Monthly Market Commentary
The Energy Conundrum
Philip Blancato, Chief Market Strategist, Advisor Group
Energy has been central to many conversations we’ve held in 2022, and for a good reason. Oil and Natural gas prices have fluctuated widely in recent years1 . Additionally, nearly every aspect of the average American’s day touches the energy industry in some form, whether driving a vehicle or simply turning on a light switch. We focus our energy research efforts on understanding some key areas: Global Perspective, Supply and Demand, Production and Consumption, Inflation, and Opportunity. Understanding these dynamics allows some clarity in an otherwise noisy environment.
Crude oil is a naturally occurring petroleum product called a fossil fuel because it is composed of hydrocarbon deposits and other organic matter. Once extracted from the ground, crude oil is refined into petroleum products such as gasoline and heating fuel. An interesting tidbit, a US 42-gallon barrel of crude oil yields about 45 gallons of petroleum products through the refining process2. Refined products have a lower specific gravity or density than the crude oil processed, resulting in a larger volume output than input.
Natural gas is also a fossil fuel formed deep beneath the earth’s surface. Numerous extraction methods are utilized, including horizontal, vertical, and hydraulic (fracking) drilling. Domestically, most of the natural gas consumed in the US has been produced in the US.
The oil and gas industry are dominated by two groups, the Organization of Petroleum Exporting Countries (“OPEC”), a 13- member group led by Saudi Arabia, and the 30+ member Organization of Economic Cooperation and Development (“OECD”) led by the US. Notably, China and Russia are not OPEC members and are free to pursue their own independent strategic objectives.
Supply/Demand and Production/Consumption
In terms of sheer volume produced, the US is the largest producer of oil and natural gas. The US produces roughly 11.6 million barrels of oil a day, over a million more barrels than the next largest oil producer. When it comes to natural gas, the US is once again the dominant producer, generating 2.6 billion cubic feet a day1 .
Supply and demand are interrelated with production and consumption. The law of supply states that the quantity of a good supplied (i.e., the amount owners or producers offer for sale) rises as the market price rises and falls as the price falls. Conversely, the law of demand says that the quantity of a good, demanded falls as the price rises, and vice versa4 . In addition, Crude oil and Natural Gas are traded in the global market and are inherently impacted by geopolitical events. When supply and demand factors break down, prices tend to fluctuate widely. Economic prosperity also plays a meaningful role. Expanding economies consume more energy than contracting economies, and as the fortunes of nations change, so do their production and consumption needs.
Removal of Russian oil and gas in the marketplace, a repercussion of their invasion of Ukraine by western powers, certainly impacts supply. Domestically, US production is still in a recovery phase following the impacts of the COVID-19 pandemic. During the pandemic, energy demand was curtailed, bringing about a collapse in prices and a reduction in capital expenditures across the industry. When the US economy began opening back up, production was stalled, and coupled with Russian import sanctions, global supply has notably diminished. Prices rose, resulting in the unprecedented move for the US to release from the strategic petroleum reserve to offset lower Russian exports.
Economically, the US is also battling roaring inflation, the Federal Reserve is determined to control inflation by employing an escalating pattern of rate hikes. The rate hike policy is designed to stall economic growth, which ultimately curbs energy demand. Outside of the US, China, the world’s second-largest economy, has handcuffed the country’s growth and energy demand following numerous state-mandated zero-tolerance Covid policy lockdowns. These headwinds are not likely to abate quickly and will have a notable impact on demand.
One way to frame the energy independence conversation is domestic energy production being greater than or equal to consumption. In this instance, the US would be considered energy independent, having produced more energy than consumed in 20215 . Alternatively, if oil or gas are imported for any purpose, the argument for energy independence is rebuffed. The US imports oil for refinement into gasoline and other petrochemicals. Most recently, in 2021, the US imported about 6.11 million b/d of crude oil and exported about 2.90 million b/d (Figure 23).
Leasing federal lands for drilling is often discussed when seeking ways to boost domestic production. The Biden administration has leased fewer acres for oil-and-gas drilling than any other administration in its early stages6. The pace of leasing decline has certainly quickened under Mr. Biden, down nearly 97% from his predecessor’s term. An attentiongrabbing statement, however, the federal leasing program has been in an overall decline for years. Oil and gas companies have prioritized fracking shale on private lands over the more conventional routes. Of the roughly 35 million acres (the equivalent of New York state) now leased from the federal government, 60% are not actively producing. Roughly 9,000 permits are approved and yet to be drilled; however, this is a small percentage of the approximately 100,000 producing wells onshore on federal lands7
The near-total removal of Russian energy from the OECD marketplace certainly provides the opportunity to capitalize on European energy demand. The vast majority of Russia’s crude oil and natural gas exports last year were to Europe8 . This presents a unique opportunity for US natural gas to fill the void in Europe. US natural gas exports have ramped up over the last 20 years, from 243 million cubic feet a year in 2000 to 6.6 billion cubic feet in 2021 (Figure 33). That proposition comes with its own issues. As more US natural gas is exported to Europe, domestic supply diminishes. A smaller amount of US supply available for consumption pushes prices higher for US consumers.
We believe energy prices will continue to be the proverbial elephant in the economic room. An ever-changing geopolitical theater in Europe, curtailed global growth, inflation concerns, production and consumption impediments, and lastly, the delicate balance act of managing export opportunities while maintaining steady domestic prices each plays a dynamic part in energy price directionality. Avoiding soundbites and maintaining equanimity is essential through this uncertain period.
OPEC9 – The Organization of Petroleum-Exporting Countries was formed in September 1960. Its current 13 members are Algeria, Angola, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, the Republic of Congo, Saudi Arabia, the United Arab Emirates and Venezuela.
OECD10 – The Organization for Economic Co-operation and Development (OECD) is comprised of 38 Member countries: Australia, Austria, Belgium, Canada, Chile, Colombia, Costa Rica, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Latvia, Lithuania, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Turkey, the UK and the US.
EIA11 – The U.S. Energy Information Administration (EIA) collects, analyzes, and disseminates independent and impartial energy information to promote sound policymaking, efficient markets, and public understanding of energy and its interaction with the economy and the environment.
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2 Refining Crude Oil | www.EIA.gov
3 Figure 1, Figure 2, Figure 3, data and charts obtained from www.EIA.gov 4 Ehrbar, A. (2018, June 27). Supply | www.econlib.org
5 Short-Term Energy Outlook | www.eia.gov 6 Puko, T., & DeBarros, A. (2022, September 4). | www.wsj.com
7 Drilling Down on Federal Leasing Facts | www.api.org
8How Much Oil Does the European Union Import from Russia | www.reuters.com