Let’s imagine that a few years ago in early 2014 that Vladimir Putin had tossed a coin in a wishing well and asked for a more supportive market for Russian oil and gas, their chief source of foreign currency. A mere seven years ago, after the Russian invasion and takeover of Crimea, the country was a pariah on the world stage. U.S. sanctions intended to cripple the Russian economy, combined with low oil prices following the Saudi decision to take back market share held by upstart American shale, were delivering just the results intended. The Russian economy was soon in tatters, and the Ruble had fallen to post-Soviet lows. And then, slowly, the tide began to turn. If Putin had indeed tossed a coin into the well in 2014, he could hardly have dreamed up a more complete delivery of this wish than the world in which we now live as 2021 nears its close. A number of decisions by Western (American and European primarily) policymakers over the years favoring “Green Energy” sources over traditional petroleum, have effectively handed Putin the trump card in negotiations involving Europe’s energy security. When you combine these now questionable decisions with the alliance Russia has formed with OPEC (now generally referred to as OPEC+), you have a world in which the Russian president must delight.
In this article, we will summarize the state of the global energy environment. In particular, we will focus on how one decision - the U.S. dropping sanctions on the Nord Stream-2 gas pipeline - has put Russia squarely in command 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, American shale has dominated the marginal balance of global oil and gas supply increases. A relentless push toward growth at any cost drove American production to all-time highs as recently as 2020. The pandemic, combined with a new administration’s push to accelerate the transition to green energy sources, dropped oil prices into the cellar in April of 2020. Many energy producers brought to near-bankruptcy before prices began to rise again restrained development of new wells, preferring to reward long-suffering shareholders with increased dividends and share buybacks. I discussed this trend in an Oilprice article back in June.
American production dropped precipitously as a result before stabilizing just above 11-mm BOPD. The associated gas that had been produced fell as well. At the same time, exports of American gas as LNG to European and Asian markets took off to new highs. The net effect of the reduced drilling and rise in exports was to lower the amount of oil and gas in storage, some 30% below inventories just the year before.
The EU is the leader in the green energy transition, and companies headquartered in member states have gotten a clear message to reduce their Scope I, II, and III carbon footprints. Shell (NYSE:RDS.A, RDS.B) is the most striking example of this emphasis, with the Dutch court finding against them. I discussed the ramifications of this order in an Oilprice article in September. As part of this energy transition, the EU has disincentivized new gas drilling and chosen to use gas as an emergency backup to wind and solar sources on the spot market, as opposed to signing long-term contracts for storage. As I noted in the linked article, this has brought EU supplies to dangerously low levels, at a time when the wind farms offshore have under-produced expected supplies of electricity due to a relatively calm wind environment.
Add in a ramp-up of the global economy as the Covid impacts begin to recede, a renewed Asian demand for winter heating, and OPEC’s decision to stick to the moderate increases in output, and you have a good snapshot of the energy situation the world, and particularly the EU, faces going into the winter of 2021-2. You also have one 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 gas pipeline.
Nord Stream-2 negotiations
The Nord Stream-2 gas pipeline was vigorously opposed by the two prior American administrations. There were geopolitical and energy security reasons for this opposition and American sanctions had largely stymied its completion over the final critical phase. In May, the Biden administration withdrew these objections ostensibly to repair frayed relations with Germany and allowed progress to continue. Nord Stream-2 is now complete with gas flows expected to start as soon as final approvals from Germany whose territory it crosses are received. In a recent Wall Street Journal article an energy expert summarized the leverage Putin now possesses over EU energy security:
“The European gas crisis has shown the extreme leverage that Russia has over Europe and beyond,” said Thierry Bros, an energy expert and professor at Sciences Po Paris. “Putin is the only one who could prevent blackouts in Europe because Russia has spare capacity. This is a position of power.”
The article notes that in contrast to the West, Russia has become an energy “Super-Store” with surging 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, outpacing even Saudi Arabia with 12.6%. It is also supplying coal to China in the absence of Australian imports, which China has chosen to ban for diplomatic reasons.
In negotiations with the EU about increased 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,” Kremlin spokesman Dmitry Peskov said Wednesday. Any extra deliveries are “a matter of negotiating.”
It remains to be seen as to how firmly Russia will hold to this position as the winter progresses. A couple of things are certain though. Firstly, the low-cost energy environment that has persisted for the last several years is probably giving way to the one we are just now beginning to appreciate. Higher prices and concerns about supplies will dominate both global policymakers’ and consumers’ thoughts as we go forward.
Secondly, the new prominence of Russia on the energy market and on the global stage of world affairs is set to grow. Putin has outlasted sanctions from the Crimea event, which you rarely hear much about these days as the news cycle has moved on, and now casts a larger shadow than ever in geopolitical circles.
How to invest in this new era
The prices of energy stocks in the U.S. and Canada have surged in recent months as the full potential impact of this new era has settled upon the market. In the space of a year, independent companies like Devon Energy, (NYSE:DVN) have quadrupled as low prices encouraged market consolidation. Even oil majors like ConocoPhillips, (NYSE:COP) have surged to pre-pandemic highs and made strategic acquisitions as I noted in an Oilprice article earlier this month. We think these companies remain investible in this environment, and renewed realization of the true importance of petroleum energy sources could assist in propelling their valuations still higher.
Nowhere is this more true than for the major energy service companies. Halliburton, (NYSE:HAL) and Schlumberger, (NYSE:SLB) remain our favorites, and their current valuations are not reflective of the potential demand for their services in the coming quarters.
We should also mention the incredible values seen in Canadian companies, many of which we’ve highlighted in past articles. Tourmaline Oil Corp, (OTC-TRMLF) the largest gas producer in Canada, still sells at a single-digit earnings multiple, 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 backs driving profits higher as demand increases for oil in transportation, industrial, and as a substitute for gas in the case of high gas prices, for electricity generation. CNQ’s stock is up 60% this year, and we think it has further to run and pays nice dividends to shareholders.
The need for brevity prevents other suggestions in particular companies. The energy sector has been challenged in recent years and has only recently come back into favor. As noted, we think investors can still find bargains in the new energy price era that has just settled on the global energy market.
We would leave the reader with this generalized comment that we view the entire North American energy complex above and below the 49th parallel, as a target-rich environment, with few bad choices in today’s market. The reader is encouraged to do their own due diligence and consult an investment advisor before making any investing decisions.
By David Messler for Oilprice.com
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