By: Matthew Iak, Executive Vice President at U.S. Energy Development Corp. and
Fred Gratz, Director of Business Development at U.S. Energy Development Corp.
As prognosticators, we’ve all been told before that we can’t see the forest through the trees; however, with the current Russia-Ukraine conflict and its predictable impact on the United States energy market, it’s sure to rile up leaders in the oil and gas industry. We all have an intrinsic understanding that a conflict, such as what’s unfolding in Eastern Europe is bad; bad for Europe, bad for global stability, bad for markets, and bad that it will no doubt further contribute to an already elevated price of oil.
Over the last few weeks, we’ve seen energy prices experience double-digit increases. This was predictable, given that we saw this happen in 2014 when Russia annexed Crimea and global energy prices soared above $100/barrel. The late Sen. John McCain famously described Russia as “…a gas station run by a mafia that is masquerading as a country.” A perfect description then, as it is now in 2022.
However, the current geopolitical risk premium, baked into the market, does not fully explain all the dynamics of rising oil prices, should this conflict escalate further. ”Any disruptions to oil flows from Russia in a context of low spare capacity in other regions could easily send oil prices to $120,” Natasha Kaneva, JPMorgan’s head of global commodities strategy.
Seeing the forest through the trees requires a broader focus on an issue, such as the absence of a “cushion” in the oil market. Historically, the larger the U.S. and global inventory of oil (and natural gas), the more muted the impact a geopolitical event will have on oil and gas prices. But currently, this inventory thinness has us sitting in a delicate price range with the total global crude stock sinking to its lowest volumes since 2018.
In addition to low inventory levels, it’s expected that oil prices will continue to experience upward pressure this year due to continued excessive demand and a lack of U.S. and OPEC+ production to meet it. Additionally, the oil market structure has recently moved into super-backwardation, an indication of extreme scarcity which exacerbates price swings. Super-backwardation means that there is an extreme premium for the front oil contract over longer-dated contracts.
It’s important to note that OPEC+ price increase agreements are not reliable, and there is a significant difference between OPEC’s target oil production compared to what is actually being produced. For example, in January 2022, the 10 OPEC members that are subjected to quotas only produced 23.9 million barrels per day, compared to their target production of 24.6 million barrels per day. OPEC+ currently has a one million barrel shortfall between its target supply and the actual supply hitting the market. These production factors, combined with an already low “cushion”, clearly create additional near-term upside price risk.
Oil prices will likely be higher by year-end due to structural reasons, though the crisis in Ukraine is clearly dictating near-term pricing. Most excess supply has been consumed, and there is insufficient production coming into the market to meet growing demand. Renewables are essential, but we have been misled about the true capability of renewables today and cannot rapidly replace our global energy needs going green.
Europe needs an energy transition that prioritizes a significant reduction of its dependence on the flow of piped gas from Russia. Diversifying its supply beyond this relationship will likely benefit nuclear, storage and other natural gas source providers, as well as renewable energy resources. While Europe is currently at the forefront of this energy crisis, it offers the U.S. a glimpse into the potential damage from its current “cancel culture” approach, emphasizing an “at-all-costs” shift away from fossil fuels. Instead, the long-term domestic solution should include an energy policy that minimizes its dependence on “bad actors” and their tactics of weaponizing their resources at their discretion.
Every nation’s energy strategy pursues a long-term energy partner and not be beholden to an adversary. The ideal candidate must have the capacity to supplement the world’s energy needs, providing low-cost oil and natural gas, and nations should be encouraged to produce what they can to increase their supply. Today, only three countries have the ability to deliver – Russia, Saudi Arabia and the U.S. We know that Saudi Arabia and Russia are commodity-rich, but can they truly become the trusted and reliable energy partner the world needs at a time like this?
Despite the U.S. having some domestic advantages; in November 2021 the U.S. released 50 million barrels of oil from its Strategic Oil Reserves, which currently amounts to four and a half days of production. Conversely, today the U.S. lacks production reserves or a “cushion” to absorb the spike in oil price and demand.
There has been a false sense of geopolitical security for far too long. The U.S. was on a path to energy independence, briefly achieving it in 2019, which allowed for sustained lower energy prices globally. It should be an international priority to make the U.S. the swing producer, given transparency requirements related to oil production methods, ESG efforts, and the scrutiny of multiple government regulatory authorities. With this accomplished, the world would no longer be beholden to unpredictable energy partners with low levels of transparency and trust.
The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.