Day late and a ruble short

Bottom Line

The greatest existential threat in the world today is Russia’s unprovoked attack on Ukraine. Many civilians have been killed, and more than six million people have fled the country (out of a population of 44 million), as Russia’s relentless bombing has turned Ukraine into rubble over the past three months, with no end in sight.

Energy production is Russia’s most important industry, accounting for roughly half its GDP, and the country has clearly benefited from the resultant surge in market prices. Since Russia’s invasion started on Feb. 24, crude oil prices (WTI) spiked from $90 per barrel to $130 (up 45%) and have settled back to around $110 Friday. Natural gas prices more than doubled from $4 to $9 over this same period, and now sit just around $8.

Inexplicably, the world continues to purchase energy from Russia It is using those profits to fund their ongoing war against Ukraine. To be sure, the U.S. ceased purchasing 700,000 barrels per day of crude oil from Russia last month (about 4% of our daily consumption). Europe, however, has much greater energy dependency, as Germany purchased as much as 55% of its natural gas from Russia, with the rest of Europe at 40%. 

Importantly, the 27 European Union nations are finally planning to sanction Russian energy, but they hope to slowly phase those purchases out over the balance of this year. Germany has shelved plans for the Nord Stream 2 Russian gas pipeline (which would have doubled the flow of natural gas into the country), and Russia has cut off gas sales to Poland and Bulgaria when those countries refused to pay for their gas in rubles, rather than with euros or dollars (as the contracts required). Earlier this week, Ukraine’s natural gas grid operator announced that it would stop transmitting Russian gas through an eastern border entry point to the rest of Europe. 

Baby steps Europe and the U.S. are finally taking steps to wean themselves off Russian energy production and increase their leverage to end the Russia/Ukraine war, but the process is going much too slowly. As the largest energy producer in the world, we should demonstrate global leadership to fill this energy void both here and abroad, to reduce Russia’s economic and military influence more expeditiously.

Energy 'Marshall Plan' A possible solution is to produce more natural gas in an environmentally responsible way to increase American energy security, and to build additional liquified natural gas facilities in Europe, to which we would then export more energy. We were producing a record 13.1 million barrels per day pre-pandemic in March 2020. But the Biden administration’s energy polices contributed to a 16% reduction to 11 million barrels last year, with bans on the Keystone XL pipeline, drilling in Alaska, fracking on federal lands, offshore drilling and an accelerated transition to electric vehicles. 

Given the current global supply/demand imbalance, however, energy production has since increased to about 11.8 million barrels per day, with an estimated rebound to 13 million next year. But Europe could use another four million barrels per day now, to fully offset the energy it now buys from Russia. As the so-called Saudi Arabia of natural gas, the U.S. could help to fill at least part of that void. 

Unshackle our domestic energy production To achieve this goal, according to the American Petroleum Institute, we should release more permits for drilling on federal lands, lease more tracts for offshore oil development, accelerate permits for energy infrastructure such as pipelines and roll back legal and regulatory uncertainty. Here in the U.S., lagging gasoline prices have more than doubled from $2.11 per gallon in November 2020 to a record $4.43 last week, which has helped to spark the highest inflation in 40 years.

Root causes? Rather than directly address this global supply/demand energy imbalance and soaring domestic gas prices (which are expected to rise further this summer), the Biden administration has been more focused on applying temporary band-aids.

• OPEC-Plus Russia and Saudi Arabia are the two leading partners of this cartel, which announced last week that its collective production would increase by only 432,000 barrels of oil per day in June, rebuffing the Biden Administration’s pleas to pump millions of additional barrels daily. 
• Venezuela Despite its abysmal environmental and human-rights records, we are encouraging it to sell us more oil.
• Iran President Biden has re-engaged the country on the stalled nuclear-pact negotiations, is willing to make sizable concessions on its nuclear ambitions and will allow it to produce and sell us more oil.
• Strategic Petroleum Reserve The world’s largest emergency supply of crude oil, which was established after the 1973-74 Arab oil embargo, is comprised of four enormous underground salt caverns in southern Louisiana and Texas, with an authorized storage capacity of 714 million barrels. Biden ordered the release of 50 million barrels in November 2021 and another 30 million in March 2022, bringing the current balance down to an estimated 568 million barrels. He is now releasing another 180 million barrels from May through October, at an average daily pace of about one million barrels per day. That would take the reserve balance down to about 388 million barrels, or roughly 54% of capacity, which could create a serious oil-production problem if we have an active hurricane season in the Gulf of Mexico this year. 
• E15 Last month, Biden announced an environmental waiver to allow the sale of 15% ethanol gasoline blends this summer. The Clean Air Act historically has prohibited this because higher ethanol blends increase smog in hot summer weather, and erode the engines in older cars, gas pumps, storage tanks and pipelines. The impact on gas prices at the pumps could be negligible, as only about 2,300 of the nation’s 150,000 gas stations (1.5%) are outfitted to sell E15 gas. But by diverting more corn from food consumption to energy production, corn prices that have already doubled over the past 18 months should rise further, exacerbating inflationary pressures. 
• Gas-tax holidays Senators are contemplating suspending the 18.4 cent-per-gallon federal gas tax through the end of 2022, and many governors are similarly discussing suspending their individual state gas taxes. But how will we generate the funds needed for road and bridge maintenance? 
• Energy stimulus checks and gas tax rebates Another approach under discussion is to keep the federal and state taxes in place but provide lower-income Americans with government money to offset their higher energy costs. 
• Windfall profit taxes Biden launched a Federate Trade Commission (FTC) investigation into alleged price gouging by U.S. energy companies. Why are global oil prices higher, but investment in U.S. oil production is down? Meanwhile, oil companies are prioritizing share repurchases and dividend increases. Along with rising revenues and profits, the energy sector has been the S&P 500’s best performer over the past two years. 
• Electric vehicle growth estimates unrealistic There are around 290 million gas-powered cars on U.S. roads right now (with an average useful life of about 12 years) and only two million electric vehicles, a miniscule 0.7% market share. There’s no doubt that the pace of EV sales over the coming decades will far outstrip that of combustion-engine vehicles, but expectations are unrealistic. The widely accepted goal of having 30% domestic electric vehicle penetration by 2030 implies a 60% annual growth rate, while a more achievable 15% annual growth rate means that we will hit our goals by the middle of this century. Yet, we are conducting our energy policy as if these numbers are reversed. 

Rightsizing our energy policy goals is not mutually exclusive No one wants to engage in a shooting war with Russia, potentially triggering a nuclear or chemical response from President Putin. So we need to prioritize our own energy self-sufficiency and help to fill the energy void in Europe now by producing more domestic energy, breaking our collective dependency on Russia. At the same time, we should continue to pursue a clean energy future.

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