Inflation is being driven by certain sectors of the economy, for the purposes of this post, we will look at energy costs.
The U.S. Energy Information Administration says “Crude oil prices are determined by global supply and demand,” rather than supplies available in localized or regional markets.
Importantly, “Geopolitical events and severe weather that disrupt the supply of crude oil and petroleum products to market can affect crude oil and petroleum product prices. These events may create uncertainty about future supply or demand, which can lead to higher volatility in prices.”
This is about to become a BFD if Russia invades Ukraine this week and the world responds with crippling sanctions on the Russian economy. Russia is a large supplier of natural gas and oil to Europe. Taking its production out of the global supply will increase crude oil prices, even though OPEC has excess capacity and could easily replace the Russian supply of crude oil to Europe if it so chooses.
Neil Irwin at Axios reports, The U.S. is now energy independent:
For decades, politicians have talked about the U.S. achieving energy independence, a seemingly elusive goal of producing enough fuels to avoid relying on the rest of the world to fill up gas tanks and keep electricity flowing.
It’s elusive no more. The U.S. produced more petroleum than it consumed in 2020, and the numbers were essentially in balance in 2021, according to the Energy Information Administration.
Why it matters: The surge in oil prices taking place in 2022 has radically different implications for the U.S. economy — and for key geopolitical relationships in the Middle East and Russia — than in past episodes when energy prices have risen.
The big picture: In the past, when oil prices spiked, the impact on the U.S. economy was straightforward: It made America poorer, as more of our income went overseas to pay for imported energy.
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- Now, after the shale gas revolution of the last 15 years, the impact is more subtle. Higher fuel prices disadvantage consumers and energy-intensive industries, yes. But there is a counteracting surge in incomes for domestic energy producers and their workers.
- Higher oil prices no longer depress overall measures of prosperity like GDP and national income, but rather shift it around toward certain regions. Texas and North Dakota win; Massachusetts and North Carolina lose.
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By the numbers: As recently as 2010, America imported 9.4 million barrels a day of oil more than it exported. That had swung to a 650,000 barrel per day surplus in 2020, and preliminary numbers for 2021 show trade pretty much in balance last year.
Worth noting: To the degree the U.S. does still import oil, more of it is coming from our closest ally. Canada was the source of 51% of U.S. petroleum imports in the first 10 months of 2021, compared with 8% from the Persian Gulf
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- By contrast, the Gulf states supplied more than 30% of American petroleum imports in 2008.
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The impact on geopolitics extends to a potential Russian invasion of Ukraine. Disruptions to European energy supplies would have a less direct effect on the U.S. than they might have in an earlier era.
The bottom line: When oil prices spike, it’s no longer a problem for overall growth—but because energy is a global market, it still means pain for American consumers and the sitting administration.
Gasoline prices are based on a combination of monetary and fiscal components. The Energy Information Administration describes these pricing components as follows:
What are the main components of the retail price of gasoline?
The retail price of gasoline includes four main components:
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- The cost of crude oil
- Refining costs and profits
- Distribution and marketing costs and profits
- Taxes
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Retail pump prices reflect these components and the profits (and sometimes losses) of refiners, marketers, distributors, and retail station owners.
What determines the cost of crude oil?
The cost of crude oil is the largest component of the retail price of gasoline, and the cost of crude oil as a share of the retail gasoline price varies over time and across regions of the country. Many factors affect crude oil prices; learn about seven major factors that influence crude oil prices in What Drives Crude Oil Prices? Increases in U.S. oil production in the past several years have helped reduce upward pressure on oil and gasoline prices.
Taxes add to the price of gasoline
Federal, state, and local government taxes also contribute to the retail price of gasoline. The federal tax on motor gasoline is 18.40 cents per gallon, which includes an excise tax of 18.30 cents per gallon and the federal Leaking Underground Storage Tank fee of 0.1 cents per gallon. As of January 1, 2021, total state taxes and fees on gasoline averaged 30.06 cents per gallon. Sales taxes along with taxes applied by local and municipal governments can have a significant impact on the price of gasoline in some locations.
