“Energy independence is our greatest geopolitical and economic tool and we cannot lose sight of that as instability rises around the globe.”

– Joe Manchin on February 17, 2022

It seems that despite this warning and others, this message seems to be getting lost, and we may see real consequences shortly as Russia sits on the doorstep of Ukraine. In what I believe is underreported news, the shift to renewables, while laudable, is not ready to replace traditional energy sources. Politicians do not seem bothered by this issue as re-election seems to be taking priority over reality. The consequences may be far-reaching for not only global security but also inflation. The unbelievable part is that we put ourselves in this situation. 

We start with the United States, which recently became energy independent with the development of fracking technology. The pandemic put a dent in the demand and price for oil which logically reduced the number of wells and budget for new exploration. With oil back over $90 a barrel, Amrita Sen of Energy Aspects says the industry needs “at least $520 billion in investment each year” to maintain production of 100 million barrels. Currently, the industry is only spending $370 billion. Just a few reasons are listed below.

  1. Environmental pressure – Recently, Exxon Mobile shareholders replaced three board members with individuals that want them to move away from fossil fuel production and focus on reduced carbon energy production.  Large shareholders like Blackrock and pension funds are using their influence to encourage green energy and move investments away from traditional producers.  This trend has been growing for quite some time as the California Public Employees’ Retirement System (CalPERS) had $900 million invested in green energy as early as 2013.  Joseph Dear their chief investment officer at the time referred to these investments as “a noble way to lose money.”  This type of influence is becoming common across all regions but especially Europe as ESG investing becomes a larger focus.  We discussed this at length in our article on How to Build a Sustainable Investment Portfolio.
  2. Financing changes – Activists are pushing investors and banks to withdraw lending facilities for energy producers. Drilling for oil is a capital-intensive activity so any increase in interest rates or difficulty securing long term financing will result in less exploration.
  3. Share prices –Increasing dividends and keeping share prices high by spending less keeps some of the largest investors engaged. Less production reduces supply which means they get paid more per barrel which improves margins.      
  4. Regulatory state – The first day in office the Keystone Pipeline project was cancelled by President Biden.  This provided the signal that new projects would be harder to get approved.  The Federal Energy Regulatory Commission (FERC) which approves new gas pipelines showed how this works in practice last week by expanding the criteria for new transmission to include greenhouse gas emission costs that occur both before and after it enters the pipeline. This didn’t stop the request for OPEC to increase their production.  They declined.     

Europe feels many of the same pressures as the United States but is doubling down on some policies that exacerbate the problem even further. Some of these are self-inflicted.

  1. Fracking – France, Germany, and Great Britain have all banned fracking.  This makes them dependent on countries like Russia and Norway for their supplies.  If these partners aren’t reliable, we see what occurred in 2021 with a 600% increase in gas prices including a 37% spike in a single day in October. 
  2. Storage – The United Kingdom closed their main gas storage facility in 2017 which provided 70% of the gas storage and had for 30 years. They currently have enough on hand to last for four to five winter days. This lack of a buffer adds a degree of risk and adds to the volatility that customers pay.  While neighboring countries may have more, all are vulnerable to a supply crunch.    
  3. Energy transition – On the last day of 2021 Germany closed three of its six nuclear power plants with the rest slated to closed by 2022.  Twenty years ago, 30% of their electricity came from nuclear. Belgium and Switzerland are eliminating theirs as well.  Coal is being phased out across the continent. A cold winter, increased demand, and less wind than expected showed just a few of the variables that can affect this switch. This made for an expensive winter for many consumers.    
  4. Compulsory Carbon Markets – Europe uses a cap-and-trade scheme to encourage the development of renewable energy by setting limits on emissions.  Over time, permits to emit become more expensive making fossil fuels cost more which will encourage producers to develop alternatives. This can backfire, as it is now, when natural gas prices spike.  Countries including France, Spain, and Italy are reducing taxes or directly subsidizing the cost of this fuel to offset the damage. 

Fortunately, some help is on the way. In January, the United States loaded liquified natural gas (LNG) onto tankers at all seven of their export terminals for the first time. Most of this gas is destined for Europe, where it is desperately needed. It can’t get there quickly enough, as Russia is in a prime strategic spot to violate international norms. Europe is dependent on its pipelines to deliver fuel, and cold weather is still here for a couple more months. Russia lost its spot in the G8 after taking Crimea in 2014, but even recently, others expressed interest in them rejoining. Add in the specter in inflation where every dollar increase in fuel cost results in higher prices, and Putin might view now as the time to act. Perhaps now we will focus more on energy independence, but I doubt it. After all, it is election season again. 

Increasing prices don’t have to hurt you and your portfolio. Futures programs often have the ability to perform well in inflationary environments. Please reach out if you want to learn more. 

Greg Taunt – 847-877-0887             

Photo by Ivan Serediuk on Unsplash