Russia and Ukraine Conflict: the effect on energy prices, globally
What the world should expect
January 27th, 2022
As Russia builds a military presence with over 100,000 troops on the Ukrainian border, and the US and Britain sends weapons to Ukrainian allies, it's worth revisiting Russia's role in global energy markets, and risks to those markets in the event of conflict.
If we talk about it, conflict could be violent, spread beyond borders and result in a humanitarian crisis, or it could be none of those things, but we certainly don’t know what the case is going to be here in this situation. But currently the Ukrainian electricity production sector is in an almost critical situation. Recently, stocks of coal reserves amounted to 584,000 tons, which is the lowest amount in history to be available at the start of the heating season. The crisis in the energy sector may delay the integration of the Ukrainian power system with the EU’s ENTSO-E, which Ukrenerho had scheduled for the first quarter of 2023. But this conflict is not about only Russia and Ukraine, it could leave a direct impact on the rest of the world, especially Europe. In the past Europe has faced drastic raise in its energy prices and they could increase to extreme level of severity.
First, it is worth noting that Ukraine does not produce as much oil and gas as we might have thought. According to EIA, 75kb/d of oil (<1% of global market), and 10bcm of natural gas (<2% of European market) is produced domestically. But in contrast it is Russia that rules this market with producing 11mb/d of crude oil and 620bcm of gas. Hence, the reason of almost 40% of Europe’s natural gas supply coming from Russia and Russia exporting 70% of its gas to Europe. Putting Russian oil supplies into context - from 2014 to 2016, a 1mb/d oil surplus took Brent oil prices from $110/b to $35/b. Given today's tight oil market, removing even a fraction of Russia's 11mb/d would send oil prices well into the triple-digits and likely to all-time highs ($150+). According to natural gas experts, natural gas inventory levels across Europe sits 18bcm below the 5yr average, and in response, prices have risen 500%. Removing even a small fraction of Russia's 620bcm of gas from the market would create shortages and send natural gas prices in Europe (and globally, ex. North America) to record levels.
Importantly, Russia exports ~half its oil production to Europe, with the remainder consumed domestically, or piped/shipped to places like China, Turkey and other jurisdictions potentially unwilling to comply with Western sanctions; it would be reasonable to assume the Kremlin could sell 2-3mb/d, even if heavily sanctioned (the Eastern Siberia pipeline flows directly to the Sea of Japan, and carries 1.6mb/d, for example).
In the case of gas, Russia exports ~70% of its gas to OECD Europe and would struggle to sell significant volumes abroad if Western-led sanctions were uniformly enforced in Europe. Of course, Ukraine is home to several natural gas and oil pipelines, though having been allowed to complete Nord Stream II, Russia can move sufficient natural gas to Europe without passing through Ukraine; note the Druzhba oil pipeline (~400kb/d) would be at risk of damage/sabotage in a Russia and Ukraine conflict.
Given low levels of Ukrainian fossil fuel production directly at risk from conflict with Russia, any impact on the energy market, globally, would be the direct result of decisions made by Western leaders.
What would happen?
If Western allies’ sanction Russian oil exports, prices could easily surpass all-time highs (~$150, July 2008) - presuming Russia is able to export ~3mb/d, revenues would shake out at ~$450m/d; in 2019, Russia exported ~8mb/d of oil and oil products at ~$64 Brent, generating ~$500m/d. Under a scenario where prices trade above $166, Russia could generate more revenues under Western sanctions than what Russia generated prior to COVID. Meanwhile, $150 oil in the West would accelerate already rising inflation levels by producing record prices at the pump and driving chemicals prices (the core ingredient in everything from latex gloves to polyester suits) to new highs. Even if we peek at how much the prices have already risen, it is not a sight for sore eyes.
Sanctioning Russian gas would hit Russia's bottom line, given the Kremlin's relatively restricted ability to export outside of Europe; however, it would come at a heavy price for energy consumers globally -- heating prices, electricity bills, fertilizer prices and associated food costs would all reach record levels; perhaps surprisingly, the US industrial base (feedstock gas chemicals, fertilizer, Liquefied natural gas (LNG) exports) would benefit, as domestic gas prices remain disconnected from global markets (outside of New England).
Wrapping up, what could conflict in Ukraine mean for energy markets
- 1) Directly, very little, as domestic supplies are low and piped volumes could largely be re-routed.
- 2) If sanctions were implemented, the world would see record oil and gas prices, even if sanctions were poorly enforced.
- 3) Sanctioning oil exports could be challenging, given Russia's ability to export to places like China; furthermore, higher prices would offset much of the volume impact to export receipts.
- 4) Sanctioning gas exports could cut into Russia's export revenue but would create energy shortages globally and drive costs for everything from heat to electricity and food to new highs.
- 5) Those most impacted by high prices and shortages would be the 3 billion people living in poverty, as every molecule of coal, gas and oil would bid up and be exported to the wealthy Western nations implementing the sanctions.
How do the experts see this?
We have already discussed that natural gas flowing through a web of pipelines from Russia heats homes and power factories across much of Europe. Russia is also one of the continent’s key sources of oil. This winter Europe is living through an gas energy crisis with soaring prices for natural gas and electricity. It started when storage levels of gas fell well below normal last year. Natural gas is trading at about five times the price of a year ago. But where could the prices go? Prices of natural gas are skyrocketing: at the Dutch Title Transfer Facility, Europe's leading benchmark, prices have risen from €16 megawatt per hour in early January to €88 by late October, a hike of more than 450% in less than one year. This, in turn, has sent electricity prices skyrocketing. “In Italy, consumers have already faced ct a 40% increase in their bills over the past few months”, said Roberto Cingolani, minister for the ecological transitions.
Oil futures rallied on Friday, January 7th, 2022 to post a fourth straight weekly gain, with an analyst offering a dire warning of potential supply disruptions as tensions between Russia and Ukraine intensified.
“From an energy standpoint, this could be a seismic event,” said Phil Flynn, senior market analyst at The Price Futures Group. Russia is not only a major oil producer but Europe, in their rush to get off of fossil fuels, has “become more dependent on Russia as major source for their energy.”
High gas prices raise electricity costs, threaten big increases in consumers’ bills and have pushed some energy-hungry factories like fertilizer plants and metal smelters into temporary shutdowns.
"If things get really messy in Ukraine, one can only observe that Europe is in an exceptionally vulnerable position right now,” said Thane Gustafson, author of “The Bridge,” a study of the natural gas trade between Russia and Europe.
"While flows of natural gas vary and have fallen of late, about one-third of Russia’s gas exports to Europe usually go through Ukraine. Those pipelines could become collateral damage during a Russian invasion”, analysts say.
"Import capacity in Europe is being tested right now, so the region would struggle to take substantially more,” said Laura Page, an analyst at Kpler, a research firm.
Moreover, to wrap this up Isabel Schnabel, Member of the Executive Board of the ECB, at a panel on Climate and the Financial System said, “I will argue that governments will need to push the energy transition forward, while at the same time protecting the most vulnerable members of society from energy poverty.”
- Why europe's energy prices are soaring and could get much worse.
- Increase in carbon prices will help accelerate the green transition.
- Surge in gas prices in Europe could worsen the energy crisis.
- Massive consequences for Russia if it decides to invade Ukraine.
- Major energy crisis in Ukriane. Russia's decision to stop the electricity and coal exports is largely political.
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