Refining costs and profits
Refining costs and profits vary seasonally and by region in the United States, partly because of the different gasoline formulations required to reduce air pollution in different parts of the country. The characteristics of the gasoline produced depend on the type of crude oil that is used and the type of processing technology available at the refinery where it is produced. Gasoline prices are also affected by the cost of other ingredients that may be blended into the gasoline, including fuel ethanol. Gasoline demand usually increases in the summer, which generally results in higher prices.
Distribution and marketing
Distribution, marketing, and retail dealer costs and profits are also included in the retail price of gasoline. Most gasoline is shipped from refineries by pipeline to terminals near consuming areas, where it may be blended with other products —such as fuel ethanol—to meet local government and market specifications. Gasoline is delivered by tanker truck to individual gasoline stations.
Some retail outlets are owned and operated by refiners, while others are independent businesses that purchase gasoline from refiners and marketers for resale to the public. The price at the pump also reflects local market conditions and factors, such as the fueling location and the marketing strategy of the owner.
The cost of doing business by individual gasoline retailers can vary greatly depending on where a gasoline fueling station is located. These costs include wages and salaries, benefits, equipment, lease or rent payments, insurance, overhead, and state and local fees. Even retail stations close to each other can have different traffic patterns, rent, and sources of supply that affect their prices. The number and location of local competitors can also affect prices.
Even though the U.S. is essentially energy independent, this has little effect on the price of gasoline at the pump, because this depends on the price of crude oil set on the global market.
Oil producers have been keeping supplies tight as the gobal economy recovers from the global pandemic, trying to recover their market losses after the price plunge in 2014 by profiteering and price gouging to satisfy shareholders. Why isn’t Big Oil drilling more as gas prices surge? The answer is more Wall Street than White House:
A popular trick at gas stations this fall is to slap a sticker featuring President Joe Biden pointing to the price per gallon and saying, “I did that.” But the real answer has more to with Wall Street than Pennsylvania Avenue.
The root cause of today’s high gas prices isn’t politics: It’s financial pressure on oil companies from a decade of cash-flow losses that have made them change financial tactics. Investment in new wells has dropped more than 60%, causing U.S. crude oil production to plummet by more than 3 million barrels a day, or nearly 25%, just as the Covid virus hit, and then fail to recover with the economy. For an oil-drilling sector that lost 90% of its stock value from 2012 through early last year, it hasn’t been the toughest call in the world.
Oil company chief executives and finance chiefs have faced years of rising demand from markets for more disciplined capital spending after a spree of development centered in West Texas and North Dakota produced an estimated $10.9 billion in negative free cash flow in 2014 alone — roughly speaking, operating profit minus capital spending. That persistent cash drain made blue-chip oil exploration stocks drop 90% from their peak and spurred demands that companies eschew fast growth in favor of steadier profits and stock-boosting finance moves like higher dividends, more share buybacks and reduced debt.
“For really the decade that ended in 2019 or 2020, there was an energy revolution and what did the energy sector get? They were the worst performers in the S&P 500,″ said Rob Thummel, portfolio manager at Tortoise Capital in Overland Park, Kansas.
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“Strong operating cash flow enabled us to deliver on our financial priorities, including the resumption of share repurchases,” Chevron CFO Pierre Breber said on the company’s earnings call. “Cost efficiency and capital efficiency are essential to navigate commodity price cycles.”
“The equity holders said, ‘you’ve got to give me cash,’” according to McNally. “Now the companies are being run to generate free cash more than growth.”
Much discussion, including on social media platforms like Twitter, as to why crude oil and gasoline prices have spiked has focused on politics … But if there are political leaders to take the credit, or the blame, according to Tom Kloza, president of Oil Price Information Service, the people most responsible are not Americans, but Russian President Vladimir Putin and Saudi Arabia’s Crown Prince Mohammed Bin-Salman.
