Amid Europe’s Russia ban, renewables mismatch could drive long-term instability in US gasoline prices

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Much to the respite of US dwellers, gasoline prices have seen a sustained downtrend over the past three months. Gas prices fell for 13 consecutive weeks, a fresh record.

This decline was driven primarily by a fall in global oil prices, which impacted gas prices downstream, as well as a marked slowdown in demand after the end of the summer driving season in the US.

With civilians battling high prices at the pump, the Biden administration has been deploying the Strategic Petroleum Reserve (SPR) since March 2022.

Much to the relief of the Democratic party, gasoline prices have fallen to a national average in the three-dollar seventy cents range.

Source: US EIA

However, it is unclear if this easing will continue, or if prices will erupt once more.

As noted in my article at the end of August, analysts’ expectations of oil prices diverged drastically from each other, ranging from a low of $75-$85 per barrel to $120-$130 by the end of the year.

To get an in-depth picture of the latest developments, be sure to check out more of Invezz’s research on the oil market here.

Tightness in the US market

With the 5th of December Russian ban deadline fast approaching, the US mid-term elections around the corner, and the chaotic developments in the Europe-Ukraine-Russia stand-off, the issue of gas prices does not seem to be dying down.

In the United States, the energy market has tightened for the following reasons:

  • The SPR comes to an end in October. There have been suggestions that the US government could extend the program. However, reserves are at their lowest since 1984 and the administration would be in a precarious position in case of a sudden demand shock or natural calamity.
  • As reported previously on Invezz, OPEC+ seems incapable of boosting global production meaningfully.
  • Perhaps most importantly, US refining capacity is insufficient, and approximately 5% below pre-pandemic levels. The prolonged lack of demand, restrictions on movement and chronic underinvestment mean that the rapid expansion of supply is very difficult.
  • Energy firms in the US have been cashing in on higher profits rather than increasing production.

To learn more about the global energy scenario, check out Invezz’s Energy category.

Renewables starve capital

An often under-discussed element in the energy crisis is the negative incentives that are presented to long-term investors following the push for the energy transition. With energy projects taking years or even decades to reach profitability, capital for fossil fuel infrastructure has dried up significantly in an environment where green seems to be the flavour of the future.

Given the expectation that the market will transition to clean energy in the next decade, investors are dissuaded from backing traditional production, refining and storage projects that are needed now more than ever.

Even as clean energy technologies rapidly improve, they are still in relative infancy, and certainly far from the required adoption levels.

Rick Newman, Senior Columnist at Yahoo Finance noted:

Renewables is probably going to take 30 years or 40 years.

This is a highly worrying trend, as much-needed output is likely to stay depressed over the next few years, ushering in periodic mismatches in global energy demand and supply.

European reliance on Russia

As per the International Energy Agency, Europe relies on Russia to meet approximately 40% of its energy demand.  

However, with the invasion of Ukraine earlier this year, EU Commissioner for the Economy, Paolo Gentiloni, made it clear that Europe had two key goals vis-à-vis Russia:

…denying Russia revenues to fund Putin’s brutal war against Ukraine and putting downward pressure on global energy prices.

Gentiloni also confirmed in early September, that as part of the EU’s sixth sanctions package, the G7 shall look to roll out price caps on Russian oil exports and ban all seaborne imports of Russian oil by 5th December 2022.

These restrictions would apply to all petroleum products by the 5th of February 2023.

Appearing on Yahoo! Finance LIVE Newman noted that markets are underestimating the likelihood of the disruption that would ensue if the ban materializes. He stated:

…the market has not priced in that kind of tightening of the market.

Despite what many may see as the moral imperative, treading this path has proved to be strategically and politically challenging for the European bloc, while downright painful for most households.

If enforced, estimates suggest that the ban could have a seismic effect on the global fossil fuels market with 2.4 million barrels per day of oil going offline immediately.

This would force prices higher in Europe, but also impact gasoline prices in the US, where the Fed is expected to continue to raise interest rates.

Having been unable to secure sufficient alternative supplies to fill this vacuum, and with a potentially harsh winter on the way, one can’t help but wonder if European leaders, in their quest to do good, have been too enthusiastic to subject Russia to punitive measures.

A BBC reporter spoke with Gianandrea Pipolo, the owner of an ice cream parlour in Trieste, Italy who said:

We’ll have to stop paying (energy) bills soon. So they will shut us down. My grandfather opened this place in 1929. We survived the second world war and now it will hurt a lot if we have to close…. maybe the government should look at how hungry its people are and ask if it can still help Ukraine. 

As I mentioned in my earlier piece here, it is quite likely that there is a growing wave of resentment sweeping across Europe, as natural gas prices trade 10x of last year’s levels.

However, European officials insist that the shortages are due to Russia’s closure of Nord Stream 1, a pipeline that runs from Russia to Germany.

Vladimir Putin on his part has pointed to Europe suspending the licensure of Nord Stream 2 earlier in the year.

At the recent Shanghai Cooperation Summit (SCO) in Samarkand, Uzbekistan, Putin stated:

They don’t want to open it, and we are to blame.

As per the Kremlin, supplies can return to normal if sanctions are lifted.

However, the war in Ukraine shows no signs of easing, and reports suggest that Russian military forces have ceded territory in some areas, adding to the risk of an oil shock in the coming months.

Moreover, the situation on the ground is escalating, with the US agreeing to supply additional weapons systems to Ukraine in the new few weeks.

Effects on US gas prices

To manage the possible fallout of declining Russian oil deliveries and a heating up of the Ukraine conflict, the United States and other G7 members are looking to institute price caps on Russian oil exports, as mentioned above.

No easy task at the best of times, it is yet to be seen if the US will be able to follow through with concrete steps, since the upcoming mid-terms may prove to be the Achilles’ heel of the Biden government.

The White House may be wary of the Russian government using this as an opportunity to disrupt oil flows and gain leverage.

Given the sensitive position of the administration, it may be prudent to prepare the country for a potentially deep cut in Russian natural gas and oil supplies to the global market, as retaliation for instituting price caps.

If oil supplies were to plunge, gasoline prices would shift higher and likely breach the $4 mark in the US by the beginning of 2023.

Earlier today, the EIA saw an inventory build-up of 1.6 million barrels of gasoline, signalling weak demand. This is a reversal of last week’s drawdown of 1.8 million barrels and may be partly due to cautious markets ahead of the Fed press conference today.

Be sure to visit our economy news section to stay up to speed with the latest developments on the Fed and global markets.

For Europe, the consequences could prove to be much more grave in the near term, with Elliot Clarke, an economist at Westpac Banking, noting that:

…a recession (is) essentially guaranteed if gas inventory cannot be raised further ahead of winter, or the weather proves harsh. 

In the coming days

One of the most important events in the run-up to December 5, will be Italy’s snap elections later this week. There is the possibility of a new far-right-led government coming to power, that will likely move to end sanctions on Russian oil.

This would be beneficial to the average householder but may lead to even deeper splinters in European integration. 

To avoid any fresh political frictions, Europe may be best served by keeping in mind the unfortunate position of common citizens, the viability of the collective and agreeing to water down the ban for the time being.

At the macro level, the broader headwinds across the energy sector led by a combination of under-investment and a lack of renewable replacements will likely mean that shortages will continue to flair up in the US and Europe for years to come.

With gasoline accounting for above 4% of the US CPI, long-term instability in energy prices could be an added headache for the Fed.
 

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