Europe’s Energy Supply

The increase in European natural gas and power prices being exacerbated by Russia's invasion of Ukraine could create a US manufacturing advantage for a couple of years if domestic power and gas prices remain lower than in Europe, experts said April 1.

To address current energy policy challenges, it is important to look at the origins because it is easy to blame current commodity price increases on Russia's actions, "but let's recall we had an electricity and natural gas crisis in Europe prior to the Russian invasion," Brenda Shaffer, senior advisor for energy at the non-profit research institute Foundation for Defense of Democracies, said during a webinar hosted by Our Energy Policy. OEP is a non-profit energy topic discussion platform.

During winter 2021, a simultaneous cold snap in Asia and Europe made LNG cargoes expensive and hard to find, "and we saw a mini energy transition from natural gas to fuel oil, diesel and coal," Shaffer said.

Although people are focusing on the Russian war in Ukraine as an oil crisis, it is as much an electricity and natural gas price crisis, hitting every market, she said. This will leave the US with a manufacturing advantage for a year or two because energy is the biggest input in that sector, and higher power and gas prices in Europe and Asia will give the US, where those prices are lower, an advantage, Shaffer added.

Energy transition considerations

Shifting the conversation to discuss the energy transition more generally, Yossie Hollander, co-founder and chairman of the Fuel Freedom Foundation, a group dedicated to ending US oil dependence, said the US made a political decision in electricity markets to dial back coal and nuclear development.

That mostly leaves gas and some renewables, "which can never sustain full 100% reliability, so we need to reopen optionality in the electricity market," Hollander said.

For example, Florida has one major natural gas pipeline and without it in a week there would be no electricity in Florida, he said.

Asked about the role of fossil fuels in the transition to cleaner energy, Shaffer said it was important to remove the binary rhetoric of renewables versus fossil fuels because the current generation of renewables works with a baseload of generally fossil fuels.



"It's not like you can have renewables and not be using natural gas and have that baseload running," Shaffer said, adding that she hopes US, and European policy makers will look at treating natural gas differently than the other fossil fuels because "clearly oil and coal are in completely different categories regarding climate impacts."

The adamant opposition to all fossil fuels by some groups risks throwing away something that can lower air pollution in many places, Shaffer said.

"I think we accept the climate imperative and that the energy transition is inevitable, in process and technology is evolving, but we have to be realistic and pragmatic about the timescale over which this change can occur," Dean Foreman, chief economist at the trade and lobbying group American Petroleum Institute, said.

Financial Market Pressures

The global economy was in a reasonably strong position in the early months of 2022. The omicron variant of COVID-19 had delivered a sharp but short-lived blow to activity and was in decline almost everywhere. As we had highlighted in our previous S&P Global Economics reports, the health and economic impact of each successive wave of the virus was diminishing. This reflected relatively widespread vaccinations, particularly in the advanced and middle-income economies, as well as governments, firms, and households learning how to manage and live with the virus.

While the observed pace of activity was strong, the economic recovery from the pandemic remained incomplete. Although the "Big Three" economies--the U.S., China, and the eurozone--had all regained their pre-pandemic output levels, they were still below their pre-pandemic paths. The gap between the advanced and emerging markets was wide, with many economies in the latter group likely to suffer lasting damage to their output.

The final piece of the early 2022 picture was the continuing rise in inflation. This was particularly the case in the U.S., where the Federal Reserve dropped the word "transitory" from its narrative and increasingly signaled that it would need to move aggressively to head off inflation pressures that appeared more domestically than externally driven, owing to energy and supply-chain effects. While the Fed's about-face reverberated through markets (although much of the expected action had already been priced in), the upside was that inflation pressures reflected a robust recovery, including the effectiveness--and perhaps over-effectiveness--of fiscal policy.

Meanwhile, however, the eurozone was feeling notably less pressure, despite an equally robust rebound. This is due to less demand-driven fiscal policy and a smoother recovery of the labor market that is containing wage pressures.



