The oil and gas industry has been at its closest to demand in 2022, but despite all the concerns over high gas prices in the United States, natural gas has seen a more consistent rise in yields. VettaFi contributor Dan Mika spoke to VanEck commodity strategist Roland Morris about what drives the spread.
(This interview has been edited for clarity and brevity.)
Dan Mika, VettaFi contributor: Energy is the only thing that makes money in the markets. But as oil prices began to fall after Russia invaded Ukraine, natural gas continued to rise. They’re usually talked about in the same breath, so why are they acting so differently when it comes to their performance year-to-date?
Roland Morris, VanEck: Before the war, energy prices were already rising due to a lack of long-term investment in production. People forget that there are rates of decline, where existing oil fields around the world decline and those resources lose production. We are probably losing 4 million barrels per day per year. If you don’t replace that, you have a problem.
Then we went through COVID, where prices crashed and investment continued to be non-existent. OPEC tried to adapt to the drop in demand during COVID. And then they added production back as the global economy rebounds. China has been sluggish this year. This is therefore a significant demand that has lagged behind normal. But the bottom line is that OPEC is really at the end of its production. This is the main reason why we saw such an addition announced for production this month; they are reaching the end of their capacity.
You will likely see oil prices around $100 (per barrel), possibly even higher next year. Simply because this war is causing structural problems in the way crude oil flows around the world. It’s probably going to be high.
But it’s not as dramatic as what happened to natural gas this year. Natural gas is the real story. Putin is playing games with Europe, Europe bet on Russia for energy, and they made a bad bet, led by Germany. They could get cheap natural gas from Russia, and Russia built the pipelines, but they controlled all the goods. And now that there’s a war, Putin has dramatically cut natural gas, and you can’t just turn it on and off and easily get it from another source. We have tons of natural gas in the United States, but you need these very complicated facilities to both ship it, and it’s expensive. Ten years ago, Germany wanted to diversify its risks and American companies were begging them to sign long-term contracts to build the facilities. But they had no interest because they had cheap Russian gas. So that created the problem, and now we have a complete mess in Europe for energy. This problem is going to be persistent, because natural gas is really essential for heating for electricity production. This should have been our transition fuel that we as a world have embraced because it is so much cleaner, and we have failed to do so.
And now we have a real problem. Natural gas has a different way of pricing and measuring natural gas in Europe. Our natural gas is trading for about $8 today. If you translated European natural gas the same way we price ours, it would be $60. There is no way to fix this problem quickly. We are trying to build new export facilities, which is why our natural gas prices are high. And that’s the lack of pipeline capacity. They basically stopped building infrastructure, and that was a real problem.
So you have a situation where we need this energy over the next 10, 15 years as we move away from fossil fuels, especially for power generation, because natural gas is essential for that. And then, of course, natural gas has other uses. That’s how you make fertilizer. So European fertilizer producers have basically closed down because the price is too high. Nitrogen is four times higher than a year ago. So farmers around the world are not applying the required amount of fertilizer, which means we will have lower yields globally for the next two years. So we have a food problem and a natural gas problem. These are the real critical issues.
Crude oil, you can sort of separate it, in my opinion. It is a much easier commodity to transport, and the United States has increased its production thanks to hydraulic fracturing. At some point, demand will start to drop in the longer term. But in the short term, we just don’t have enough crude oil. Everyone is at production capacity and we haven’t invested enough. Nobody will invest in this volatile environment where there are pressures in the United States, whether it is ESG or societal pressures. So you just don’t get the required investment. So we’re going to have high energy prices for, you know, probably for the next ten years, I guess.
Mikhail: Focusing more on this year, oil soared in the days and weeks after the start of the Russian invasion, but slowly declined as the market began to panic over fears of recession and decline in demand. How much of that is factored into the gap between how oil is performing versus natural gas, which I suspect is not a similar indicator of economic growth?
Morris: The difference is that the offer of the two products is very different. Natural gas is difficult to transport outside of pipeline networks. Putin has total control over Europe; they depend entirely on him for their short-term energy. The world oil market is flowing quite easily and a large part of Russian oil is shipped to China via India. It just changes the delivery location, so the total amount of oil supply is correct. What has helped Crude Oil over the past two months is really the release of the Strategic Petroleum Reserve, which is only a short-term solution. This is going to end at the end of September, and at some point we will have to replenish these stocks. They are the lowest they have been in history. It is a manipulated market in the short term. Personally, I don’t think oil will go much lower than it is today.
Mikhail: You mentioned that energy prices will remain quite high for the next 10 to 15 years. Given all of these conflicting factors right now, the short-term supply crisis for oil and gas, combined with the longer-term divestment in fossil fuel production because it contributes to climate change, how are you doing this from an investment perspective?
Morris: I think energy producers will be a good place to invest because I think commodity prices will remain high. We decarbonize supply before decarbonizing demand. In short, that’s the problem. We’re going to need those products, and we’re going to be tight and likely to have persistent shortages. But not right now, because we have a global economy that is slowing down because we have an inflation problem and central banks are raising their rates. The request will be contained.
But the real problem is supply, and natural gas is another issue directly related to Russia. While crude oil is more of a global and easily transportable commodity than natural gas. Natural gas is essential for the production of electricity. It is a tragedy that Europe is burning more coal now because it has no natural gas. They’re going to burn a lot more coal over the next winter than they’ve done in the last decade, and that’s because they have no choice.
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