Friday, October 28, 2022

Energy: The Last Frontier of the Ukraine War

By Oscar Silva-Valladares - October 28, 2022 at 10:31AM


The Ukraine war has intensified the old energy conflict between Russia and the US. The ultimate result of this struggle is uncertain but US main allies, i.e., Europe, are not expected to perform well.

Fossil fuels (coal, crude oil and natural gas) are the main sources of world energy providing 80 percent of the world’s consumption. In Europe, and despite long-dated political, social and media initiatives in favour of green energy, in 2021 fossil fuels sourced 70.6 percent of total energy consumption and renewables only 12.3 percent, the latter an unremarkable feet as green promotion started in the late 1970s. Historically Europe has relied on Russian fuels and as of May 2022 Russian oil imports represented 23.7 percent and 16.1 percent of OECD Europe’s oil demand and total imports, respectively, whereas in 2021 Russian gas equaled 71.7 percent of Europe’s total gas pipeline imports and 49 percent of total gas imports, respectively.

Reflecting a deep structural transformation in economic clout, the balance of power in the world energy markets has changed in the last decades to the West’s detriment. In 2021, the BRICS (Brazil, Russia, India, China, and South Africa) energy production was 37.9 percent of the world’s total against 21.6 percent by the G7 and 4 percent by the European Union (EU), and the BRICS energy consumption was 40.1 percent of the world’s total against 25 percent by the G7 and 9.4 percent by the EU. Meanwhile, the energy weight of the US and Russia is backed by both having the world’s highest levels of fossil fuel reserves – each about 14 percent of world’s total in 2020 – and producing 15.9 percent and 11.8 percent of the world’s total energy, respectively. 

In the US there is an old symbiotic relationship between government policy and its oil multinationals with geopolitical gains and corporate profits going hand in hand. In 1946 an early Cold War crisis unfolded when the US pressed the USSR to evacuate Northern Iran to protect US Middle East oil interests. In 1953 the fall of Iranian Prime Minister Mossadegh started with a US oil company blockade followed by a CIA sponsored coup. Price competition from Russia led Exxon in 1959 to cut oil prices without consulting its host nations, prompting producers to create OPEC the year after.

From the 1920s to the 1950s the US established its Middle East oil presence at the expense of France and Russia and by 1955 the five major US oil companies produced two-thirds of world oil. Although being the largest oil producer, the USSR had limited market impact as one-fourth of its production went to its East European allies, but nevertheless played a growing geopolitical role for instance through military support of Colonel Gaddafi in Libya, who organized in 1970 against Occidental Petroleum the first oil price increase of a producing nation. In the 1970s the US regarded the Arab/Persian Gulf as a security problem second only to the Soviet Union.

After the 2nd oil shock of 1979, the Carter Administration laid out an energy policy that allegedly set the stage of US modern geopolitical initiatives. The US-led interventions in Kosovo, Afghanistan, Iraq, Kuwait, Libya, and Syria were ultimately aimed at securing the Eurasian energy space for the US “strategically compatible partners,” as pointed out by former US National Security Advisor Brzezinski in 1997. “Global War on Terror”, “Assad Must Go” and “Rules-based International Order”, among others, have been questioned as euphemisms for US policies directed at geopolitical hegemony through the control of energy sources and transportation routes.

US natural gas is a late comer in this conflict. In 2000 US gas exports were only 1.2 percent of the world’s total but by 2021 they have reached 17.5 percent and have become Europe’s main source of LNG imports representing 28.5 percent of total. US increasing denunciations against the impact of Russian gas on Europe’s security, as mentioned for instance by US former Secretary of State Rice in 2014 and by US former President Trump during his mandate, coincided with the growing potential of US natural gas to compete and displace Russia.

The Ukraine conflict has turned the table on the geopolitical and energy struggles. For the US, the war is an opportunity to end once and for all Europe’s energy dependence on Russia, destroy the old Russo-German economic partnership based on cheap Russian energy and enable further European reliance on “the US energy platform” as pointed out by Rice. The war has also stopped Russo-Norwegian attempts to counter US LNG through lower pricing. Sanctions purportedly destined to cripple Russian energy exports and stop its war machine financing have also sought to destabilize and induce regime change in the Kremlin, the latter the ultimate geopolitical prize worth the US oil companies’ recent departure from Russia.