Impact From The Russia-Ukraine Conflict

The Russian invasion of Ukraine on Feb. 24 has dominated the macro narrative for the past month. Although the economic effects are moderate on balance so far, it is doubtful we have seen the full impact, and the risks are clearly on the downside.

We have identified the following four channels through which the conflict could affect macroeconomic outcomes:

Direct economic links to Russia and Ukraine. Russian and Ukrainian production and GDP will both fall sharply as a result of the conflict. Any disruption of production will have direct effects on the trading partners of the two countries. These effects will likely follow a "gravity model," where the economies geographically closest will feel the biggest impact in terms of quantity.

Higher energy and commodity prices. Price effects will matter greatly as well. The conflict has added fuel to the fire of already elevated energy and commodity prices. For instance, West Texas Intermediate crude had risen to $95 per barrel on the day the invasion started from $75 per barrel at end-2021, and since has made a quite volatile rise to around $120 in late March 2022. Energy and commodity price changes are net zero on one level, since every buyer corresponds to a seller and every importer corresponds to an exporter. But higher prices destroy demand because users spend more than producers.

Confidence effects. These are indirect effects and less precisely measured. Lower confidence will make households more cautious and therefore scale back or defer their discretionary spending plans, including for big-ticket items, renovations, and vacations. This, in turn, will lead firms to dial back or defer capital expenditure plans. This decline in private demand will reduce growth.

Policy responses. There are two components here. First, we have updated our fed funds rate forecast to include six more hikes this year (with a 50-basis-point hike likely in May), plus four more next year. This will take the policy rate above the 2.50% neutral level. Second, we are assuming a fiscal policy response in China aimed at negating any downside effects on growth from the Russia-Ukraine conflict, in light of the high weight authorities place on stability and Premier Li Keqiang's recent announcement of a 5.5% approximate GDP growth target this year.

China's Evolving Role

Energy supply diversification to China has been at the core of Russia's eastern pivot, while Russian gas is central to China's energy diversification away from the Middle East and Australia.

Russia has become the third-largest natural gas supplier to China, including both pipeline gas and LNG, and is currently its second-largest crude supplier after Saudi Arabia, making Beijing's geopolitical stance -- somewhere between Moscow and Washington -- increasingly important in the ongoing conflict between Russia and Ukraine.

When the preliminary Power of Siberia gas pipeline deal was signed in 2014, the spot price of LNG was around $10.50/MMBtu. But prices have risen manifold since then, making pipeline gas much cheaper for China. Economics alone will make it tougher for Beijing to cut Russian gas supply.

Still, China will have to consider its options, given its own exposure to the US and global financial systems in the event of secondary sanctions. Alternatively, turmoil in Russia gives Beijing leverage in both energy and financial markets.



Prices

- Spot Asian LNG prices hit a record high twice within a span of a week. On March 3, the Platts JKM for April deliveries touched $59.672/MMBtu. On Mar. 7, Platts JKM rose 79.21% from a day earlier to $84.762/MMBtu, registering the single largest daily jump in the price assessment, according to S&P Global Commodity Insights data.

Trade Flows

- Russia is the third-largest natural gas supplier to China, including both pipeline gas and LNG. Russian natural gas accounted for around 10% of China's total gas imports of 121 million mt in 2021, against 25.9% and 19.8% from Australia and Turkmenistan, respectively.

- Russia exported 12.145 million mt of natural gas, comprising 4.61 million mt of LNG and 7.54 million mt of pipeline gas in 2021, according to China's General Administration of Customs. The total volume rose 51% year on year, with LNG imports falling 9.8%, while pipeline gas imports rose 154%.

- Russia is the second-largest crude supplier to China after Saudi Arabia. It delivered 1.6 million b/d of crude in 2021, customs data showed, down 4.6% year on year. But Russia's share increased slightly to 15.5% from 15.4% in 2020. China cut overall crude imports by 5.1% to 10.3 million b/d in 2021.

