Amidst Russia’s invasion of Ukraine and rising prices at the pump, President Biden is set to deliver his first State of the Union address. Biden will attempt to breathe life into the climate provisions of his Build Back Better agenda, calling for green spending to combat inflation. The Biden administration is dealing with immense challenges: Providing affordable energy to American families and businesses, helping European allies loosen Russia’s grip on energy markets, and addressing climate change. Opening access to markets and modernizing regulations to build cleaner and faster will help with all three.
The Relationship Between Oil Markets and Prices at the Pump
The national average price for gasoline is $3.61 per gallon – up nearly a dollar from a year ago. The price of a barrel of crude oil makes up the largest share (43 percent) of the price of a gallon of gasoline. Refining (25 percent) and federal and state taxes (22 percent) are next. Although there are different types of crude oil, oil is a globally traded commodity. Therefore, the supply of and demand for oil around the world affects the price at the pump in the U.S.
Before Russia’s invasion of Ukraine, oil prices steadily increased over the past three months as demand outpaced supply. As countries lift Covid-19 restrictions and warmer weather encourages more travel, forecasters project that oil demand will surpass pre-pandemic levels.
Russia is the world’s second largest oil producer, providing 10 percent of the world’s supply. Geopolitical risk makes oil markets uneasy because of the fear that conflict will curtail supplies. Even the threat of a supply disruption could drive oil prices higher in the near-term as oil traders fear that supply will be adversely affected. Oil futures markets can temporarily drive prices higher if producers take oil and refined products off the market with the hope of fetching a higher price for it later (though they’ll have to sell it eventually). In the same manner, traders can help drive down prices in the short-term. Russia’s invasion of Ukraine pushed oil prices above $100 per barrel. Actual damage to energy infrastructure or sanctions on Russian banks could threaten the delivery of oil to the market, further increasing prices.
Spare capacity, or the lack thereof, also affects how quickly oil prices increase. The Energy Information Administration (EIA) defines spare capacity as “the volume of production that can be brought on within 30 days and sustained for at least 90 days.” The lack of spare capacity results in faster price spikes as producers are unable to respond quickly to higher prices. American producers are ramping up production but getting that oil to market will take some time. EIA projects that U.S. production will surpass 12 million barrels per day by the end of the year and hit 12.6 million barrels per day (reaching record highs) in 2023. OPEC producers, including Iran on the verge of a nuclear deal, will likely increase production as well, though several OPEC members have underdelivered over the past year.
Natural Gas and Europe’s Dependence on Russia
Natural gas prices in Europe have also surged in recent days. Although natural gas markets are becoming more connected internationally, changes in prices are more regionally focused. Over the last few decades, European demand for gas was relatively flat while production decreased, resulting in increased imports (from Russia, Norway, Algeria, Qatar, and the U.S.).
Europe depends on Russia for about 40% of its consumption. Some countries are almost exclusively reliant on Russian gas. The relationship is more interdependent as evidenced by Russia not turning off gas supplies to the rest of Europe.
There are a few silver linings that make the conflict in Ukraine less harmful for European energy consumers as compared to decades ago. First, far less Russian natural gas moves through Ukraine today. The Wall Street Journal reported, “In 2006, for example, 80% of Russian gas supplies to Europe went through Ukraine. In recent years, Ukraine has played a smaller role and as of Feb. 20, roughly 18% of the natural gas that Russia’s Gazprom through pipelines to the EU went through the country, according to its own disclosure.” The primary concern is the well-being of the Ukrainian people. But if 80 percent of Europe’s natural gas moved through Ukraine, damage to large portions of that infrastructure could have crippled an entire continent that is barely surviving an energy-starved winter.
Another silver lining is that Europe has diversified its natural gas imports, with American exporters stepping up in a big way. By expanding its capacity to import liquified natural gas (LNG), Europe has imported more LNG from the U.S. and Qatar. The U.S. was the largest exporter of LNG to Europe in 2021, and American exporters nearly doubled supply from November to January to help Europe’s winter energy crunch as natural gas inventories across Europe were low. In fact, Europe was on the “receiving end of nearly 77% of U.S. LNG cargoes exported in January.” As we move closer to warmer months, building up Europe’s natural gas inventories is imperative to avoid another (potentially much worse) energy crisis next winter. Relative to Europe’s entire natural gas consumption, the LNG market is still rather small, but the LNG market has grown in importance and helped to diversify Europe’s natural gas choices.
Displacing all Russian gas with other sources would be incredibly challenging, and it is unlikely LNG from other countries could displace the entirety of Russian gas any time soon. Nevertheless, Europe’s expansion of LNG facilities does provide a roadmap to significantly curtail Russia’s ability to manipulate energy markets for political purposes. Manhattan Institute Senior Fellow Mark Mills made this very point in 2018 testimony:
“There is no denying that gas delivered by Gazprom pipelines can arrive in Europe at lower cost than even the record low prices now associated with shipping U.S. LNG there. But it bears noting that the EU, as have many nations, frequently embracing policies that require paying a premium for some energy supplies based on key non-price attributes – security and resilience are attributes worth something. In that regard, it bears noting that based on the current price spread between U.S. LNG and Russian natural gas, even if Europe were to use all of its idle LNG import capacity to buy American gas, Europe’s overall annual energy import costs would rise by less than 10%. In the long run, that could be the cheapest resilience hedge EU leaders could buy.“
Expanded American LNG exports could also help reduce global greenhouse gas emissions. The Department of Energy’s National Energy Technology Laboratory (NETL) analyzed life cycle greenhouse gas emissions from LNG exports. In different scenarios comparing U.S. LNG shipped to European markets, when compared to coal use or Russian piped gas, the study found life cycle emissions from U.S. LNG exports to be lower.