After oil prices tanked in 2014 and 2015, with the U.S. national average price for gasoline reaching an early-2016 low of $1.72 a gallon, the Organization of Petroleum Exporting Countries linked up with Russia to contain oil production, which had outstripped demand as U.S. production rose to 9 million barrels per day in 2016 from 5 million in 2008. Daily worldwide demand now is about 100 million barrels, according to a report last month by BP.
Production limits by the OPEC+ bloc let gas prices rise slightly during Trump’s pre-Covid presidency. Even as U.S. crude production kept rising, peaking at 13 million barrels in November 2019, gas prices, which averaged $2.37 a gallon at Trump’s inauguration, stayed between $2.24 and $2.92 until Covid sent them plunging to an April 2020 low of $1.77. That pushed U.S. oil drillers to finally cut production back to 9.8 million barrels per day by February 2021. Meanwhile, OPEC+ continued to hold its own production near-steady.
“You have a cartel that is traditionally as disciplined as Charlie Sheen’s drinking, and for the last year they’ve been as disciplined as Olympic gymnasts,” Kloza said.
Another reason is that investment in finding new wells peaked in 2014 and has dropped sharply since, making it hard for drillers to react quickly to an improving economy. According to S&P Capital IQ data, 27 major oil makers tripled capital spending between 2004 and 2014 to $294 billion, ad then cut it all the way back to $111 billion by last year. Once old wells were capped, new ones haven’t been available to fill the production gap quickly, explained CFRA Research analyst Stewart Glickman.
The pressure on oil companies to stop draining cash took many forms. The catastrophic drop in independent oil stocks forced a series of mergers of independent oil producers, and debt markets became more wary of oil companies, forcing producers to pay more attention to stockholders’ financial strategy demands.
“In effect, shareholders [had been] subsidizing the global price of oil,” says IHS Markit analyst Raoul LeBlanc.
[H]anging over all of this is pressure from environmentally conscious investors to push carbon emissions lower, and the awareness that gasoline demand will likely erode as electric cars get more popular. “Companies don’t know where this is going and don’t trust the future too much,” LeBlanc added.
With crude still at $70 a barrel, even after a big dip caused by the emergence of the omicron variant of Covid-19, there would seem to be plenty of room to boost production with many areas of the U.S. flush with oil that would cost $50 or less to produce, according to IHS Markit data. And indeed, production has recovered to about 11.7 million barrels per day, helping to spur an 11-cent drop in gasoline prices in the last month.
But the most conspicuous part of the production jump has come from producers whose stock isn’t publicly traded, according to experts. Privately owned oil and gas exploration firms are moving faster because they don’t have the day-to-day shareholder pressure that has made CEOs and CFOs of bigger drilling companies change their tactics. One sign that the pressure is still working: The number of U.S. oil wells that have been drilled but are not completed, or ready to begin pumping, is still down more than 30% since 2018, according to government data.
The question is how long the restraint by publicly traded oil companies will last. Glickman is betting that it will be durable, with capital spending around $135 billion next year – less than half of 2014′s level. Kloza suspects the discipline will break down sooner, helping gas prices keep falling.
The worst combination for gas purchasers would be a quick recovery from omicron, followed by a surge in economic activity and continued low spending. That could pull gas prices toward $4 a gallon again if the economy is strong, according to Glickman, while McNally said consumers could benefit from a recent rise in gasoline inventories.
And if Russia starts a war in Europe this week, prices will really spike.
For shareholders, the outlook is for more dividend hikes to protect 2021 gains in energy stocks, followed by stock buybacks rather than plunging into new drilling — and, ultimately, a shift in investment toward the future that many companies have already telegraphed.
“They’ll start spending capex on decarbonization,” Thummel said. “For these companies to get investors to return, you have to show a solid cash-flow-making business. It’s kind of a prove-it story for the industry.”
So once again it is the investor class aka The Predator Class, as Dick Meyer dubbed them, driving supply shortages in crude oil and inflation in gasoline prices.
