Can the US replace Russia’s oil and gas supply to Europe?

Trader’s Corner, a weekly partnership with Cost Management Solutions, analyzes propane supply and pricing trends. This week, Mark Rachal, director of research and publications, examines the ability of the U.S. to supply Europe with oil and gas.

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There has been a lot of rhetoric about the capability of the U.S. energy industry to eliminate crude and crude product imports from Russia. We covered that topic in our last Trader’s Corner. This week, we will explore the second claim by politicians about the U.S. being able to supply Europe with all of the oil and gas it needs to replace Russian energy supplies if the U.S. energy industry were unshackled from regulations and government limitations on where drilling can occur.

Europe gets 4.3 million barrels per day (bpd) of crude and 9.75 billion cu. ft. per day (Bcf/d) of natural gas from Russia. Therefore, we will be exploring if the U.S. can replace that amount of supply to Europe.

Let’s look at the crude first:

Official data shows that in January, the U.S. was a net importer of 3,994,000 bpd of crude. Crude imports were 6,530,000 bpd and exports 2,536,000 bpd. Some import/export activity was simply out of convenience to markets. But most is a need to export an oversupply of light crude and import heavy crude to overcome a domestic shortfall in the production of heavy crude. Let’s assume this import/export activity remains the same out of a necessity to balance our own need for heavy crude. Currently, the U.S. is producing 11.6 million bpd of crude. That is down 1.5 million bpd below peak production, last hit in March 2020, just before the pandemic impacts took hold.

The U.S. is currently refining 15.398 million bpd of crude. Our production of 11.6 million bpd, plus the approximate 4 million bpd of net crude imports, provides the U.S. with the feed for its refineries. Currently, our refining is yielding enough to meet our domestic needs and provide 2,351,000 million bpd of refined products for buyers in primarily Canada, Mexico, South America, the Caribbean, Japan and South Korea. It would not do any good to end those longstanding relationships to provide refined fuels to Europe. Therefore, we need to increase crude production and/or refinery throughput to help Europe.

We already know we can produce 1.5 million bpd more than we are now. With crude prices at $120 per barrel, it would seem there is every incentive in the world to increase production. It varies by field, but wells in shale formations break even at $48 to $54 per barrel. Crude has been over $54 per barrel since February 2021, yet U.S. crude production has been largely flatlined for about three months – around the 11.6-million-bpd mark. Some political rhetoric would suggest that this is because of new government regulations on the energy industry. Government regulation may be playing a small part, but it is not the key reason to this point.

The key reason that production has not increased is because oil companies that primarily focus on shale formations were already struggling financially before the pandemic. The pandemic put many out of business and left others focusing on paying down debt and returning money to stockholders to encourage investment. Many banks got burned by the energy industry, and stockholders were not getting a return on their investment. Oil companies are focused on being more fiscally responsible to address those issues.

To be clear, U.S. production has not recovered because of a lack of investment. Credit has been difficult, and a lack of fresh investment money coming into the industry has limited drilling and thus the recovery in production. The lesson that appears to have been learned is that it does no good for shale producers with the highest production costs in the world to overproduce and drive prices below their breakeven.

If U.S. producers broke with the fiscal discipline that has been serving them well over this past year, they run the risk of hurting themselves significantly. Assume they take the bait and substantially increase drilling due to the current price. If the geopolitical environment changed, they could quickly be in trouble again. European crude sourced from Russia is going to be cheaper than crude sourced from the U.S. If Russia ended its aggression, then who is to say Europe wouldn’t quickly forgive and resume buying Russia’s relatively cheap crude? U.S. producers would need to have long-term commitments from European buyers to drill more. It will be interesting to see if they are willing to make those commitments.

If we assume they do, the challenges are just beginning. It will be difficult to substantially increase active crude drilling rigs due to a lack of workers. Thousands of workers who once worked in drilling have moved on, and most aren’t coming back. Even at the current level of drilling, many drilling companies are finding it difficult to fill out crews. Many are working short-handed and with less-than-competent workers. Currently, there are 519 active crude rigs and 130 active natural gas rigs working in the U.S. It would be a monumental challenge to significantly increase those numbers. Assuming new drilling rig crews could be hired and trained, it takes months to drill and complete wells.