- State-owned China National Petroleum Corp (CNPC) and Russia's Gazprom signed a 30-year sales and purchase agreement in May 2014, for 38 Bcm/year of natural gas supplied via the Power of Siberia gas pipeline.

- The Power of Siberia line started supplying gas to China from Dec. 2, 2019, and volume has reached 43 million cu m/day or around 15 Bcm/year since December 2021. Volumes through the pipeline, which is called the China-Russia natural gas pipeline eastern route in China, is expected to reach 38 Bcm/year after the third section of the Chinese portion is completed in 2023.

Sanctions Against Russia

Crude oil production by OPEC and its allies fell in March from February for the first time in more than a year, the latest S&P Global Commodity Insights survey found, contributing to a tightening market thrown in flux by the Russia-Ukraine war.

Western sanctions began biting into primary non-OPEC partner Russia's oil flows, and sizable disruptions in Kazakhstan and Libya also led the coalition's production lower, the survey found.

OPEC's 13 members raised output by 60,000 b/d to 28.73 million b/d, but that was more than offset by a 160,000 b/d decline by the bloc's nine allies, who pumped 13.91 million b/d.

With the net decline of 100,000 b/d, the widening gap between the OPEC+ production and quotas jumped to a record-high 1.24 million b/d—casting further doubt on the group's ability to meet growing global oil demand, which many analysts expect to return to pre-pandemic levels in 2022.



The drop was the first since February 2021, when Saudi Arabia instituted a unilateral voluntary 1 million b/d cut to help prop up the market that at the time was still wobbly from resurgent coronavirus cases.

Since August, with the global economy on firmer footing, the producer group has stuck to a plan of gradually raising quotas by 400,000 b/d each month but has faced mounting pressure from the US, India, Japan, and other major oil-consuming nations for accelerated supplies to cool off rising energy prices.

But several countries have not hit their output targets in months, and March's shortfall resulted in a compliance figure of 148% for the 19 members with quotas, according to S&P Global calculations. Iran, Libya, and Venezuela are exempt from quotas under the OPEC+ agreement.

Concerns over OPEC+ production capabilities, in combination with the Russia-Ukraine war and recovering oil demand, have helped lift the Platts Dated Brent benchmark to nearly $140/b in recent weeks, although it dropped to $98.28/b April 7 as the International Energy Agency announced a 120 million barrel stock release from strategic petroleum reserves, led by the US. OPEC+ officials have attributed the volatility to geopolitics, and not market fundamentals.



Production woes

OPEC kingpin Saudi Arabia, one of just a handful of countries that appears to hold significant spare capacity, kept its production steady in March at 10.25 million b/d, the survey found. Ship-tracking data indicated its exports fell during the month, but several analysts surveyed cited increased refinery runs and said storage volumes may have also increased.

Non-OPEC leader Russia, hit by western sanctions targeting its financial sector, saw its crude production fall to 10.04 million b/d, the survey found. Many traders have stopped transacting with Russian commodities, and analysts expect production shut-ins to build up in April and May, though some flows are shifting to Asian customers.

Effects on Oil

Sanctions and boycotts on Russian oil over its war in Ukraine are heaping more pressure on global diesel markets which were already running low on stocks as demand rebounds from the COVID-19 pandemic. As traders scramble to source alternative supplies, diesel cracks have soared to record highs, far outpacing price rises for gasoline and other fuels. Europe is by far the biggest casualty of lower Russian diesel exports, which account for about half the region's total diesel imports or some 700,000 b/d.

Implications for Gas

With the West's relations with OPEC stalwarts Saudi Arabia and the UAE on rocky ground, neighboring gas giant Qatar's warming ties with the US and Europe are a sign of shifting energy alliances.

Even before the Ukraine war had Europe scrambling for alternatives for Russia's oil and natural gas, Qatar's ambitions to grow its LNG business were coinciding with burgeoning energy demand by western countries amid the recovery from the pandemic.