Additionally, Europe can advance energy security objectives by developing its own resources, building nuclear power plants (or withdrawing plans to close existing plants), energy efficiency, electrification, demand-side responses, and expanding renewable energy development. The roadmap away from Russia is diversification and choice.
The U.S. Can Provide Europe with Cleaner Energy Choices
No magic bullet exists to replace Russia’s natural gas supply to Europe overnight, but Congress and the administration should improve processes to deliver more energy choice to Europeans as quickly as possible. The United States should continue to be a leading trading partner to affordable, reliable power to Europe that would benefit the U.S. and Europe economically and geopolitically.
Congress and the administration should:
- Expedite permitting for energy projects and infrastructure, including but not limited to LNG export terminals, renewable power, transmission lines, and electric vehicle charging stations. The UNSHACKLE Act and BUILDER Act are two bills that would dramatically improve the permitting process.
- Fast-track permitting for LNG exports. If the U.S. does not have a free trade agreement (FTA) with the country receiving or sending the natural gas, the Department of Energy must make a public interest determination. The reality is LNG exports benefit Americans economically and geopolitically and private companies should be able to sell natural gas to any buyer they want, so long as it does not compromise national security. The ESCAPE Act would accomplish a similar objective.
- Provide alternative pathways to site and permit LNG facilities to remove bottlenecks, including authorizing state regulators to conduct the environmental reviews while pulling in technical expertise from the Federal Energy Regulatory Commission (FERC) as necessary.
- Eliminate steel and aluminum tariffs, which drive up the cost of energy infrastructure.
- Expand U.S.-EU partnership on small modular reactors (SMRs). In November 2021, the U.S. and Romania announced a partnership for Romania to build six small reactor modules American SMR company NuScale’s design. Expanded SMR technology throughout Europe using American technologies can help Europe achieve its energy security and climate objectives.
Of course, Europe could be even more aggressive in a transition away from Russian gas. Nikos Tsafos, an energy expert at the Center for Strategic and International Studies that specializes in European gas, proposed Europe go even bolder. In a tweet, Tsafos urged that Europe needs big ideas and proposed a European Defense Production Act (DPA) to install 100 million heat pumps, paying suppliers to increase gas supplies and paying industrial users not to consume gas. A DPA-style effort (which could apply to heat pumps, LNG import terminals, renewable and nuclear power projects) could be the necessary tool to move away from Russian dependence as quickly as possible. When Russia is run by a warmonger and a murderer, desperate times call for desperate and urgent measures.
Policy Options to Reduce Gas Prices Here at Home
No magic bullet exists to lower gas prices overnight, either. The Biden administration could work with other countries and the International Energy Agency to coordinate a release of oil reserves, but the price impact would likely be modest and short-lived. Even so, governments are not private actors in the market and may not get the timing right. If governments think the situation is going to worsen, they may wait too long to have any meaningful effect.
While supply and demand are the main drivers of gasoline prices, government policies and regulations affect supply and demand and consequently, add to the price at the pump. Congress and the administration should:
- Temporarily waive blending requirements for summer gasoline, which can add 5 to 15 cents per gallon.
- Repeal the Renewable Fuel Standard (RFS). A 2019 Government Accountability Office (GAO) study found the mandate was “associated with modest gas price increases in areas outside the Midwest” for “limited effect, if any, on greenhouse gas emissions.”
- Waive or repeal the Jones Act, which mandates that oil (and other goods) shipped between two ports in the U.S. must be transported on a U.S.-built, U.S.-flagged vessel with a crew that is at least 75% American. Southern Methodist University professor James Coleman pointed out that refiners in the northeast U.S. paid triple the price to ship oil from Texas than West Africa or Saudi Arabia. The Jones Act also distorts the transportation of LNG.
- Approve the Keystone XL pipeline and conduct oil and gas leases sales on federal lands and waters. While not immediate, open access would increase supplies and continue to position America as the world’s largest oil and gas producer.
Russia’s invasion of Ukraine was a wake-up call. Countries and companies are responding appropriately. Germany froze the Nord Stream 2 pipeline project and is revisiting plans to retire the country’s fleet of nuclear power plants. Shell and BP are divesting from Russian state-owned oil and gas company Gazprom. Now it’s time for U.S. policymakers to step up with policy reforms to expand competitive energy markets that will deliver affordable energy to Americans and energy security to America’s allies.
- Russia is the world’s second largest oil producer, providing 10 percent of the world’s supply.
- Europe depends on Russia for about 40% of its natural gas consumption.
- In 2006, 80% of Russian gas supplies to Europe went through Ukraine. As of Feb. 20, that number is roughly 18% (according to Gazprom’s own disclosure).
- In January 2022, 77% of U.S. LNG exports went to Europe.
- The U.S. first began exporting LNG in 2016. In 2022, it is expected that the U.S. will have the largest LNG export capacity and be the largest exporter in the world.
- In 2021, the U.S. imported 209,000 barrels per day of crude oil (3% of crude imports) from Russia and 500,000 barrels per day of other petroleum products.