Since the U.S. has produced 13.1 million bpd, we know there is the infrastructure to handle that much production. After that, there could be the need to increase infrastructure to handle more. Again, we are talking capital-intensive projects that would need years to return a profit. Without long-term contracts, there will be no one to invest in these projects. At 13.1 million bpd of production, the U.S. theoretically would only be able to offset 1.3 to 1.5 million bpd of the crude currently going to Europe from Russia, leaving Europe 3 million bpd short of replacing Russian supplies. Again, without long-term commitments from European buyers, we don’t see production getting to 13.1 million bpd, much less past it. Despite the current emotion generated by the horror going on in Ukraine, we should not assume that European buyers will be willing to make long-term commitments to U.S. crude that would increase their cost of energy.

Let’s take a look at natural gas next:

The latest official data has U.S. natural gas production at 3,270 billion cu. ft. in December, or about 105.5 Bcf/d. The U.S. has plentiful natural gas reserves. Increasing crude production would also increase associated natural gas production. We don’t think the issue with natural gas would be the production side. The bottleneck is going to be with export capacity.

The U.S. exported a record 11.13 Bcf/d in December, essentially maxing out available capacity. The U.S. Energy Information Administration reports completed LNG export capacity at 10.72 Bcf/d, with another facility currently commissioned, which is adding to the current exports. When that unit is fully online, the capacity will be 11.43 Bcf/d.

The timeline for building a new LNG export facility is 10 years from concept to operation. Construction time alone is about five years.

There are currently five units under construction each with a capacity of 0.795 Bcf/d. The first is due to start commissioning in September this year. This will be the first opportunity to add new exports to Europe to offset what it is getting from Russia. One of the units is expected to be commissioned in 2024. Three are expected to commission in 2025. The combined capacity of all five units is 3.97 Bcf/d. Even when all are complete three years from now, these projects could only provide 41 percent of the natural gas that Europe gets from Russia.

There are around 14 other projects that remain in the planning phase. Not all have their expected capacity available, but those that do have a combined 1.13 Bcf/d. These are projects that are not likely to be operational before 2027.

The bottom line is that the U.S. in not in a position to replace Russian-sourced natural gas supplies for Europe anytime soon. By the end of this year, we could provide maybe 8 to 10 percent of the shortfall. Other nations are going to have to contribute, and we are not sure what is possible. Europe does have natural gas reserves. It is not a lot of proven reserves, but if they are serious about getting off Russian dependency, they must produce more of their own needs. Norway has the largest reserves and could have the biggest impact.

A couple of comments about renewable energy and nuclear:

There is a lot of talk about simply moving away from hydrocarbon use. That is a great goal, but it is long term. Electric cars account for about 3 percent of all passenger vehicles. At this point, a conversion to electric cars may be good for the environment, but we may be jumping out of the frying pan into the fire. China controls two-thirds of the world’s battery manufacturing. Currently, there is a shortage of computer chips needed for any new car (including electric), which is slowing production. The timeline for renewables is simply too far out to offset the energy that Russia provides. We need to develop renewables for all energy needs as quickly as possible, but it’s going to be a minimal factor in addressing the need to replace Russian energy in the short term. Further, electrical vehicles do reduce emissions, but most electrical power generation still comes from hydrocarbons. To supply electric cars, electricity generation from natural gas, coal, nuclear and renewables would need to increase, and so will the car-charging network.

Obviously, any nuclear power plants are probably decades away in design and construction. The U.S. government approved the sale of some of the U.S. uranium reserves to Russia and now only has about 3.02 percent of the global supply. Kazakhstan has the world’s largest share of uranium at 32.36 percent. It was part of the Soviet Union before the USSR dissolved in 1991. It has a close business relationship with Russia. Its population has an 87 percent positive view of Russia, and 88 percent support a closer relationship with them. Canada and Australia, with 15.72 percent and 10.7 percent respectively, would likely be the sources of uranium for most Western powers. Ukraine has about 1.55 percent of global supply.

It would appear Western nations are extremely challenged here. Most of the big energy producers in the world – in the Middle East, South America and central Asia – have a better relationship with Russia and China than they do with the West. The West needs to understand that if it stands by and lets Russia take Ukraine, those energy-rich partners of Russia and China will only be encouraged to cozy up closer to them. From a purely energy perspective, the West is fighting for its survival and should think very carefully about allowing Russia to take control of Ukraine’s crude, natural gas and uranium supplies. Western leaders need to understand how vulnerable most democracies are at this point, and the greatest vulnerability currently is that most of the world’s energy is held by adversaries. The West is conducting itself as if the only threat is nuclear war with Russia. That is very far from the case.

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