In January, Qatar's emir secured the first head-of-state visit to the White House in 2022. President Joe Biden designated the nation a "major non-NATO ally" and the US and Qatari energy ministers discussed enhancing energy relations at the CERAWeek by S&P Global conference in early March.

At the same time, Saudi Arabia and the UAE had ignored US requests for more oil to cool gasoline prices, the top driver of record high inflation, dismayed by the cognitive dissonance of the Biden Administration's climate activism.

The Saudis and the Emiratis also consider the US response to intensifying attacks by Yemen's Iran-backed Houthi rebels, often targeting vital oil infrastructure, as insufficient, and they continue to sound alarms over the Biden Administration's attempts to revive the nuclear deal that would end sanctions on Tehran's energy industry.

Redrawing map

"The Ukraine war is redrawing the global friends and foes map, so we might be entering a new energy phase here," said Vandana Hari, CEO of Vanda Insights. "The US wooing Qatar sits nicely in the context of the US trying to secure more avenues of gas for Europe to replace Russian molecules."

Qatar was the biggest LNG exporter globally last year with total supplies amounting to 110.2 Bcm of gas equivalent, according to S&P Global data. It was followed by Australia (107.2 Bcm) and the US (96.3 Bcm).

Qatar currently produces about 77 million mt/year of LNG and is expanding its giant North Field to boost capacity to 126 million mt/year in the coming years. Qatar is also the majority owner of the Golden Pass LNG terminal in Texas with partner ExxonMobil. The site has an authorized export capacity of up to 18.1 million mt/year. The $10 billion project is expected to start up in 2024.

Qatar quit OPEC at the end of 2018 to focus on its gas ambitions. At the time, OPEC kingpin Saudi Arabia and the UAE were leading a trade embargo against Qatar in a political dispute. Relations were restored in January 2021.

Impact on Metals & Chemicals

Top nickel-producing nations can rapidly ramp up production and meet global demand if sanctions or an export ban curtail supply from Russia, the world's fourth-largest nickel producer.

Russia, home to nickel giant PJSC MMC Norilsk Nickel, produced 195,000 tonnes of mined nickel in 2021, or 7.2% of global supply, according to data from S&P Global Commodity Insights' Metals and Mining Research team. It produced 121,000 tonnes of primary nickel, or 4.6% of global production. And while nickel has not been the subject of sanctions or a target of Russian President Vladimir Putin's March 10 ban on certain exports, markets fear the loss of so much supply.

With nickel demand high for use in batteries used in electric vehicles and on the grid, nickel prices have skyrocketed since Russia's Feb. 24 invasion of Ukraine. A member of The Wall Street Journal's editorial board articulated market fears in a March 14 commentary headlined "Russia Can Hold Nickel Hostage."

But analysts and nickel producers say the Russian supply can be replaced. Scrap recycling becomes viable at high prices, helping backfill any deficits in the very near term, and nickel-producing heavyweights in the South Pacific have new mines and processing plants set to come online soon.

"Western Australia is the world's fifth-biggest producer of nickel and is well placed to meet the strong global demand for nickel," Western Australian Minister for Mines and Petroleum Minister Bill Johnston said in an email.



Here come the nickel mines

High nickel prices were stimulating exploration and mine expansion even before the Russian war in Ukraine. The London Metal Exchange three-month nickel price is up 54% to $31,803 per tonne since the start of the year, according to S&P Global Market Intelligence data, though it is down from the more than $100,000/t the metal hit amid a short squeeze March 8, which caused LME trading to shut down.

BHP Group Ltd. announced in October 2021 that it produced the first nickel sulfate crystals from its Nickel West sulfate plant in Western Australia. The miner is looking for opportunities to grow production at the plant, Johnston said.

"BHP is ramping up to 20,000 nickel-equivalent tonnes per year to be fed directly into the electric vehicle battery market," Johnston said.

According to BHP, the plant will produce 100,000 tonnes of nickel sulfate per year, enough to make 700,000 electric vehicle batteries each year. The company did not clarify when the plant will be fully operational and has not responded to a request for comment.

