In this week’s energy industry analysis, we take a look at the recent OPEC+ production cut decision, the U.S. government stepping up investment and policy support around battery manufacturing, and the landscape of carbon capture incentives in Canada.
OPEC+ cuts cause supply scramble
After over five months of oil prices holding near or above $100 per barrel, prices have declined nearly 20% since the end of June on fears of a global recession. Reasons for significant supply apprehension around both oil and gas include sanctions on Russian exports, supply chain interruptions, increases in U.S. oil and gas production regulation and most recently, OPEC+’s decision in early October to cut oil production by 2 million barrels per day.
That decision was intended to pre-empt decline in demand caused by a potential recession, and the White House called the move “short-sighted,” Reuters reported. OPEC+ member countries say the decision was purely technical, based on economic forecasts and in no way political. Speculation around the cuts may prompt more price movement than the actual cuts themselves, as many OPEC member countries have been producing below targets.
In the aftermath of the OPEC+ decision, the administration is considering other alternatives to increase supply. Here is our take on some of these considerations:
- Releasing oil from the Strategic Petroleum Reserve (SPR): The administration is considering releasing additional barrels from the SPR, an emergency stockpile of petroleum maintained by the U.S. Department of Energy. The potential release would be in addition to the decision last spring to release 180 million barrels in tranches through the end of the year. To date, about 165 million barrels have been delivered or put under contract since the program was put into effect, according to Bloomberg. As of Oct. 14, the SPR was at about 57% of storage capacity which is a 40-year low, according to the SPR website. While releasing more of the SPR may temporarily put downward pressure on prices, it is not a long-term solution and could come with consequences. It is crucial that the SPR is available during an emergency such as a natural disaster and depleting the reserve to temporarily ease prices puts our country at risk.
- Restarting oil exports from embargoed countries: The United States has considered easing sanctions imposed on Venezuela’s oil production. This agreement hinges on the Venezuelan government taking certain steps toward resuming democracy. One consideration with this alternative is the environmental cost of producing oil in Venezuela is higher than it is domestically, making it less attractive than increasing U.S. production. Additionally, Venezuela’s historically contentious political climate makes some skeptical that this is a dependable solution.
- Banning U.S. exports: White House officials have asked the U.S. Department of Energy to analyze potential impacts of a ban on exports of gasoline, diesel and other refined petroleum products, according to Bloomberg. While such a move might be intended to control prices, this tactic could have the opposite effect. Globally, particularly in Europe, there is dire need for energy supply (especially natural gas, of which the United States is the largest exporter). Limiting exports could disrupt supply globally, disincentivize domestic oil and gas operators from ramping up production, reduce refining capacity and ultimately raise prices.
- Investing in/incentivizing domestic production: The past several years have been marked by underinvestment and increased regulation in domestic fossil fuel production, contributing to less energy independence, and therefore lower energy security domestically. The energy crisis we are experiencing highlights vulnerabilities in our energy system and the need to ease regulation on the private energy sector. This does not mean we abandon the energy transition, though. Somewhere between competing narratives is a balance that we must achieve; meeting the current needs of society while staying on the path to clean energy. It is our view that we can do both, but must rethink the path to getting there.
Another factor in play is the upcoming price cap on Russian oil (to go into effect Dec. 5). Countries that buy oil above that cap will face consequences such as prohibiting them from providing shipping insurance. With so many factors in play, we expect prices to remain high in the medium term. Current economic conditions across the board (commodity prices, interest rates, geopolitical tension) are not expected to ease for the remainder of 2022 and first half of 2023. It will be imperative that policy allows for and supports the domestic production of oil and gas to support global demand.
Positive outlook for U.S. battery projects
In response to rising electric vehicle demand, more than 10 new giga factories (large scale battery manufacturing facilities) have been announced in North America in the past year and battery cell manufacturers have announced even more manufacturing capacity coming online by the end of 2030, according to Bloomberg. While still behind China and Europe, U.S. battery manufacturers are scaling up to meet demand.
EVs represent 83% of the annual demand for battery-sourced energy expected in North America in 2030. While building a battery cell manufacturing plant has always been expensive, costs have been worsened by supply chain disruption and inflation.
Asia, where the operating and permitting costs are lower, has become a leader in battery production, with China investing over $60 billion to build its lithium industry, according to Forbes. The United States produces only a fraction of the lithium required to meet rising demand. This coupled with the push to reduce U.S. dependence on China, has triggered the U.S. government to step up investment and policy support around battery manufacturing.
The Inflation Reduction Act will play a large role in the investment needed to boost domestic battery manufacturing, EVs and energy storage. The act dedicates $369 billion to clean energy, with a portion specially for EVs, and is considered the largest U.S. effort focused on EVs to date. Inclusion of battery-related tax credits will allow companies to take tax credits for investments in input materials such as critical minerals and battery electrode active materials, battery cells and modules, electric vehicles and energy storage. This investment is a huge step forward in bringing North America to the table when it comes to both battery and EV production. As organizations consider investment in transportation, it will be important to consider how potential credits weigh into the cost benefit analysis of transportation alternatives.
The landscape of carbon capture incentives
The importance of carbon capture, utilization and storage (CCUS) in reducing emissions is recognized by both the Canadian and U.S. federal governments, but Canada risks losing investment in projects to the United States if it does not shore up its incentives.
Canada released final details of its carbon capture investment tax credit in August, subsidizing 50% of capital costs for a majority of CCUS projects and 60% of equipment used in direct air capture projects. Days later, the U.S. administration topped the announcement with the Inflation Reduction Act, which bolstered its 45Q tax credit by increasing it from $50 per metric ton of carbon dioxide captured to $85 per ton, and offering up to $180 per ton for direct air capture projects.
Approximately two thirds of the costs are operating costs over the life of a project, and Canada’s tax credit consequently covers less than 20% of a project’s cost, while the U.S. credit is expected to cover up to 85% of a project’s total expenses, in line with other global peers. Additionally, Canada’s tax incentives do not provide protection against future changes in carbon prices and will be halved in 2031, while the U.S. credit de-risks investment by providing a price for carbon offsets over a 12-year period.
The Pathways Alliance, a consortium of Canada’s six largest oil sands companies that contributes approximately 95% of oil sands production in the country, announced in October that it will commit CA$16.5 billion to the development of a CCUS facility before 2030, but require additional commitments from the federal government.
“There’s definitely a risk that Canada will get left behind in the race to decarbonize by the United States,” the Alliance said in a statement. The federal government said in October that it may need to do more with respect to an investment tax credit to keep up with the United States, but has also called on provincial governments to contribute with incentives. Alberta has committed CA$1.8 billion to develop CCUS to date, and is considering providing an offset in royalties, but maintains that the federal government needs to keep pace with, or exceed, the Inflation Reduction Act incentives.
Canada has five of the world’s 27 commercial-scale CCUS facilities, and is calling for capacity to triple over the next decade to meet net-zero targets. It takes approximately six years to bring a facility online, and with CCUS being central to emissions reduction for not just the energy industry, but also for the production of cement, steel and fertilizers. Canada runs the risk of failing to meet its emissions targets if it is unable to incentivize carbon capture investment to remain north of the border during a critical period when final investment decisions are considered.