Reuters reports, “Germany blocks Nord Stream 2 gas project as Ukraine crisis deepens”, https://www.reuters.com/business/energy/germanys-scholz-halts-nord-stream-2-certification-2022-02-22/
Germany on Tuesday halted the Nord Stream 2 Baltic Sea gas pipeline project, designed to double the flow of Russian gas direct to Germany, after Russia formally recognised two breakaway regions in eastern Ukraine.
Europe’s most divisive energy project, worth $11 billion, was finished in September, but has stood idle pending certification by Germany and the European Union.
The pipeline had been set to ease the pressure on European consumers facing record energy prices amid a wider post-pandemic cost of living crisis, and on governments that have already forked out billions to try to cushion the impact on consumers.
“This a huge change for German foreign policy with massive implications for energy security and Berlin’s broader position towards Moscow,” said Marcel Dirsus, non-resident fellow at Kiel University’s Institute for Security Policy.
“It suggests that Germany is actually serious about imposing tough costs on Russia.”
[E]conomy Minister Robert Habeck said Germany’s gas supply was secured even without Nord Stream 2.
But he told journalists in Duesseldorf that gas prices were indeed likely to rise further in the short term.
Ret. Admiral Dennis C. Blair and Ret. General Joseph F. Dunford, Jr. write at the New York Times, “The West’s Delusion of Energy Independence”, https://www.nytimes.com/2022/02/22/opinion/russia-ukraine-energy-conflict.html
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In recent years America has been lulled into a false sense of energy independence. The shale revolution of the past decade has generated incredible supplies of vital natural gas and oil. European countries, blessed with diverse economies, have also felt relatively secure in recent years. But that is changing.
[In] the United States, gasoline prices have reached levels not seen since 2014. America is still bound to international oil markets that have grown increasingly nervous at the unpredictability of Russia, a key global oil producer. While U.S. policymakers scramble to find the usual Band-Aids, consumers and businesses are once again being stung by rising prices at the pump. America’s recently self-proclaimed “energy independence” is a lot more interdependent than advertised.
Are the United States and its allies adequately focused on the risks of today’s energy reality? Have they positioned themselves for a future in which they have ready access to the raw materials essential to emerging technologies?
The answer is no — they are at risk of being usurped by adversaries. And perhaps the biggest threat ahead is China. The United States and its allies are making strides to harness diverse and clean energy sources like wind, solar and hydrogen. They are smartly deploying electric vehicles to end our dependence on oil and its market-controlling cartel. Increases in battery efficiency are helping to encourage both trends.
But the danger of the electric vehicle transition especially is that it will convert America’s current vulnerability to oil and gas markets to dependence on a supply chain for critical minerals for advanced batteries that is now controlled by and flows through China.
Over a decade ago, China made a strategic decision to corner the world of electrification. It made substantial investments in the manufacture of batteries and the assembly of electric vehicles, as well as in the mining and processing of minerals vital for E.V.s.
As of 2020, Chinese firms controlled more than 60 percent of the world’s lithium and nickel refining and over 70 percent of cobalt refining, according to a report prepared by the consulting firm Roland Berger for SAFE, the energy security group that one of us chairs. These are essential for lithium ion batteries used in electric vehicles. The same report found that U.S. companies account for only 4 percent of lithium, 1 percent of nickel and zero percent of cobalt refining. Further along this supply chain, Chinese companies produce 41 percent of the cathodes and 71 percent of the anodes used in E.V. batteries. The United States produces essentially none of these key components.
The bottom line is that the United States now depends heavily on supply chains from nations that do not share our interests and values. Policymakers must heed this risk or risk being held hostage by these nations.
[T]he situation facing Ukraine has demonstrated how quickly the dynamics of energy dependency can be turned against Western interests. To set the United States and its allies on a path of long-term national security, America must focus on supplying the energy it needs today while rapidly building out a renewables supply chain that is beholden to no single nation.
