Imagine that a few years ago, in early 2014, Vladimir Putin threw a coin into a wishing well and demanded a more favorable market for Russian oil and gas, their main source of foreign exchange. Just seven years ago, after the Russian invasion and takeover of Crimea, the country was an outcast on the world stage. American sanctions destined to paralyze the Russian economy, combined with the weakness of oil prices following the Saudi decision to take back the market share held by the American shale, which have yielded the expected results. The Russian economy was soon in tatters, and the ruble had fallen to post-Soviet hollows. And then, slowly, the wind started to turn. If Putin had indeed tossed a coin down the well in 2014, he could hardly have imagined a more complete fulfillment of that wish than the world we now live in as 2021 draws to a close. A number of decisions taken by Western policymakers (mainly American and European) over the years in favor of âgreen energyâ sources over traditional oil, have effectively given Putin the trump card in negotiations involving the energy security of Europe. When you combine these now questionable decisions with the alliance that Russia has formed with OPEC (now generally referred to as OPEC +), you have a world in which the Russian president must rejoice.
In this article, we will summarize the state of the global energy environment. In particular, we will focus on how a decision – the US drops sanctions on Nord Stream-2 gas pipeline – put Russia in the driver’s seat of negotiations that will have a direct impact on Europe’s energy security this winter.
Energy in 2021
For much of the past five years, the U.S. shale has dominated the marginal balance of increases in global oil and gas supply. A relentless push for growth at any cost has led US production to all time highs as recently as 2020. The pandemic, combined with pressure from a new administration to accelerate the transition to green energy sources, caused oil prices to drop in the basement in April 2020. Many oil producers Energy nearly went bankrupt before prices started to rise again, limited development of new wells, preferring to reward long-time shareholders with increased dividends and share buybacks. I have discussed this trend in a Oil price article back in June.
As a result, US production fell sharply before stabilizing just above the 11mm BOPD. The associated gas that had been produced also fell. At the same time, US gas exports in the form of LNG to European and Asian markets have reached new heights. The net effect of reducing drilling and increasing exports has been to reduce the amount of oil and gas stored, some 30% less than the stocks of the previous year.
Related: America’s Shale Industry Desperately Needs Drilling
The EU is the leader in the green energy transition, and companies headquartered in Member States have received a clear message to reduce their carbon footprint in Scope I, II and III. Shell (NYSE: RDS.A, RDS.B) is the most striking example of this accent, with the Dutch judgment against them. I have discussed the ramifications of this order in a Oil price article in September. As part of this energy transition, the EU has discouraged new gas drilling and has chosen to use gas as emergency aid wind and solar sources on the spot market, as opposed to signing long-term storage contracts. As I noted in the linked article, this brought EU supplies to dangerously low levels, at a time when offshore wind farms by-produced expected electricity supplies due to an environment relatively calm wind.
Add to that an acceleration in the global economy as the impacts of Covid begin to fade, renewed Asian demand for heating in winter, and OPEC’s decision to stick to the moderate increases in production, and you have a good overview of the energy situation facing the world, and in particular the EU, as the winter of 2021-2 approaches. You also have a very, very happy Vladimir Putin as he begins to negotiate increased gas shipments to the EU in conjunction with final approvals for the newly completed Nord Stream-2 pipeline.
Nord Stream-2 negotiations
The Nord Stream-2 pipeline has been vigorously opposed by the two previous US administrations. There were geopolitical and energy security reasons for this opposition, and US sanctions had largely hampered its completion during the critical final phase. In May, the The Biden administration withdrew these objections ostensibly to mend frayed relations with Germany and allowed progress to continue. Nord Stream-2 is now complete with gas flows expected to begin as soon as final approvals from Germany whose territory it passes through is received. In a recent Wall Street Journal article, an energy expert summed up the influence Putin now has on EU energy security:
“The European gas crisis has shown the extreme influence that Russia has on Europe and beyond,” said Thierry Bros, energy expert and professor at Sciences Po Paris. “Putin is the only one who can prevent blackouts in Europe because Russia has spare capacity. It is a position of power.”
The article notes that unlike the West, Russia has become an energy âsuper-storeâ with increasing volumes of gas, oil and even coal. The article estimates that Russia now controls 25% of global gas and LNG shipments and 13.3% of oil shipments, even overtaking Saudi Arabia with 12.6%. It also supplies coal to China in the absence of Australian imports, which China has chosen to ban for diplomatic reasons.
In negotiations with the EU on increasing gas for the winter, Russia appears to be using this leverage and taking a fairly hard line.
“Nothing can be delivered beyond the [existing] contracts, âKremlin spokesman Dmitry Peskov said on Wednesday. Any additional delivery is “a matter of negotiation”.
It remains to be seen to what extent Russia will maintain this position as winter progresses. A few things are certain, however. First, the low-cost energy environment that has endured for several years is probably giving way to one that we are only just beginning to appreciate. Higher prices and supply concerns will dominate the thoughts of policymakers and global consumers as we move forward.
Second, Russia’s new importance in the energy market and on the world stage of world affairs is set to increase. Putin survived the sanctions of the Crimean event, which you rarely hear about these days as the news cycle has evolved, and is now casting a bigger shadow than ever before in geopolitical circles.
How to invest in this new era
Energy stock prices in the United States and Canada have surged in recent months as the full potential impact of this new era has taken hold in the market. Within a year, independent companies like Devon Energy (NYSE: DVN) quadrupled, with low prices encouraging market consolidation. Even oil majors like ConocoPhillips (NYSE: COP) have reached pre-pandemic highs and made strategic acquisitions, as I noted in a Oil price article earlier this month. We believe these companies remain investable in this environment, and a renewed awareness of the true importance of petroleum energy sources could help propel their valuations even higher.
Related: The Facts Behind Saudi Arabia‘s Outrageous Oil Claims
Nowhere is this more true than for large energy service companies. Halliburton, (NYSE: HAL) and Schlumberger, (NYSE: SLB) remain our favorites, and their current valuations do not reflect the potential demand for their services in the coming quarters.
We should also mention the incredible values ââseen in Canadian companies, many of which have been highlighted in previous articles. Tourmaline Oil Corp, (OTC-TRMLF), Canada’s largest gas producer, is still selling at a multiple of single-digit earnings, which is sure to change as winter approaches. Another company we particularly like is Canadian Natural Resources (NYSE: CNQ). CNQ’s long-life, low-decline heavy oil production ensures high net revenues, increasing profits as demand for oil increases in transportation, industry, and as a gas substitute at high prices gas, for the production of electricity. CNQ stock is up 60% this year, and we believe it still has some way to go and pays shareholders handsome dividends.
The need for brevity prevents further suggestions in particular endeavors. The energy sector has been put to the test in recent years and only recently returned to favor. As stated, we believe investors can still find good deals in the new era of energy prices that has just taken hold in the global energy market.
We would leave this general comment to the reader that we see the entire North American energy complex above and below 49e parallel, as a target-rich environment, with few bad choices in today’s market. The reader is encouraged to exercise due diligence and consult an investment advisor before making any investment decision.
By David Messler for Oil Octobers
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