Europe, deprived of fossil fuel reserves except coal, has blindly followed US policies and is suffering a vicious circle of energy supply disruptions, severe increases in energy prices with direct impact on population’s welfare, decreasing industrial competitiveness leading to business closures and job losses, and deterioration of financial conditions. Differing actions are preventing a European unified energy response including unilateral aid support on consumer energy costs (Germany) and attempts to carve out Russian sanctions from preferred sectors like oil marine transportation (Greece) and nuclear fuel (France). European politicians are realizing that US gas is sold in Europe at prices four times higher than domestically. The UK Prime Minister just became the first casualty of misguided economic policies intended to control rising energy bills.

Europe’s preference for natural gas purchases through exchange quotations rather than by long-term contracts is worsening supply uncertainties as major providers like Qatar and Nigeria - representing 32.8 percent of combined 2021 LNG imports - insist on contractual arrangements and are prompting LNG suppliers to sell to the highest bidders. Europe appears paralyzed in its own ambivalences and contradictions on energy policy, including big business versus the green agenda and the future role of nuclear energy and coal.

Russia, meanwhile, does not seem to be losing the energy war as it just showed, due to higher energy export earnings, a Jan-Sep 2022 current account surplus of US$ 198.4bn which is 2.6 times larger than in 2021. Japan, with Russian fossils sourcing 7.1 percent of its energy needs, has conveniently been exempted from a planned Russian oil price cap. Russia is quickly pursuing alternative markets for its energy stocks, with China and India growing as buyers for their own use and intermediaries to third countries. From buying almost no Russian oil, in July 2022 India imported from Russia about 1 percent of the world’s oil global supply.

Europe’s weak market position could neutralize the impact of energy sanctions on Russia as the latter will likely circumvent the West’s planned oil price cap through alternative shipping and insurance arrangements. European officials are acknowledging the West’s “overestimation of control of global oil trade” as they witness Russian, US and Norwegian companies increase their energy profits. Moreover, Russia has unleashed several initiatives intended to expand and strengthen energy-linked political-economic partnerships, like a planned Turkey gas hub that could become a major energy crossroad potentially enabling Europe to access again Russian gas mixed with Central Asian sources.

The recent OPEC+ decision to reduce oil production has been justified by the need to preserve market stability but is also a response to the attempted Russian oil price cap which is perceived as a dangerous precedent that could equally be used against other producers or even other commodities. The US has entirely blamed the OPEC+ output decrease on Saudi Arabia, given the latter’s 25 percent share of the cartel’s production, and is considering using old antitrust legislation to lift sovereign immunity and allow suing oil producing nations in US courts on market manipulation grounds. This would not be the first time that the US uses this legislation to pursue geopolitical aims but targeting OPEC+ states could further destroy US credibility and lead affected governments to protect themselves, for instance through divestures from US financial holdings currently at over US$ 200 billion.

But the Biden Administration appears to be using oil not only to pursue long-term geopolitical goals but also to support its short-term agenda. The US Strategic Petroleum Reserve, an emergency stockpile created in 1973 to counter severe supply interruptions has been brought down to early1980s levels in a perceived effort to control domestic gas prices and have a happy electorate ahead of the coming mid-term vote.

The explosions at the Nord Stream gas pipelines have risen energy warfare to an unseen level as they have taken away from Germany an energy supply alternative (cheaper than Russian gas imports via Ukraine), severely weakened a diplomatic option for the Ukraine war and enable further European reliance on US gas as admitted by US Secretary of State Blinken. Suspicions that the US is the main beneficiary of these events will only increase apprehension and ultimately damage whatever trust still exist on US good intentions towards Europe. Sadly, this episode will not be the last escalation step on the energy theatre as the Ukraine war continues.

Oscar Silva-Valladares is a former investment banker that has lived and worked in North and Latin America, Western & Eastern Europe, Saudi Arabia, Japan, the Philippines, and Western Africa. He currently provides strategic consulting advisory on financial matters across emerging markets.

from Peace and Prosperity


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