UPDATE: The New York Times reports, “The U.S. is planning to boost supply of minerals needed for electric vehicles.”, https://www.nytimes.com/2022/02/22/business/minerals-electric-vehicles-supply.html
President Biden announced several public and private investments on Tuesday aimed at expanding the domestic supply of minerals that are needed to make electric vehicles, computers, solar panels and other products but are currently sourced from overseas.
“We can’t build a future that’s made in America if we ourselves are dependent on China for the materials that power the products of today and tomorrow,” Mr. Biden said at a White House event.
The initiative is part of a White House push to make the United States less dependent on foreign products, given supply chain disruptions that have resulted in shortages of goods, helping to fuel inflation. The investments announced on Tuesday were aimed at boosting domestic supplies of minerals — including lithium, cobalt and rare earths, many of which typically come from China — that are used in a wide array of technologies.
The Pentagon awarded MP Materials, an American mining company, $35 million to expand a rare earths project in Mountain Pass, Calif., with the company expected to invest another $700 million in the supply chain by 2024. The project would establish the first complete supply chain within the United States for permanent magnets, which are used in electric vehicle motors, wind turbines and defense applications, according to a White House statement.
Berkshire Hathaway Energy Renewables announced plans to break ground this spring on a California facility to test the commercial viability of a process that extracts lithium from geothermal brine. If the test is successful, the company could start commercial production of lithium hydroxide and lithium carbonate by 2026.
Redwood Materials said it would discuss a pilot project with Ford Motor and Volvo to extract lithium, cobalt, nickel and graphite from retired lithium-ion batteries used in electric vehicles, according to the White House statement.
The Biden administration has warned that a dependence on foreign lithium, cobalt, nickel and other minerals, particularly from China, poses a threat to America’s economy and security. It has promised to expand domestic supplies of semiconductors, batteries and pharmaceuticals, as well as the mining, processing and recycling of critical minerals.
The infrastructure law passed last year contained funding for projects to recover rare earths and other critical minerals from coal ash and mine waste, refine battery materials, and recycle electric vehicle batteries.
Mr. Biden said Tuesday that the United States had to import close to 100 percent of the critical minerals it needed from other countries, particularly China, Australia and Chile. “I was determined to change that, and we’ve seen what happens when we become dependent on other countries for essential goods,” he said.
AND there it is! “Oil prices jump, shares sink as Ukraine crisis escalates”, https://apnews.com/article/russia-ukraine-business-asia-tokyo-europe-e6b1a6678833d81272b2dd7b130aa25a
Oil prices surged nearly 5% and stock prices dropped after Russian President Vladimir Putin recognized the independence of rebel-held regions of Ukraine, raising fears that a full-scale invasion was near.
Russia is a major energy producer and the tensions over Ukraine have brought wide swings in volatile energy prices, on top of the inevitable risks of a broader conflict.
Oil prices already had surged recently to their highest level since 2014. By early Tuesday, the advance of U.S. benchmark crude oil had abated slightly. It was up about $3, or 3.5%, to about $94 per barrel in electronic trading on the New York Mercantile Exchange. The price of Brent crude, the standard for international oils, gained about $4.50, or nearly 5%, to hit about $98 per barrel.
U.S. futures were down, with the contract for the S&P 500 down 0.1% and the future for the Dow industrials 0.2% lower.
The biggest losses have been in Russia, where the MOEX index was down 5% Tuesday after losing nearly 11% on Monday.
The ruble was 2.5% lower.
“The current situation is tightening financial conditions for Russian companies, destabilizing markets and reducing business predictability,” Elena Nazarova of FxPro said in a commentary.
[M]any Asian economies depend on oil and gas imports, and even if those don’t come from Russia, the spillover effects on world markets will raise energy costs at a time when countries are still barely recovering from the pandemic.
“Crucially, while Russia may not be the most prominent source of direct energy imports for (emerging markets in) Asia, its sheer heft as a global producer/exporter means energy shocks emanating from Russian supply disruptions will nevertheless be disproportionally large,” Mizuho Bank’s Vishnu Varathan said in a report.