The Last Barrel: What a difference a war makes
In the height of the Covid panic, the unimaginable happened, when crude prices went into the red at minus $36.98/bbl on April 20, 2020. The dire predictions by executives and consulting firms about the short-term/long-term effects of Covid-19 on the industry were overwhelming. The unrelenting onslaught of “we will never recover” or “nothing will ever be the same” seemed short-sighted and clearly did not take into account the critical role that oil and gas play in driving our economy and perpetuating our way of life.
But yes, energy derived from hydrocarbons was on its way out, to be replaced by renewables and clean energy alternatives. The environmental groups were convinced the energy transition could be accomplished with unproven blue-sky technology, flowery talk and pressuring government authorities to restrict and/or ban leasing and drilling activities. The intimidation tactics worked and created an unprecedented reduction of investment in hydrocarbon-based energy, in favor of developing green resources. So how is this brilliant strategy working, now that Russian supply is being severely restricted?
Energy prices skyrocket. The war in Ukraine has limited Russian oil and gas supplies and has the potential to cause a major shift in the world’s energy market. No one knows how long Russia intends to wage war in Ukraine or how much of its crude will be affected by sanctions and for how long. The uncertainty caused by the supply disruption has driven crude prices to an eight-year high. And anxieties persist that surging oil prices may rise so high that demand destruction will damage the economy and cause a worldwide recession. However, Russia’s invasion of Ukraine is creating a new market for U.S. LNG producers, as product flows to Europe to replace Russian natural gas. The longer the conflict persists, the more entrenched U.S. LNG will become.
Russian oil embargo. The Russian oil embargo being considered by the EU would tighten global crude markets and shift trade flows unprecedentedly. The repercussions of the embargo would be comprehensive and wide-ranging, pushing oil prices higher in the short-to-medium term. As the sanctions are negotiated, crude prices will stay elevated while war-related uncertainty persists, and summer demand ramps up in the next several weeks (Rystad Energy).
The EU is close to enacting its proposed ban on Russian oil imports, including sanctions on shipping and insurance. Since unanimity is required within the EU, and given the current stance of Hungary in particular, a compromise version of a proposal is being re-negotiated in Brussels. However, it seems certain that the EU will impose an oil embargo with certain exemptions made for the land-locked countries of Hungary, Slovakia and Czech Republic, which together imported 290,000 bopd from Russia in March 2022, within the EU total of 3 MMbopd. The EU oil embargo will trigger a seismic shift in the European and global crude markets, which Rystad expects could see as much as 3 MMbopd of EU crude imports from Russia cut by December 2022 in a full-fledged implementation of the policy.
U.S. LNG. To replace Russian natural gas, Europe is importing more LNG from the U.S., while seeking solutions to the ruble payment issues, as they emerge from the Russian side. European gas prices remain muted, due to mild weather, strong wind generation and high LNG imports. The first shipment of U.S. LNG to Poland was completed in early May, demonstrating that Europe can, and will, find alternatives to Russian gas. High U.S. LNG exports to Europe continue despite high domestic prices in early May, due to a late cold snap in April. The U.S. commitment to Europe’s energy security continues with increases in LNG exports and supplies holding constant.
Russia softens payment position. Russia has increased natural gas flows to Europe through Ukraine and proposed a solution to its demand for payments in Rubles, indicating that Russia’s willingness to bend, to ensure gas and revenue payments continue to flow in the immediate future. In addition to concern over EU sanctions, there is also an upside risk related to threats from Russia terminating natural gas exports, as has already happened in Bulgaria and Poland. If Russia shuts off supplies to more countries unwilling to pay in rubles, then prices could skyrocket in the near term. And most European countries will struggle to replace a sudden drop in supply. Germany and Italy are likely to suffer severe economic consequences, given their heavy reliance on Russian gas imports.
Poland currently has ample natural gas storage, at 79%. Poland has prepared well for this eventuality and has the capacity to ramp up LNG imports and will also benefit from the Poland-Lithuania Gas Connector that started operating the first week of May at a capacity of 2.4 Bcm/year. Bulgaria, which was 100% reliant on Russian gas imports, will need to quickly take opportunities to diversify its gas imports. A new floating LNG facility near the Greek port of Alexandroupolis, will start operations at the end of 2023.
Common sense in short supply. We are seeing the results of assuming that the world’s major hydrocarbon producers will cooperate and use the same playbook to ensure a smooth energy transition. When has that ever happened? OPEC and Russia have used oil as a weapon of economic war for decades. Remember the battle between U.S. shale companies and Saudi Arabia in 2014-2015? And the 1973 Arab oil embargo that triggered a major worldwide recession? If governmental authorities and the environmental guys had thought more and talked less (about energy requirements they clearly don’t understand), the industry might have had surplus production capacity available to meet demand when the unexpected supply disruption occurred. Welcome to the age where political correctness supersedes common sense.
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