What's Happening With Russian Oil and U.S. Gas Prices?

Taking a look at the war in Ukraine, Motley Fool analyst Bill Mann discusses:

• Ripple effects for European countries.
• Whether seizing property of Western companies would spell the end of foreign investment in Russia.
• Why Energy Secretary Jennifer Granholm's recent comments give him hope.
• Rising raw material costs affecting companies like McDonald's (MCD -0.05%) and Domino's Pizza (DPZ 1.36%).
• The J Curve.

Many have wondered about the price of gas. If Russia provides just 3% of America's oil supply, then why have gas prices spiked? Motley Fool podcast producer Ricky Mulvey talks with Motley Fool analyst Nick Sciple to get some context.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 10, 2022.

Chris Hill: Today, we're digging into the latest on Russia, oil, and the price of gas. Motley Fool Money starts now. I'm Chris Hill joined by Motley Fool Senior Analyst, Bill Mann. Thanks for being here.

Bill Mann: Hey, Chris, how are you?

Chris Hill: I am looking forward to the latest edition of where are we now with oil and gas? Let me start with this. The US House of Representatives voted overwhelmingly to ban the imports of Russian oil, natural gas, and coal into the United States. Whether their colleagues in the United States Senate take up the bill remains to be seen. Regardless, how important is this industry for the Russian economy?

Bill Mann: It is almost everything for the Russian economy. I would describe the Russian economy as being mafia in how it is structured, and the very core is the oil and gas, the extractive industries in Russia. Funding for the government and funding for the elements of the country that are most important to Vladimir Putin come almost exclusively from the oil and gas industry.

Chris Hill: Despite the fact that we get three percent of our oil from Russia, that didn't stop the price of gas increasing 49 cents a gallon in a single week. It is the largest one-week spike since Hurricane Katrina. That's the ripple effect here. What is the ripple effect of what we're seeing play out in Ukraine for people and economies in Europe?

Bill Mann: The natural gas price in Europe that matters the most is called the TTF price, which is the price of natural gas assets delivered to Rotterdam in the Netherlands which is the primary depot. As of earlier this week, it was up 1,300 percent year-over-year. The prices have come down very sharply since then, and as we were recording, they were down only 700 percent on year over year. It came down pretty sharply this week. We remember economic classes or the concept of the J curve, and we have had a disruption in the form of the elimination of oil and gas as a product or as a threat even, and we're getting ready to come into a new synthesis. I don't know if the synthesis is better, but the pricing has come down pretty sharply in the last couple of days.

Chris Hill: I've never taken an economics class in my life. What is the J curve?

Bill Mann: [laughs] You faked it so well. The J curve is essentially the disruption of a status quo, which causes a drop of some form, and then you move to a new place, in terms of pricing, in terms of demand, those types of things. To get off that topic as quickly as humanly possible.

Chris Hill: No. Educate, amuse, and enrich, that's our model [laughs] or it was once upon a time. One of the headlines this week is US-based companies like McDonald's, Coca-Cola, and Starbucks closing up shop and suspending operations in Russia. On Wednesday, in Russia, the legislative commission approved measures that essentially paved the way for the nationalization of property in Western companies that are leaving. I read that, I hear that, and I try to wrap my head around the Russian government taking possession of a lot of McDonald's and Starbucks. Although, at least, in the case of Starbucks, I think there are more Starbucks in South Carolina than there are in all of Russia. But the larger point to me, is this the end or the beginning of the end of foreign investment in Russia if western companies think there's a chance that this could happen?

Bill Mann: I don't believe there is. Keep in mind that the western companies, let's take McDonald's, for example, which is closing about 800 restaurants in Russia, they are almost all company-owned. Honestly, what is the Russian government or their successor company going to do? They're not going to come in and have access to McDonald's, they've just got space. We have seen dislocations in the past where people have pulled entirely out of an economy. Iran is one, Cuba is one, Vietnam was one. But you go to Vietnam now and every Western brand you can conceive of is there. Yes, this is something that is happening. I would not view this as the end of Western investment in Russia at all. Russia is still a market of 150 million people, and that matters. That matters in the long-term. In the short-term, these companies are voting with their conferences, if you will, and getting out of the market. But there's always this such a delicate balance between making sure that you're doing the moral thing, and making sure that you're not actually harming your own company in a grievous way in the process.

Chris Hill: I'm not asking you to predict what Vladimir Putin does next.

Bill Mann: That's good. [laughs]

Chris Hill: I am curious, however. Where do you think the next couple of weeks go? What are you watching to give you an indication? Because I think that what most if not all of us are hoping for is an end to this conflict and a return to normalcy in terms of relations and hopefully, there are some rebuilding of Ukraine. Short of that, what are the things you're keeping your eye on?

