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Energy Prices Brief

February 28th

Authored by: Graham Copley, Founding Partner

“There is inadequate capacity to meet energy demand with U.S. oil and gas E&P spending falling. U.S. energy policy should be encouraging production for the benefit of the U.S.”

Summary

• The high energy prices consumers now face are the result of supply shortfalls combined with a series of policy errors on the part of specific governments, particularly the U.S.
• The Biden administration has forgotten that energy security is a core responsibility. By failing to take a true leadership role in how we manage energy access and supply, the administration has handed too much influence to those who lack the broad economic understanding needed to measure the larger ramifications of what they are demanding.
• Russia’s invasion of Ukraine, coupled with Europe’s reliance on Russian energy, is another urgent wake-up call for the Biden administration to get our domestic energy house in order.
• Trying to predetermine the best route for the energy transition by, for instance, limiting leasing and being too prescriptive with pipeline bans, will only serve to hamstring the degrees of freedom that the energy industry will have to address both affordable energy supply and other priorities.
• The Biden administration has grossly overestimated the rate at which the U.S. can deploy renewable energy. Attempts to move faster are causing inflationary bubbles, the result being that all energy costs, not just oil and gas, are rising rather than falling.
• Tactically, to ensure both energy security and affordable energy prices, the Biden administration should be encouraging as much oil and natural gas production as possible, while maintaining the priority focus of reducing global greenhouse gas emissions.
  • The Biden administration has an opportunity to take a leadership role in low-cost and low-carbon hydrocarbons, something that the U.S. will need for decades.
  • This could create an investment boom in the U.S. with the right policy. However, with the administration’s policy shortfalls and inconsistencies, we are missing a huge opportunity to lead and create significant wealth through capital investment and high-quality job creation.

Before putting pen to paper for this brief, we looked back over all of the energy commentaries that we had published this year and noticed an interesting theme. We kept trying to pin the current energy shortage and high prices on “one thing.” We did it several different times, with a different issue each time:

• Underestimation of growth
• Overestimation of renewable power additions
• Too much reliance on other countries or regions
• Lack of consistent policy or policy messaging
• Too much power in the hands of investors with an “ESG” mandate
• The Russo-Ukrainian conflict

The reality is that, to some degree, all of the causes above have had an impact. But the other reality is that these issues all come back to domestic energy policy. It is the government’s job to manage all risks and ensure energy security. If, as an administration, you fail to lead, or lead poorly, other forces will fill the vacuum, often with very different agendas. It is a lack of leadership that has led to insufficient oil and natural gas production and rising prices. This result serves no one’s interest. 

“If you have a surplus of energy, then you have degrees of freedom around what energy you encourage and what you discourage. If you have a shortage, you have no degrees of freedom at all.”  

While the U.S. has abundant hydrocarbon reserves, continued production depends on continued investment. The decline rate, shown in the EIA chart below, will quickly lead to lower production without investment. A surplus of energy allows degrees of freedom in terms of how you manage energy supplies, particularly in terms of what you encourage and what you discourage. On the other hand, an energy shortage provides no degree of freedom at all. This lack of flexibility has real-life consequences. Administrations have seldom survived periods in which their constituents have frozen in the winter or boiled in the summer.

In the past year, the U.S. has seen an increase in natural gas prices from $2.85 to $4.60 per million BTUs, while average regular gasoline prices have increased by almost 45% from $3.07 to $4.43 per gallon. These prices directly affect U.S. families and businesses. As the chart above shows, the increase since President Biden’s inauguration has been substantial.

The Biden administration is directly to blame for the lack of E&P investment in the U.S. over the past year and the subsequent stall in oil and gas production. In short, the administration has allowed a hostile investment environment to develop in the U.S. The Biden administration has missed this opportunity. Government agencies have access to comprehensive macro-economic and energy models – all of which show the decline rates in U.S. oil and gas production (oil shown previously; gas shown below) and the dependence on investment to maintain production. Failing to use these tools to recognize potential shortages and dictate effective energy policy to prevent them is an inexcusable mistake. Looking ahead, the Biden administration is missing a significant economic opportunity to provide lower-cost energy, not just domestically, but to allies.  Restrictive moves such as the ambiguity on new offshore drilling leases and almost impossible standards required for new pipelines could deny the U.S. a significant economic opportunity, while at the same time condemning its citizens to ever higher energy prices – or subsidized energy prices paid for through higher taxes. 

Russia’s invasion of Ukraine last week further complicates these issues. Global benchmark Brent crude shot up to $105.79 per barrel within the first 24 hours of the attack. European natural gas prices soared almost 70 percent on day one. Russia meets more than 30% of European gas demand for industrial use, heating, and electricity generation. There is no immediate solution to fill the void should Russian gas supply be curtailed. In the U.S., natural prices have risen 60% in the past year. This tense geopolitical situation, which has triggered fresh market worries, is all the more reason for the Administration to get our domestic energy house in order.  

