due togreater
conservation
Fig. 2.10: Independence from OPEC oil
Factors influencing future US crude oil supply, in million barrels per day
10
8
6
4
2
0
OPEC imports
Non OPECimports
Non OPECimports
Fig. 2.11: Shale production poised to accelerate
Note: Shaded area indicates projections.
Source: Energy Information Administration, UBS
US natural gas production by resource, in trillion cubic feet
25
20
15
10
5
0
30
Non-associated onshore
Coalbed methane
Non-associated offshoreAssociated with oil
Alaska
Tight gas
1990 2000 2010 2020 2030
Shale gas
OPEC oil
exports to the
US could fall to
zero by 2020.
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22 June 2012 UBSresearch focus
ply base will be in an eternal state of evolution.
We say this for three reasons: 1) there is always
a better, more efcient way to use energy; 2)
there will always be a need to increase supply to
accommodate the worlds energy needs; and 3)
we will always nd ways to harness new sources
of energy. As we look at the US, we see that the
evolution has begun. The work must go on, so
that when the time comes, the supply will be
available.
although fossil fuels will likely still compriseover three-quarters of the total US energy
resource base by the end of the decade not
much less than its current share there will be
important shis in the fuel mix toward natural
gas and away from oil and coal.
The US will remain reliant upon hydrocarbon-
based energy until aordable and practical
renewable alternatives are developed. Shale
supplies have granted some time, but without
suitable renewable alternatives, breaking the
fossil fuel habit will be next to impossible.
One non-fossil-fuel-based energy resource
that is viable but unpopular today is nuclear.
Nuclear power is used to generate approxi-
mately 20% of the electricity in the US,
whereas in France it provides closer to 75%.
The administration, once pro-nuclear, has
grown more ambivalent in the wake of the
Fukushima meltdown. However, permits
for construction of four new reactors were
issued earlier this year, the rst approvals since
the partial meltdown at Three Mile Island in
Pennsylvania in 1979. But most utilities have
curbed nuclear plans, due to increased compe-
tition from low natural gas prices, lack of fund-
ing or lackluster demand.
What about other energy alternatives: solar,
wind, tidal, geothermal, biomass and biofuels?
All have their place and all can contribute, but
costs still need to come down. We expect that
the energy resource base of the future will com-prise a wide variety of renewable energies and
technologies. Most likely, the US energy sup-
Chapter 2
What is LNG?
Liqueed natural gas (LNG) is an inno-
vation that allows natural gas to be
more easily transported long distances
by freezing it into a liquid state. A
relatively expensive process, LNG has
become a prevalent source of supply
to markets outside of the US, helping
to explain why natural gas prices are so
much higher internationally than theyare in the US.
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North American energy independence: reenergized June 2012 23
international trade, the US economy consis-
tently generates outsized gains in productivity.
Because of these productivity gains, US labor
compensation has risen by less than many of
its emerging market and advanced economy
peers (see Fig. 3.1).
Increased availability of comparatively cheap
natural gas creates an additional competitive
advantage for the US economy. Secure and
abundant supplies of energy (not to men-
tion another important resource, sustainable
supplies of fresh water) favor the return of
manufacturing, industrial and petrochemi-
Energy as a game changer
The development of domestic oil and gas
reserves holds promise for the US economy
at a time when structural deleveraging head-
winds are tempering enthusiasm about the
long-term economic outlook.
As we wrote in the June 2011 edition of the
UBS research focus entitled, US competitive-
ness: Americas still got talent, the nation
has achieved some of the strongest produc-
tivity gains among developed countries in
recent decades.1 Despite its relatively large
pool of domestic demand and low levels of
Americas energy opportunity
North Americas oil and natural gas revolution represents a boon tothe US economy and underscores our view that America will undergo
a manufacturing renaissance this decade. Oil and gas development
has employment and investment benets, the extraction technology
and fuels have export potential, and companies and consumers have
access to relatively low-cost energy. Importantly, market forces not
energy policy are creating these opportunities.
Kurt Reiman, Head, Thematic Research Wealth Management Research;Nicole Decker; Joseph Kenol; George Lambertson; David Leowitz, CFA; Andrew Sutphin;
Jon Woloshin, CFA,Analysts
Chapter 3
Fig. 3.1: US labor cost competitiveness has improved
Note: Each decade reflects the average of unit labor costs over the period.