Bill Mann: Well, one is the oil and gas policy in this country. I was very heartened to see this morning the US Energy Secretary, Jennifer Granholm. She brought some real Michigan logic in reality to the situation, she was in an oil and gas conference and she said, "Look, we need to work together to the oil and gas companies. Our future is going to be less dependent on hydrocarbons than it is now, but we need to come up with a way so that we can fill the bucket in the US to make sure that our energy needs are not disruptive." I was really heartened by that, Chris, because it tells me that there is actually an avenue for an industry they've been demonized in a lot of ways, and people are starting to talk about windfall profit taxes. Well, almost $170 billion of capital has been lost through bankruptcy in the oil and gas industry since 2015. This is an industry that has been in some ways brought to its knees. I don't think that demonizing the US oil and gas industry is actually helpful at this point. That to me was something that was very pragmatic, very heartening. I've seen very many pragmatic discussions happening in Europe, and I hope that they continue because obviously, when you cut off a massive component of not just the oil and gas industry, but other extractive industries, other markets, there's pain to be had across the board in places that we might not expect. That was really heartening to me that that conversation is taking place in that way.

Chris Hill: Last thing, and then I'll let you go. At least once a year, we have an earnings season that involves some type of a weather event of some sort, and there will be companies that will come out on their earnings report, on the conference call and they'll talk about the impact of that, and there's almost always one company that tries [laughs] to use that as cover, and it doesn't hold water at all. We all just as investors collectively go. That was a weather event in California and your entire base of operations is enduring lend, I'm not really sure how the two are connected. All of that is set up to this. I know that global supply chain challenges are very real. It seems like this is one more large event that is not helping in that regard. When you look at supply chain, is there an industry or two that is more greatly impacted by the oil and gas industry in Russia than others?

Bill Mann: It's interesting that you asked me that question because I think some of the areas where we're going to see a fair amount of pain are some of the same industries that felt a lot of pain during the COVID shutdown. I think restaurants are really in for it, not just in supply chain availability, but then the cost of raw materials. The cost of distributing it throughout their networks, I think it's going to be extreme. These are companies that I adore. Obviously, McDonald's has already made its decision, but Domino's Pizza is in forward a little bit. When you ask that question, I really think that we're going to be in a little bit of a 2020 environment again, where every time a company said, "COVID has impacted us." You said, "Oh, yeah, of course, it has." Maybe there was a little bit of the boy who cried wolf there. But, I think this is going to be another one of those scenarios in which investors really ought to think about giving their companies a bit of a pass when they say there are some real pressures that we have had no opportunity to be able to counteract in the short-term.

Bill Mann: I know you want me to call somebody out. I heard that loud and clear, but I think a little bit of grace is going to go a long way in this situation.

Chris Hill: I want you to call people out only when they deserve to be called out.

Bill Mann: Fair.

Chris Hill: I appreciate your perspective that now, this is something that pretty much everyone is going to, and deserves a pass on.

Bill Mann: Yeah. Well, we can come back after the fact and say, maybe you didn't get to quite the 98 percent of your earnings came from or were impacted by Russia. But there will be time.

Chris Hill: Bill Mann, thanks for being here.

Bill Mann: Thanks Chris. As I mentioned before, Russia only provides about three percent of our oil supply, so why are we seeing such a major impact on gas prices? For more, here is Ricky Mulvey.

Ricky Mulvey: A surge in oil prices can make any investor sweat. Today we're looking at some of the historical context why shutting off one relatively minor supplier of oil to the United States is leading prices to skyrocket. Joining me now, is Motley Fool senior analyst Nick Sciple. Nick, the United States imported about 700,000 barrels of crude and petroleum products a day from Russia last Fall. That's only three percent of our consumption. How did we get to a point where cutting off this relatively minor supplier has such a significant impact on prices?

Nick Sciple: Sure Rick. Well, thanks for having me. I think to look at what's going on with oil prices, we really need to zoom back a few years. As I'm sure a lot of people know, the oil market is notoriously a boom and bust industry. I think the oil market may have invented the term boom and bust. But the past couple of years we've really reached the bottom of the bust of the oil market. 2020, most folks are familiar, oil prices went negative, a very highly publicized headline there. 2020 was also the record the year in the history the oil and gas industry for bankruptcies. Obviously, when folks aren't making money by producing oil and gas and businesses are going bankrupt, they're going to invest less money in producing oil and gas, pulling oil and gas out of the ground, which we saw in 2021. 2021 was the lowest year for new oils discoveries since 1946. Was also, in terms of capital expenditure spent on looking for new oil and gas, was the lowest we've seen since 2004. We entered 2022 in a condition where the economy was recovering, folks are returning to travel leaving their homes, but investments in oil production were at cyclical lows. We were already in a situation where the market was very tight, yet some big banks projecting $100 bill even before the conflict in Ukraine. Of course, now we have one of the biggest oil and gas producers in the world, Russia, involved in a conflict in Ukraine. Ukraine is also one of the main through fairs by which gas gets from Russia to Western Europe. You have these duo-political issues coming at a time where the market was already heightened, and so things got even more tight and have been impacted, that's why you've seen oil prices shoot up as high as $150.

Ricky Mulvey: Also, the oil market is talked about in a very general term. Three percent of the oil comes from Russia, but Russia is also producing these very specific type of oils that affect our economy.