The challenge from the oil and gas industry on the recent flip-flop on oil and natural gas auctions has rightly focused as much on inconsistency and the mixed messages that the administration is giving to the industry as it has the potential ruling itself. On the one hand, the administration is constraining investment based on climate change and energy transition concerns. On the other hand, it is calling for more production to ease prices. This is an impractical approach that will not solve the problem.

“Whether oil and gas companies can economically develop new acreage in the Gulf of Mexico, especially with tighter emissions standards and the lead time for development, remains to be seen. But they should be given the option.”

In our view, we need a bipartisan agreement on how the energy industry should be allowed to operate so that we can ensure the supply of energy that the U.S. needs at affordable prices. This topic was covered well in a recent article by former Acting Deputy Energy Secretary Jeffrey Kupfer in The Hill linked here.

The recent uncertainty on the new offshore leasing plan in the U.S. should be a focus for all. The U.S. has successfully utilized offshore oil and gas availability for decades, and the U.S. energy industry has the requisite experience to bring new capacity online while also abiding by lower emission standards. For those reasons alone, we should be encouraging E&P spending in the U.S. Otherwise, we have a limited ability to prevent the inflation that we see today in both oil and natural gas prices. Whether oil and gas companies can economically develop new acreage in the Gulf of Mexico and other offshore or onshore locations remains to be seen. But they should be given the option, and we believe the Department of Interior’s five-year leasing plan should be renewed to allow this possibility.

The chart above shows the offshore production stability relative to the rapid decline rates in onshore shale plays. The offshore opportunities are generally larger volume by project and offer more consistent production. This more stable baseload is also often less expensive. We already have very low rig counts in the U.S., per the chart below, especially relative to the prices of oil and gas. Most of these rigs are being focused onshore. Last week, only 15 of 645 operating U.S. rigs were offshore. Today, only 12 rigs are operating in the Gulf of Mexico versus twice that number pre-pandemic and the last time oil was at or above $100 per barrel.

At the same time, we are convinced that the Federal Energy Regulatory Commission (FERC) has made the wrong moves on natural gas pipelines. We see a world that needs natural gas for decades and we can see a scenario where clean natural gas plays a very long-term role. As the world looks for more LNG, the U.S. should be lunging forward rather than hesitating. The most efficient and lowest carbon means of transporting gas is through pipelines. As we have written on countless occasions, if you let activists and environmentalists drive every aspect of policy without adequately balancing those objections against market realities, you will get the acute shortages of energy and materials that consumers face today. The Wall Street Journal Editorial Board highlights FERC’s missteps in a recent column linked here.

Through both its actions, inactions, and inconsistencies, the Biden administration has created uncertainty in the minds of E&P companies. The LNG industry offers not only domestic energy security, but also presents a significant opportunity for the U.S. to step up its exports and become the clear leader in this market. We are concerned that the stars will struggle to align to get new LNG terminals built. Independent operators are reliant on project financing, which will be more challenging unless there is a clear change in attitude towards natural gas E&P that gives new LNG projects renewed confidence that gas supply will be there. Note that the EIA estimates that natural gas production in the U.S. will rise by a fraction of the expanded LNG capacity this year. Faced with these constraints, there is a serious risk that LNG investments will stall, which is a losing move for the U.S.

The Biden administration is attempting to limit fossil fuel use, relying on what are likely far too aggressive targets on the rate of renewable power growth. On the other hand, the administration is calling for more production to ease prices. This is not a winning strategy. Without some sort of plan for managing the broad energy transition the administration wants, our government is giving confusing signals to developers and investors. In this environment, they cannot be expected to invest in anything more than a project with a very short development life today, which are generally investments in onshore wells with rapid decline rates. This means that investments will need to continue for years and possibly decades. The signals are equally confusing for those financing the industry. 

While it is easy to blame current high prices on the Russo-Ukrainian war, the supply-demand imbalance has much more to do with very poor planning by the Biden administration that both grossly underestimated energy demand growth relative to supply and is choosing poor tactical approaches to creating the energy supplies that the U.S. and the world need. If we continue to operate in a constrained oil and gas supply environment, we will likely see continued high prices and growing volatility in pricing. With markets that all participants know are finely balanced, incremental news has an oversized impact on pricing. We need more consistency.

• Promote the responsible growth of the U.S. oil and natural gas sector.
  • Allow more offshore drilling by renewing the five-year offshore leasing plan.
  • Permit new pipelines, where they make economic and environmental sense.
• Start a dialogue around how to meet both energy and environmental needs, accepting that the two are not mutually exclusive.
  • Be practical in assumptions around the evolution of renewable energy so that we make sensible decisions around the energy transition and the vital role that fossil fuels will need to play for decades. 
  • Take a leadership position in progressing low-carbon hydrocarbons, thereby making U.S. energy attractive to others while maintaining enough supply to keep prices affordable.
• Stop second-guessing the right path to lower emissions and give the oil and natural gas industry the tools and freedom to produce more low-carbon, low-cost energy for families and businesses.

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