(WoodMac, 23.Feb.2023) — Ukraine’s battle is existential. The country has suffered a year of lost lives, its people forced to live each day in perpetual fear and witness the destruction of homes, communities and infrastructure. Millions have fled the country.
Russia’s war has had a huge impact outside Ukraine, too, not least in global energy markets. Soaring prices and supply chain disruption have led to a fuel affordability crisis in many countries and fed the inflation that’s dragging down the global economy. One year on, here are our team’s thoughts on how the war has changed energy markets.
Energy supply will no longer be taken for granted
No country can ever again allow itself to become reliant on imported energy from a single supplier. In future, energy security will be about the diversity of fuels and sources, and the primacy of domestic resources.
Because of the war, all energy importers have accelerated in this direction.
Europe can live without Russian gas
The global market has adapted remarkably quickly. High prices dampened demand in Europe and Asia and pulled what supply was available into the European market – limited volumes of alternative pipe gas and every cargo of flexible LNG from around the globe.
There’s growing confidence that Europe can muddle through the next three years, albeit with relatively high and volatile prices. New supply volumes, mainly US and Qatari LNG, arrive from 2025, helping prices to ease back to ‘normal’. Longer term, LNG growth is still all about Asia.
The war, though, has fundamentally changed the market forever – it’s now a more global market, flexible and fungible, but likely more volatile as Europe competes with Asia for the same LNG cargoes. Could Europe buy Russian gas again in the future? Maybe, but it will be a long time, require regime change and, even then, in our view no more than 15% of its needs.
Oil and coal’s resilience
Despite ever-tightening sanctions, governments have been forced into expediency to keep the lights on and economies ticking over. Russian exports of both oil and coal have continued to flow at close to pre-war volumes. The appetite for its crude and oil product exports (albeit from different buyers) has helped Russia, which delivers 10% of global oil supply, to maintain its domestic oil production close to the levels of a year ago.
We expect sanctions to take their toll over time, however. Oil prices, after spiking in the early months after the invasion, have fallen all the way back to below pre-war levels, suggesting the global market is currently adequately supplied.
Global refining, in contrast, has been significantly disrupted. Discounted Russian oil exports were forced away from Europe, mainly to China and India; and products are now undertaking the same re-shuffling but to different markets.
The resulting friction in crude and refined product trade, shipping logistics and refinery flexibility is reflected in historically high refining margins that will ease later this year as new capacity comes online.
A booster shot for the energy transition
Self-sufficiency, at a reasonable price, will define energy security in the future – domestically produced low-carbon energy, using domestically owned technology and supported by domestic supply chains.
Many countries are nowhere near that today, and dependency on China for critical transition metals and hardware is a widespread concern. But most countries already planned to make the journey over the longer term as they progress towards net zero, the war has just made it happen quicker.
The US is off to a flying start, introducing game-changing tax incentives in the Inflation Reduction Act of 2022. One example – we have since raised our forecasts for the installation of US wind, solar and energy storage capacity by between 50% and 100%. We anticipate a similar acceleration of investment in other low-carbon technologies, including CCUS, hydrogen, next-generation nuclear technologies and advanced battery chemistries.
The EU, too, has acted in the last month to beef up incentives to ensure capital flows into Europe to help realise its own ambitious low-carbon goals. So, perhaps temporarily higher CO2 emissions before much faster reductions.
Limitations of power markets
Extreme market conditions have revealed the limitations in Europe’s marginal price-based power markets. A combination of rising input fuel costs and stretched power supply led to very high wholesale prices across the continent. Some generators made huge margins as consumer bills hit the roof.
Governments have been forced to subsidise bills temporarily to deal with an affordability crisis, and regulators have intervened with the aim of reforming wholesale markets at both regional and national levels. The challenge is to alight on a means of price setting that’s ‘fair’ and still incentivises the industry to invest in new generating capacity and supporting technologies.
Power markets around the world will follow with interest. Expanding grid infrastructure, cross-border and domestically, is also imperative.
Who has fared well?
Big importers of Russian oil ignoring the sanctions, including China and India, and accessing heavily discounted crude and products. Crude and oil product shippers. Gas-producing countries, particularly those connected by pipeline into Europe. Oil and gas producers, particularly integrated companies with trading capabilities, along with US refiners. Power producers in Europe with high exposure to renewables, hydro and nuclear merchant capacity (though windfall taxes and market reform may make any gains short-lived).
The US LNG industry, set to double capacity, and Qatar. The US economy, energy-independent and with relatively low energy costs. Investors in low-carbon technologies and associated supply chains.
Who has fared badly?
Gas and electricity consumers in many parts of the world. Gas importers, including some in Europe that have required government bailouts. Last but not least, Russia, which has not only lost 130 Bcm of annual gas exports to Europe worth more than US$30 billion a year of pre-war revenues and unlikely ever to be replaced by alternative export options. It’s also blown its credibility as a reliable trading partner.
By Wood MacKenzie Chairman, Chief Analyst and author of The Edge Simon Flowers