Source: Bureau of Labor Statistics
Manufacturing labor costs per unit of output, US dollar index (2002 = 100)
0
40
120
80
160
Canada
US
Germany
France
South Korea Taiwan
Japan Singapore UK
2000s1990s1980s1970s1960s1950s
Fig. 3.2: Hollowing out of manufacturing since World War II
Manufacturing value added as a share of US GDP, in %
10
5
0
35
30
25
20
40
15
45
1940 1950 1960 2000199019801970 20100
5
10
15
20
25
30
1950 1960 1970 1980 1990 2000 2010
Source: Bureau of Labor Statistics, UBS WMR
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energy sources rather than imports is animportant potential antidote to ongoing debt
deleveraging and a sluggish US economy.
At a time when many economic sectors are
either limping along or are in the midst of an
outright decline, employment and investment
in natural resource industries, though small,
could prove benecial to income formation
(see Figs. 3.3 and 3.4). Moreover, indirect
employment gains through associated indus-
tries, such as in petrochemicals, materials,
utilities and autos, could be a multiple of the
direct employment benets.
Americas relatively lower energy costs could
mean more income and prots to reinvest
in research and development, perhaps even
in renewable fuels, which could boost long-
term productivity growth and generate new
technology to propel the next wave of above-
trend economic growth. In addition to secur-
ing natural resources, the country will need to
continue investing in efciency upgrades and
the best available energy technology. Aer
all, advances in productivity and innovation
matter greatly to economic growth over the
long term. In a similar vein, the US will need
to develop untapped resources in a way that
does as little harm to the greater environment
as is possible.
cal activities to the US aer a decades-longexodus (see Fig. 3.2) since these industries are
big energy consumers and would accrue enor-
mous cost savings. Moreover, the extraction
technology is exportable to overseas markets,
as are the fuels.
A June 2012 Q-Series report from UBS
Investment Research concludes that a sustained
relative energy price advantage in the US could
boost intermediate-term US real GDP growth
by around 0.5% per annum.2 According to
UBSs chief US economist, Maury Harris, Therelative decline in natural gas prices on balance,
over the past few years have been dramatic
enough to become a key element in the argu-
ment for a US manufacturing renaissance in
the next half decade and beyond. Moreover, if
there were no osetting stronger dollar eects,
the net eect would be around 0.8% per
annum. Although this additional growth might
not sound like a lot, if it were sustained over
25 years it would add another USD 5.3 trillion
or 40% of 2011 GDP to US economic out-
put relative to a base case of an average 2.5%
growth rate over the decade.
Given the comparative advantage aorded by
vast US natural gas reserves and the potential
for future exports, development of domestic
Fig. 3.3: Small revival in oil and gas investment
Source: Bureau of Economic Analysis, Bureau of Labor Statistics, UBS
Fixed investment, oil and gas extractionvalue added, in %
Mining employment,in %
2.5
2.0
1.5
1.0
0.5
0.0
3.03.5
0.30
0.25
0.20
0.15
0.10
0.05
0.00
0.35
Oil and gas extraction employment as a share of total US employment (rhs)
Fixed investment in mining activities as a share of US GDP (lhs)
Oil and gas extraction value added as a share of US GDP (lhs)
2002199219821972 2012
Source: Federal Reserve, UBS
0
4
2
6
12
10
14
8
2002199219821972 2012
Fig. 3.4: Value added has soared along with prices
Oil and gas extraction value added as a share of industrial production, in %
Chapter 3
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North American energy independence: reenergized June 2012 25
Americas energy opportunity
Natural resource discoveries are not without
potential pitfalls. For example, the export
demand and investment ows that stem from
nding large, previously unrecoverable oil
and natural gas deposits could cause curren-
cies to appreciate, which then disadvantages
the wider non-energy tradables sector of the
economy. Economists refer to this as Dutch
disease,3 the phenomenon in which countries
experience a boom in natural resources, makethem available as exports and then watch their
domestic manufacturing industries decline
under a stronger currency. In our view, the
prospects of Dutch disease infecting the US are
unlikely since the economy is so highly diver-
sied and because exports comprise such a
small share of GDP.
Abundance of domestic energy presents
another risk to long-term US economic growth
since cheap fuel could undermine eorts to
improve energy efciency and clean-tech
innovation. As it stands now, the US already
consumes more energy per unit of GDP and
per person than many developed countries
(see Fig. 3.5). The US also has a low share of
renewable fuels in the overall energy mix (see
Fig. 3.6). Per capita energy use is relatively high
in part because of wide annual temperature
variation and low population densities in North
America.4 However, historically low gasoline
taxes and a prolonged period of cheap
energy also encouraged wasteful behavior,such as a preference for big and inefcient
homes and cars. If energy policy does not con-
tinue to reinforce existing market-driven incen-
tives to upgrade energy efciency and make
advances in renewables technology, access to
inexpensive natural gas could do more harm
than good.
