This year the US shale gas revolution has gained increasing prominence. But what matters for currency markets is the boom that is likely to accompany the expansion in shale, namely “tight” oil.
By boosting domestic crude oil production significantly over the next decade, the US will be able to cut its reliance on foreign petroleum to the benefit of the dollar. In contrast, the world’s other major oil-consuming economies in Europe and Asia are set to experience substantially worse “petro-balances” in future, presenting longer term headwinds to the euro, yen and regional Asian currencies.
Currently, America, Europe, Japan and emerging Asia all run substantial oil deficits. The US and the eurozone last year spent more than 2 per cent of gross domestic product each on net imports of crude oil and other petroleum products, Japan over 3 per cent of GDP and the rest of Asia over 3.5 per cent of GDP.
Over the next two decades, higher energy prices and technological improvements will raise the output of oil globally. According to the US Energy Information Administration (EIA), daily oil production is set to rise from 26m to 35m barrels per day in the Middle East, from 14m to almost 17m b/d in the former Soviet Union, from 11m to nearly 14m b/d in Latin America and from 4m to 7m b/d in Canada by 2035.
Crucially, the US will also see a significant improvement in its domestic oil output owing to America’s tight oil boom. Moreover, much of this is likely to occur by 2020. UBS forecasts total US oil production will increase from just over 9m b/d now to above 12m b/d by the end of the current decade.
As a result US oil imports should fall by at least 1m b/d by 2020 from around 9m b/d now. In contrast declining production in Europe and emerging Asia and still negligible output in Japan will lead to large increases in the petro-deficits of the world’s other major oil-importing regions.
Using EIA data, Europe’s net oil imports will rise from 10m b/d to 12m b/d by 2035 while Asia ex-Japan will increase its daily oil imports from around 14m b/d now to nearly 30m b/d over the next two decades.
That will lead to a marked divergence in petro-balances between the US, Europe and Asia. Using the EIA forecasts of oil prices breaching $200 a barrel, America’s net oil imports will “only” rise from around $300bn in 2011 to $600bn a year by 2035. In contrast, Europe’s annual oil imbalance will increase from over $300bn to around $1tn while emerging Asia’s will rise fivefold from over $450bn last year to a staggering $2.5tn per annum by 2035.
As a share of GDP, the future improvement in America’s petro-balance is even more apparent. The US net oil deficit should peak in the next couple of years above 2 per cent of GDP before declining by almost 1 percentage point of GDP in future. On the other hand, Europe, Japan and emerging Asia will all experience rising energy deficits as a share of national output. In Europe’s case, its net oil imbalance is forecast to rise from around 2 per cent of GDP to over 2.5 per cent by 2020. Japan’s net oil imports are projected to increase from just over 3 per cent of GDP to close to 3.5 per cent while emerging Asia’s may rise from less than 4 per cent of GDP now to more than 5 per cent in the next 10 years.
Thus, the US tight oil revolution should lead to significant improvements in America’s energy supplies – at a time when other major oil-importing regions will face deteriorating energy positions. Indeed over the next decade America could become the largest oil producer in the world again, surpassing Saudi Arabia. That would return the US to the position it held until the 1970s.
This tantalising prospect will clearly benefit the dollar. By shaving one percentage point of GDP off net foreign energy imports, the tight oil boom will make a significant dent in the US current account deficit.
Currently, UBS estimates the fair value for the dollar is about $1.15-$1.20 against the euro. America’s energy transformation can push that range further in the greenback’s favour. Similarly, the dollar may also benefit in the long term against the yen and Asian currencies from the shift in petro-balances. The yen, having almost certainly peaked now against the dollar at Y75 earlier this year, could weaken towards Y90-Y100 in the next few years while China’s authorities have already signalled the renminbi is not a one-way bet any more by recently widening its trading band against the greenback.
As a result, foreign exchange investors should pay close attention to America’s oil boom over the next few years, and take a more constructive longer-term view on the dollar.
Mansoor Mohi-uddin is managing director of foreign exchange strategy at UBS