Nick Sciple: Not all oil is created equal, so when you hear oil prices quoted you will usually hear one or two prices. There's west prices intermediate which is the US benchmark oil price, which represents a particular bench of oil. The other grade you will hear quoted is Brent, which is the European grade of oil. In the US the oil that we produce is the light suite crude. That's best used for making things like gasoline, but you need heavier oil, stuff like oil Russia produces, to make things like diesel fuel. Part of the issue is we are in this global commodity market, where the price ain't set the US it's set by the entire world's demand. But also, just not all oil is created equal. Obviously, there is lots of demand for gasoline, but we still need to run those diesel trucks too, to get goods to market and so folks are out there looking to replace those Russian oil supplies. That's part of why you've seen the Biden administration reach out to Venezuela to try to their exports increased to United states because their oil is somewhat of a substitute for what we traditionally would get from Russia.

Ricky Mulvey: It's tough to turn on the taps because we don't necessarily know where they are to begin with, with less oil discovery. So why is it so difficult to flip the switch right now and just start pumping oil from other countries like Saudi Arabia and the UAE.

Nick Sciple: Well, part of it is in the US, oil and gas companies are facing the same supply train crunch that lots of other businesses are facing. You need things like pipe and steel to actually run your operation. The other thing is, we've seen this under-investment in production for a number of years, which means there's been a reduced amount of hiring. You just don't have the people out there working in the fields to increase production. That's in the US. When you look abroad, even before 2022, you've seen OPEC plus, that group struggled to meet its targets as far as increasing its oil production. They have over complied with cuts is the word, you hear them say. Even before this issue, the Russian war, those countries were struggling to increase production. You add urgency now, I don't think it changes the conditions on the ground. The last thing to say is, physics at the end of the day, governs how these oil wells flow. You can try to drive more production out, or some folks have called for Canadian oil companies to skip some scheduled maintenance in order to increase production in the short-term. The issues that it creates, is it hurts the production of the asset over the long term. I think we're going to need oil and gas, not just this year, but next year, and so some of the encouragement folks have to, hey, we will need to increase production now, could be harmful in the long term. That's another thing to think about.

Ricky Mulvey: Yeah, you're essentially, hey, we're going to create a short-term solution by creating another long-term problem.

Nick Sciple: Correct. That's a potential issue. The other thing is, we should be mindful of as well. When you hear oil prices quoted, you're hearing this front-month oil contract. What's oil going for today? But, what oil companies are looking at when they choose to produce is, what's the prices going to be in the future? If you look in the past week or so, the future's price for December 2022 oil, is actually down over the course of the past week. Part of the signal that the market is giving to these oil producers, is not quite as bright as you see with that headline price you get quoted.

Ricky Mulvey: It's not just oil producers and oil stocks that are being affected by the volatility, you've also seen a lot of supply chain effects for industries that you would think are relatively unrelated to oil. What are some of those?

Nick Sciple: The way I think about, is energy is the prime commodity. Energy goes into everything we produce, and so some high energy intense industries like steel making have been impacted. You've seen some steelmakers in Europe slowdown some of their production. Another industry that's worth watching is fertilizer. A key impact for fertilizer production is natural gas, and so as natural gas prices have increased. Again, even before 2022, you saw some fertilizer producers slowdown some of their production. Obviously, fertilizer prices read through into things like food, because they are a key input in food costs, and that has potential to get even worse because we saw, I think, just this morning on Thursday, Russia announced they're going to temporarily suspend exports of fertilizer. Russia and Belarus, who's also involved in the Ukraine conflict are two of the biggest suppliers of that in the world. Some of these other industries, both energy intensive industries and also industries that use oil and gas as feed stocks, are in a tough spot here.

Ricky Mulvey: It's not a shocker to say that one supply chain issue can often create a contagion for others. We've heard this adage, the cure for higher oil prices is higher oil prices. You are hearing analysts say that the solution for this is demand destruction. But, what does demand destruction actually mean for a lot of industries?

Nick Sciple: Oftentimes, you'll hear analysts say at X price, if oil prices go too high, you'll see demand destruction in the economy. What that really means, is that prices get so high that the people choose not to drive or choose not to travel etc, and so it leads to just less demand for the commodity in the economy, which leads to prices going down. Obviously, prices are a function of supply and demand in any industry, but especially so in a commodity industry like oil and gas. There's really two ways out of this current tightness ran. There's either one, you increase production which as we talked about, there are some hurdles to that, both on the supply chain side and that sort of thing. Or you reduce demand. That can come in the form of, we talked about companies that are producing less of the goods and services they make, they can come in the form of higher prices limiting folks' willingness to pay. But those are really the two ways out long term, is either you increase production, or you decrease demand. There are some constraints as we talked about on increasing production in the near term. It may be that demand destruction is what we need to get. But I will say is, implicit in that, is that's a recessionary prediction. If you're predicting that there's less demand that people are going to go around drive less, produce less goods etc. The definition of a recession is two consecutive quarters of slowing economic activity. Whenever you hear those demand destruction predictions, just get to understand what they are. They're a recessionary production.

Ricky Mulvey: Nick, thanks so much.

Nick Sciple: Thanks for having me.

Chris Hill: That's all for today. Be coming up tomorrow, a conversation with Tess Vigeland, host of the Wall Street Journal's new podcast, on the future of work. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against. We don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.