The risks of a resource boom
Source: Energy Information Administration, UBS
0
500
400
300
600
100
200
0
10
8
6
12
2
4
Brazil
Turkey
China
Argentina
Israel
Italy
Spain
UK
Germany
France
Japan
Switzerland
Netherlands
Australia
US
Canada
Fig. 3.5: Americans are inefficient users of energy
Primary energy consumption Energy intensity
Primary energy consumption, in million Btu per person (lhs)
Energy intensity, in thousand Btu per 2005 unit of GDP (rhs)
Fig. 3.6: US lags behind in renewables uptake
Source: BP Statistical Review of World Energy 2011, UBS
Renewables share of total fuel mix, in %, 2010
50
40
30
20
10
0
60
70
Canada
Peru
Portugal
Venezuela
Chile
Finland
Ecuador
Spain
Philippines
VietnamU
S
Austria
New
Zealand
Brazil
Sweden
Switzerland
Colombia
Norway
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Chapter 3
ginal cost for the next several years. Naturalgas production in the US is unlikely to grow
as fast as it has in recent years, especially
given demand constraints, but Marcellus shale
operators are advantaged by the plays lower
costs. For oil producers, well-executed growth
could be a key dierentiator. (See our report
dated 18 April 2012 entitled US Oil and Gas
Shale Guide for a list of companies exposed
to this theme).
In the North American oil and gas services
sub-sector, there are concerns that the upturnmay have peaked. However, we believe that
industry leaders will continue to benet over
the long term from robust activity and mar-
gin-enhancing improvements in operating
efciency.
Coal. The long-term outlook for US coal is
mixed, and we are cautious on the industry
for now. If natural gas supplies remain abun-
dant as we believe they will, we expect US coal
demand to gradually decline as environmental
rules that make the use of coal more difcult
take eect. However, demand for coal is robust
outside of the US, driven by steel production
in the developing economies, such as China.
Many US producers, as a consequence, have
turned to the export markets. Producers in the
A wide range of industry benetsIn addition to the boost to the overall US
economy, companies and industry sectors also
stand to benet from the eorts and incen-
tives to make greater use of North American
energy supplies. Energy companies will make
considerable investment in developing new
resource plays, as well as much-needed infra-
structure build-outs and upgrades (see Fig.
3.7). Moreover, the high price of oil both in
absolute terms and relative to natural gas will
likely encourage boosts to energy efciency
and new alternative modes of transportation.What follows is a discussion of how North
American energy independence aects specic
industry sectors. We provide a separate report
that features our views on specic investment
recommendations tied to this theme.
Energy
Oil and gas. We have a positive outlook on
the oil and gas sector and recommend selec-
tive exposure to high-quality operators in
North America. For natural gas producers,
near-term recovery in natural gas prices at
least to breakeven levels would provide sup-
port. Over time, true value creation will come
through superior execution, since we do not
expect prices to rise much beyond the mar-
Source: Baker Hughes, UBS
0
800
600
400
200
1,000
1,400
1,200
1992 1997 201220072002
Fig. 3.7: Horizontal rig count has gone vertical
North American horizontal oil rigs, in thousands
Source: Alerian, Bloomberg, UBS
S&P 500 energy sector total return index
Alerian MLP total return index
1,200
1,000
800
0
600
400
200
1,400
1996 2000 2004 2008 2012
Fig. 3.8: Oil and gas MLPs have significantly outperformed
MLP and energy sector total return indices, index (Jan 1996 = 100)
The develop-
ment of domes-
tic oil and gas
reserves holds
promise for the
US economy at
a time whenstructural
deleveraging
headwinds
are tempering
enthusiasm
about the long-
term economic
outlook.
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North American energy independence: reenergized June 2012 27
Power generation
The emergence of natural gas as a plentiful
energy resource will likely have a signicant
impact on power generation. As an inexpen-
sive, cleaner alternative to coal, natural gas
has become an economically and politically
attractive fuel choice for electricity production,
especially for new power plants. While the
prospects for natural gas are bright, investors
should bear in mind that coal will likely remain
the most widely used fuel in power genera-
tion in the US for at least the next decade,and likely longer. As a plentiful, inexpensive
and cleaner alternative to coal, natural gas
will continue to take share as one of the pri-
mary fuels used in the production of electric-
ity. In spite of the consequent negative impact
on power prices, natural-gas-red merchant
plants will benet as declining prices are oset
by higher utilization.
Because natural-gas-red plants tend to be the
marginal producers of electricity, natural gas
and power prices are highly correlated (see Fig.