Ukrainian Implications

Could Russia’s military adventurism accelerate disinvestment from fossil fuels and investment in renewables?

As I write this, it’s day two of Russia’s overt military campaign in Ukraine. Events are unfolding fast and it’s very early to give any predictions as to what might happen. Still, that’s never stopped me before. I’ve been thinking about how the removal of Russian oil and gas from global markets might impact the global energy transition.

Russia’s invasion of Ukraine has driven oil prices above USD 100 per barrel for the first time in seven years. Natural gas prices are up to nearly USD 5 per MMBtu as traders expect scarcity of supply if the West sanctions Russian gas exports. Gas was around USD 2.75 this time last year.

Russia is a big exporter of both oil and gas. If these price spikes are not to benefit Russia, then western buyers have to stop purchasing Russian oil and gas immediately and switch to alternative supplies.

Yet today, Reuters’ reports Gazprom data that gas exports to Europe via Ukraine are continuing as normal, and in fact have risen today to 83 million cubic metres, up 31.4% on yesterday. Javier Blas of Bloomberg says that the EU, UK and US will continue to buy 3.5 million bpd of Russian crude oil and refined products and about 275 million cbm of gas, at a cost of around $700m. Add to that the tens of millions of dollars spent on Russian metals, agriproduce, timber, coal and other commodities and the political hawks who want to isolate Russia entirely have a job on their hands explaining how alternative sources of supply can be obtained at short notice without driving up inflation which is already threatening economic growth in the West.

Germany now reckons that with Spring upon us, Europe can survive on gas reserves and planned LNG imports for now, which gives the region the rest of this year to think of alternative supplies, such as “Freedom Gas” from the US.

Germany has already said that Nord Stream 2 will not go ahead. But it has been quiet about Nord Stream 1 which continues to pump Russian gas into the EU. A wider agreement not to buy Russian gas might accelerate investment in other parts of the world, including the North American shale basins, but also offshore Mozambique and Tanzania, where European gas majors are already well invested.

Up to now, no Western politician has been talking about putting Russian oil exports on the naughty step. Russia exports about half of its 10 mbpd production with about 3 mbpd going to Europe and 0.5 m bpd to the US. Sanctions may not have been mentioned but even on day one of the war, I was hearing that banks were unwilling to open Letters of Credit to buy Russian oil products, or on behalf of Russian-owned traders. On day two, Reuters reports that three large scale buyers of Russian oil cannot open Letters of Credit to complete purchases.

Putin may be sanguine about this. Russia’s oil could be in part redirected to China via pipeline, rail and the oil terminal at Nakhodka in the Far East. China already takes Russian oil on a swap basis in exchange for loans, securing the Middle Kingdom a discount on the market price. China would presumably be happy for Russia to get further into its debt, even eventually turning Russia into a vassal state like Iran (which supplies China on similar terms) with the boon of vast supplies of Siberian farmland to sequester via hundred year leases. Putin may be consumed with fear and anger about what is happening on his Western borders, but in the long term Russia should really be worried about its increasingly asymmetrical relationship with China.

Meanwhile Iran and Venezuela have shown how they can get around US sanctions by selling oil on the black market. Even in these days of transparency and AIS data, oil tankers still get to load and ship oil from sanctioned nations to their customers, some but not all of whom are not friendly towards the US.

If Russia is prevented from accessing the global dollar payments system, it won’t be able to sell to Europe anyway as European buyers would find themselves sanctioned by the US. If Sberbank, Gazprombank and VTK Bank, whose shares have been volatile as sanctions talk circulates, stay sanctioned, then Russian access to overseas capital markets will take a massive hit – as will the banks’ many western shareholders. Investment in Russian oil and gas output will fall as it did 20 years ago before Putin opened it up to Western partners. In the long term, output and exports will fall.

The war is likely to change the global geography of energy. Daniel Yergin may have to write a book called Another New Map. High oil and gas prices might encourage investment in oil and gas outside Russia. Volatile oil and gas prices will give anxious politicians cause to wonder about intervening, as they are in the EU and the UK, with price caps being imposed on gas and electricity retailers, causing several in the UK at least to go bust.

High and volatile oil and gas prices might make renewable fuels look more attractive, especially when carbon taxes increase the financial burden on consumers. The EU carbon price has nearly tripled in a year and is expected to double within two years to around €200 a tonne, as more industrial sectors including shipping join the scheme but carbon allowances are not increased at the same rate.

Moreover, if the West is serious about reducing its dependence on Russian hydrocarbons, as UK Prime Minster Boris Johnson - whose party is known to depend in large part on Russian financial contributions - claimed in a televised address on 24 January, then in part that can be achieved by reducing our overall dependence on hydrocarbons, whatever their source.

Just this week, on 22 February, the International Renewable Energy Agency (IRENA) urged governments to factor in the negative impacts of volatile fossil fuel prices to future-proof their economies. IRENA asks the question, if we had invested more in renewables, efficiency, buildings renovation and green gases, would we be actually saving money instead of losing it? To this is added that governments ‘should calculate the true price of gas and coal by including their health and environmental costs.’

The authors of the IRENA report claim that, ‘Renewable power is competitive with fossil fuels, even before the price spike. Green gas prices have been considered expensive, but the fossil gas price spike raises the question: will they be competitive sooner as volumes increase?’ They go on to say, ‘Given today’s high gas prices, significant volumes of biomethane and green hydrogen would be economic now, until prices subside. But by 2030, at scale, they should be competitive against even stable gas prices. Revealing the true cost of fossil fuels is long overdue.’

The EU has a long term strategy of cutting fossil fuel use by 40% by the end of this decade, which will impact not only energy sectors but fertilisers, hydrogen and ammonia production, which are currently dependent on natural gas as a feedstock.

Now that governments in the West are having to calculate the geopolitical cost of high oil and gas prices, they might find that it makes sense to encourage more investment in renewables in their own backyards than to rely on imports from unfavourable and unpalatable regimes.

Even after the political assassinations, the adventurism in Georgia, Moldova and Syria as well as in Africa, the West has tried to tell itself that it can do clean business with Putin’s Russia. That self-delusion is surely now at an end. If banks’ own governance is going further than sanctions and preventing LOCs being opened for trade with Russian commercial entities, then the governments of the West will surely have to catch up with commercial reality.

And after Russia, will western governments audit the other unfavourable regimes with whom they do hydrocarbons business? If they do factor that in, as well as the costs that IRENA points out, then an accelerated transition to hydrogen based fuels and other renewables, traded between friendly nations sharing political ideals, is a probable outcome.

IRENA says that, ‘After COP26 there is a renewed commitment to addressing climate change and the role that decarbonising energy plays in reaching net-zero emissions. We need to stop basing the mantra of the benefits of “cheap” fossil fuels that relies, even at the best of times, on the wilful dismissal of the economic costs of unpriced externalities, such as the health, environmental and climate costs.’

One of those unpriced externalities now has a price, and it is a high one: war in continental Europe, with the inflationary pressures that will come from an invasion of one of the world’s biggest producers of grains, metals and ores, as well as a host of other commodities and manufactured goods. To this we can add the inflationary pressures of sanctions on a top three oil and gas producer.

These costs can be mitigated, along with the other hidden costs of fossil fuels, by increasing investment in renewables. This is not a political choice for the future. It is a political choice for today. And it is a choice which western politicians may be driven to by western commercial actors who are already ahead of policy makers in their application of low-carbon strategies and policies.