This week in energy: Surprise OPEC+ cuts, energy project legislation, electricity demand growth
REAL ECONOMY BLOG | April 07, 2023
Authored by RSM US LLP
In this week’s energy industry roundup, we examine the impact and aftermath of the OPEC+ surprise cut announcement, a proposed bill to expedite energy projects, and transmission constraints on electricity demand growth.
Aftermath of surprise OPEC+ cuts
A surprise announcement from OPEC+ on Sunday that it would cut up to 1.15 million barrels per day from its current oil production target starting next month sent oil markets reeling, surging 6%. In the days following the announcement, prices remain elevated, and markets continue to speculate. Beyond the immediate price shock, there are many implications for the energy sector. Among the most important:
- Inflation – Consumer economies are already struggling, and reducing the output of oil on the open market creates an imbalance between supply and demand that could fuel inflation.
- U.S. gas prices – Gasoline prices are directly tied to the cost of crude oil, as crude oil is a major input cost of producing gasoline. The amount of crude on the market depends on refinery utilization, or how much of the actual refining capacity is being used to produce fuel. High prices often result in refiners decreasing the utilization rate, which tightens supply and can boost prices. This, coupled with the cyclical increase in gasoline prices due to summer travel, likely mean higher gas prices in the near term.
- Shale market reaction – While the initial assumption may be that U.S. shale producers would increase production in response to the OPEC+ cut, analysts don’t expect a ramp up as a direct result of the cuts. U.S. shale production, which accounts for more than 50% of non-OPEC+ crude oil production, is still expected to increase year over year, just not enough to outstrip, or even meet, demand. Production does not just turn on overnight, and the lack of investment made in previous years and producers’ desire to continue conserving capital will also limit production. Higher prices will, however, have a positive impact on the bottom line for oil and gas shale producers.
While we will see a price spike in the short term, historical data has proven that similar surges have failed to materialize into long-term price stability. We expect that, longer term, the production cuts will contribute to a bearish environment for oil prices.
The Lower Energy Costs Act
A bill passed by the House of Representatives on March 30 would set forth provisions to expedite energy projects, eliminate or reduce certain fees related to the development of federal energy resources, and eliminate certain funds that provide incentives to decrease greenhouse gas emissions.
While the Lower Energy Costs Act is not expected to pass through the Senate in its current form, it represents the Republican party’s focus on bolstering domestic production to seek energy independence. With a Republican House and a Democratic Senate, though, it is unlikely that meaningful legislation will pass on such divisive issues.
The bill would expedite the development, importation, and exportation of energy resources by various means, including:
- Waiving environmental review requirements and other specified requirements under certain environmental laws
- Eliminating certain restrictions on the import and export of oil and natural gas
- Prohibiting the president from declaring a moratorium on the use of hydraulic fracturing
- Directing the Department of the Interior to conduct sales for the leasing of oil and gas resources on federal lands and waters as specified by the bill
- Limiting the authority of the president and executive agencies to restrict or delay the development of energy on federal land
In addition, the bill would reduce royalties for oil and gas development on federal land and eliminate charges on methane emissions. It would also eliminate a variety of funds, such as funds for energy efficiency improvements in buildings as well as the greenhouse gas reduction fund.
Opponents of the bill are concerned that it would raise costs for American families by repealing household energy rebates and rolling back investments to increase access to cost-lowering clean energy technologies.
Supporters and detractors alike recognize that a bipartisan effort to modify the current bill language will be necessary if there is to be a chance of making any of it into law. For instance, both sides could benefit from permitting reform: to fast track permitting of both clean energy and traditional energy projects. The issue is that each side has a different proposed approach on how to achieve the same goal.
Commodity prices are sensitive to supply and demand, both of which can be influenced by regulatory reform. Industry participants should monitor the bill’s progress when making planning decisions over the near to medium term.
Transmission constraints on electricity demand growth
As private and public entities plan development of additional electricity generation facilities, as highlighted in the Energy Information Administration’s latest annual outlook report, the state of electricity transmission lines across the country will act as a constraint on this growth. Much of U.S. power transmission infrastructure is aging, and not only is additional transmission capacity needed, but the shift to renewable energy will also call for different types of transmission infrastructure in some cases. Efforts to build new electric transmission lines are ongoing, but at a significantly slower pace than what’s needed, according to a recent Princeton University report.
In the meantime, we expect to see this electric transmission constraint materialize in multiple ways in the market:
- Delays in approval for new generation projects. Electricity generated must be transported to the end-users who will consume it, and maintaining stability and reliability of the grid is a delicate balancing act. Various governing bodies work together to maintain this balance through long-term planning and an interconnection review (e.g., technical feasibility, grid impact, compliance with standards/regulations, etc.), which takes time and coordination across entire regions. The Federal Energy Regulatory Commission’s 2022 State of the Markets report, released last month, found there was over 1,525 gigawatts of generation capacity (excluding standalone storage) in the queue for review at the end of 2022 (an “unprecedented number”). Furthermore, the amount of time from request to commercial operation increased from an average of 2.1 years between 2000-2010 to 3.7 years between 2011-2021.
- Increases in direct sale of local power to industrial facilities (distributed generation). To enable more rapid onboarding of generation capacity, especially from renewable sources like solar and wind, some power developers are already targeting industrial customers for the direct sale of power. Especially in remote locations, this is mutually beneficial to both the power developer and the customer, with reduced costs around construction of new transmission infrastructure, and shorter timelines due to the reduced approvals.
- Higher electricity costs to consumers. Making the kinds of improvements to the electricity transmission infrastructure (including lines and substations) that will be needed to serve the changes and increases expected in the coming decade is complicated and will be costly. Ultimately, the costs for the extensive planning and coordination of this new infrastructure, as well as their actual construction and approval, will ultimately have to be passed down to consumers through increased rates.
These upcoming challenges and changes will warrant ongoing attention from not only organizations in the electric power sector, but also from companies upstream in the supply chain and industrial consumers of the power being produced. These challenges may ultimately yield unanticipated business opportunities for developers or consumers with creative solutions to these constraints.
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This article was written by Anne Slattery, Alafair Hotze, David Carter and originally appeared on 2023-04-07.
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