Energy Security, Prices Take Priority Over Climate Concerns In Crisis

The Biden administration, European Union and the U.K. have imposed a raft of sanctions on Russia’s economy as punishment for invading Ukraine. So far, though, sanctions have not applied to Russia’s oil exports in an attempt to reduce the economic impact in the West.

This hasn’t stopped traders from “self-sanctioning,” though, avoiding Russian crude oil and refined products voluntarily to avoid any chance of being caught up in the widening net of sanctions on Russian banks and shipping. It’s also conceivable that sanctions on energy exports could be next if Russian President Vladimir Putin persists in his war of aggression against Ukraine.

As a result, Russian crude and products exports are down by roughly one-third, stoking fear in an already overheated oil market and pushing the price of international benchmark Brent crude to nearly $120 a barrel, a seven-year high.

Rising crude prices have already started to flow down to the corner gas station where drivers feel the pain. The national average price for regular unleaded was over $4 a gallon on Sunday, and drivers should expect prices to edge higher as long as the geopolitical situation remains unstable.

To be sure, the U.S. oil sector stands ready to help alleviate the energy crisis by ramping up domestic production. U.S. oil executives are increasingly calling for President Biden to put the federal government’s full weight behind the shale producers, a sector he has deliberately shunned as a nod to the progressive wing of the Democrats’ coalition.

Pioneer Natural Resources CEO Scott Sheffield recently said that a coordinated effort between shale producers and federal regulators could deliver a 10 percent increase in shale oil production each year through 2025. Such an increase for an industry that is already producing nearly 12 million barrels a day would go a long way to alleviating the supply crisis in oil markets, particularly as spare production capacity among the expanded producer group of the Organization of the Petroleum Exporting Countries (OPEC+) wanes while demand continues to recover from the pandemic.

Investors have been wary of allowing shale producers to pursue growth above 5 percent a year – even though markets are clearly calling on them to increase supplies – because of the industry’s past failures to deliver strong financial returns and the regulated risk associated with climate policy.

The shale sector has done an admirable job of addressing shareholder returns by delivering record levels of free cash flow, which has increased dividends, share buybacks, and strengthened balance sheets.

The last hurdle is social pressure over environmental, social and governance (ESG) risks. Those won’t vanish overnight – even with a cooperative effort between industry and the White House. But investors might be willing to loosen insistence on better ESG performance in the near term to help America and its allies improve their energy security and curb rising prices.

The CEO of Devon Energy, Rick Muncrief, recently said a request from the Biden administration could make it easier for shale producers to boost output without incurring shareholder wrath.

For now, however, that looks unlikely. The Biden administration, which has made climate change one of its central policy pillars, so far has used the conflict in Ukraine to emphasize the need to reduce U.S. oil dependence, not increase domestic output. President Biden has staked out this position despite making several attempts to get the OPEC+ coalition – which includes Russia – to increase crude production to address prices.

The administration’s position makes little sense. Biden has few options to curb prices, which could carry political consequences for Democrats in the November midterm elections. Biden can continue to draw down the nation’s Strategic Petroleum Reserve (SPR), but he’s done so twice since December without a lasting impact on runaway oil prices.

That is because global oil markets are now operating with very low inventories of crude and refined products like gasoline, diesel, heating oil and jet fuel. Tapping the SPR just reduces these stockpiles further and stokes greater fears in the market about the lack of global spare production capacity – which is the real problem on the supply side.

The world has roughly 2.5 million barrels per day in spare production capacity, mostly among Middle East producers. Half of that spare capacity is in Saudi Arabia and a quarter in the United Arab Emirates (UAE). That’s why current Russian export disruptions, estimated at 2.5 million barrels a day of crude and refined products, are so alarming. There is no cushion in markets.

Saudi Arabia and the UAE are key members of the OPEC+ coalition, along with Russia. The producer group has already said it does not plan to increase production beyond the previously announced rate of 400,000 barrels per day. In short, don’t expect the OPEC cartel and its non-cartel partners to come to the rescue, particularly since U.S.-Saudi relations have been troubled since Biden occupied the White House.

U.S. policymakers should consider an SPR release in coordination with increased shale production. That would give the market the supplies it needs now while allowing shale producers time to step up investment with the twin goals of boosting exports to our allies and replenishing the SPR. Either way, it would give the Biden administration more flexibility if Ukraine’s situation continues its current downward trajectory.

That may be a big ask of Biden and his Democratic coalition. But it’s better to prioritize the crisis directly in front of us – energy security – over the long-term one, climate change. After all, Biden and the Democrats won’t have time or the ability to tackle climate change if voters boot them out of office over high energy prices and runaway inflation.