Meanwhile, the Philippines, the world's second-largest nickel ore producer next to Indonesia, is expected to open 10 nickel mines this year, according to Mines and Geosciences Bureau Director Wilfredo Moncano. The Philippines now has 32 nickel mines in operation.



Philippine Nickel Industry Association and Global Ferronickel Holdings Inc. President Dante Bravo said the invasion has created more opportunities for junior nickel miners to bring new mines into commercial operation to take advantage of the increasing nickel ore prices, which would lead to more investments in the sector.

Indonesia and the Philippines have resources that can support the global nickel supply chain.

"I do not think that there is any mine that could match the pure nickel production of Russia, but laterite ores are abundant both in the Philippines and Indonesia that can support the ferronickel production, which is a pure nickel substitute, used for stainless steel, nickel concentrates and other nickel products that can be used for battery production," Bravo said.

Agriculture

Tightening supplies and trade disruptions fueled by the Russia-Ukraine war lifted global food prices to a record high in March, the UN's Food and Agriculture Organization said in report April 8.

The FAO Food Price Index averaged 159.3 points in March, up 34% from year-ago levels to reach the highest level since its inception in 1990, the FAO report showed.

Multiple sub-indexes, such as vegetable oils, cereals, and meat also surged to records.

In another report released recently, the FAO warned that the global demand-supply gap caused by the ongoing Russia-Ukraine war, which started Feb. 24, can further push up international food and feed prices by 8%-22% from already-elevated levels.

Both Russia and Ukraine are major wheat and corn exporters, accounting for 19% of corn and 29% of wheat exports globally, according to the US Department of Agriculture.

"Ukraine continued to be the driving force in grain and vegetable oil prices during March as hopes for a quick resolution faded," S&P Global Commodity Insights said April 7 in its Global Biofuels and Agriculture Outlook report.

Since the Russian invasion began, port closures in Ukraine, plus financial and freight challenges for Russian volumes, have hindered exports, the FAO said, adding, "these factors are likely to remain in effect for the remainder of the 2021/22 season," it added.

Cereal prices jump 37% on year

The cereal price index average in March rose to its highest level at 170.1 points, up 37%. "This reflected surging world wheat and coarse grain prices, largely driven by conflict-related export disruptions in the Black Sea region from Ukraine, and to a lesser extent, the Russian Federation," the report added.

Apart from this, poor crop conditions in the US were also seen fueling the rise in wheat prices. According to the FAO, global wheat prices saw a near 20% month-on-month increase in March.

Platts assessments of FOB prices of Australian, Russian, and Ukrainian wheat by S&P Global have increased 64%, 69%, and 47%, respectively, year on year.



Global prices of coarse grains have risen sharply in the past few weeks because of strong corn prices. "Significantly reduced corn export expectations for Ukraine, a major exporter, on top of elevated energy and input costs, underpinned a 19.1% increase in world corn prices month on month," the report said.

FOB prices of corn from Ukraine, the US, Brazil, and Argentina have increased 29%, 37%, 33%, and 25% year on year, respectively, according to S&P Global.

For coarse grains, the FAO has slashed its estimates for global trade in the marketing year 2021-22 to 226.3 million mt, a sharp 10 million mt cut from the previous month.

The FAO also reduced its global wheat trade estimates for MY 2021-22 by more than 4 million mt to 189.8 million mt in its March report.

Vegetable oil markets spike

The Vegetable Oil Price Index spiked to 248.6 points in March, up 23% on the month, as the ongoing war put sunflower oil supplies at risk at a time when consumers were turning away from palm and soybean oils because of high vegetable oil prices. Ukraine and Russia together account for about 76% of the world's sunflower oil exports.

Cyber Threat

While the U.S. power grid is well-prepared to withstand potential cyberattacks, key vulnerabilities persist that could catch utilities off-guard if Russia retaliates against the economic sanctions that were imposed after it invaded Ukraine.

The U.S. Department of Homeland Security's Cybersecurity & Infrastructure Security Agency issued a "Shields Up" alert Feb. 12 in response to the growing Russian threat, indicating that "every organization in the United States is at risk from cyber threats that can disrupt essential services and potentially result in impacts to public safety." The alert said organizations should be ready to detect unusual network behavior as well as make sure all software is up to date and that all remote access requests are validated with multifactor authentication.

North American Electric Reliability Corp. said in a Feb. 28 statement that its "suite of Critical Infrastructure Protection Reliability Standards" is ready to address those additional security challenges. Scott Aaronson, senior vice president for security and preparedness at the Edison Electric Institute, the trade group for investor-owned utilities, wrote in an email that "member companies are closely monitoring the situation and are coordinating across the industry and with our government partners."

Technology

As Big Tech cloud providers weigh shutting down access to their digital infrastructure by Russian entities as part of a global backlash to the war in Ukraine, analysts predict the impact will be felt most by private enterprises in Russia.

Amazon.com Inc. and Microsoft Corp., the world's largest cloud providers, have already stopped accepting new contracts for cloud services in Russia. Their next move is likely to cut services from existing customers, analysts said, though the companies are taking time to weigh the repercussions.

"We believe it's a matter of when and not if AWS and Azure pull the plug on cloud services in Russia," said Wedbush Securities analyst Daniel Ives. "Street pressure is building, and investors want U.S. tech firms to leave Russia quickly."

When contacted by S&P Global Market Intelligence, spokespeople from both Microsoft and Amazon declined to comment on whether they planned to completely disable their products in Russia. In a March 8 statement, Amazon said AWS had "no data center, infrastructure, or offices in Russia, and we have a long-standing policy of not doing business with the Russian government."

The company's biggest AWS customers in Russia are companies headquartered outside of the country, according to a March 4 Amazon blog post.

Actions of Energy Majors

China's state-run oil and gas giant Sinopec will comply with local and international regulations to manage its investments and conduct energy trades with Russia, a company executive said March 28.

Despite the mounting and sweeping financial sanctions against Moscow, Sinopec's investments and business operations in Russia remain relatively stable for now, though the company would rigorously assess business economics and financial risks for any Russian energy trades and projects ahead.

"The operation of the company's business and projects in Russia are generally smooth, and there is no risk to impairment of the assets for the time being [according to relative accounting regulation and rules]," company president Yu Baocai said during a conference call to announce Sinopec's 2021 annual results.

Sinopec acquired a 10% stake in Russia's PAO SIBUR Holding in 2015.

It holds a 40% stake in the joint Amur Gas Chemical Complex (GCC) project with the Russian petrochemical producer Sibur.

The projected has been under construction since August 2020, with the construction cost estimated to be below $10 billion.

Sinopec set an operation management desk in Russia to monitor the construction and associated progress. A source with knowledge about the desk told S&P Global Commodity Insights that the project has been progressing slower than usual.

The decision to buy discounted Russian crude and LNG cargoes will be governed by prices, specifications, freight, tariffs, as well as international policy obligations, the official said, adding that Sinopec will continue to diversify its import sources.

As the world's top refiner by capacity, Sinopec relies on crude imports to meet around 86% of its throughput demand.

Seaborne Russian crudes are among its sources. Sinopec is the leading buyer of Russia's Urals crude and it has purchased at least one cargo for loading in May, S&P Global reported earlier. Sinopec is not only a state-owned company but also listed in Shanghai, Hong Kong and New York.



Refining faces challenge

Sinopec Chairman Ma Yongsheng said the company's refining sector faces a rising challenge with crude prices fluctuating mostly at high levels.

Autos

The Russia-Ukraine conflict is intensifying global supply disruptions and has led S&P Global Ratings to revise downward its projections for global light-vehicle sales.

S&P Global Ratings now expects global sales to fall by up to 2% in 2022 compared with last year.

Supply issues could have short-term credit implications for some global auto producers and suppliers.

Further Reading