Perspectives on energy markets one year into the Ukraine war

Dr Edward Libbey

BP recently published its 2023 Energy Outlook. I cannot pretend to summarize a mammoth piece of analysis on top of the many years of previous publications – the BP Statistical Review itself is now over 70 years old! Together, they provide the energy industry with a huge continuous data source as well as evolving and perceptive insights on energy markets. It is a ‘must read’ for anyone who wants to interpret the past and set objectives for the future. BP identified huge uncertainties and was very careful in not calling it a forecast. My comments are personal and must not be read as judgment on the enormous breadth of BP’s analysis.

As the energy transition gains pace, there remain huge uncertainties about both the challenges and the range of possible outcomes. Some trends are clear, though there will be different views on whether they are sufficient or fast enough. The rate of global energy growth has slowed in recent years, and total fossil fuel demand will peak in the foreseeable future. ‘Clean’ electricity is replacing traditional fossil fuels; coal consumption falls sharply in the developed world, as does oil, though less so, as its use in transportation declines while natural gas continues to play a significant role. Electricity is the big winner, and the carbon intensity of power generation continues to decline sharply. As we have seen over the past decade, the costs of new solar and wind power have dropped significantly, matching the costs previously associated with ‘cheap’ fossil-generated power. However, while this represents significant progress, BP is clear that it still leaves the world with a significant carbon challenge. Government ambitions increase, but so have carbon emissions. Despite the potential impact of the US Inflation Reduction Act, further support or intervention will be needed globally if the decarbonization targets are to be met. The paradox is that the world will continue to need to invest in fossil fuels to sustain current but declining needs, while at the same time promoting the faster permitting and development of alternatives such as bioenergies, hydrogen, and carbon capture. As the USA and China provide financial support for new energies, China and India benefit from cheap Russian crude and the USA from cheap natural gas. Will Europe be squeezed?

There are of course huge regional differences, with flat or growing demand in emerging economies offset by accelerating declines in oil use across the developed world. Who pays for mitigation has raised contentious issues that I would suggest are unresolved by recent COP gatherings. BP also points out that the transition is not just about energy and fuels but also involves access to key minerals and technologies. Control over lithium and rare metal resources and the chip manufacturing capabilities raise challenging global political issues. People are also beginning to recognize that biofuels and human food production are competing for the same agricultural land that is insufficient to satisfy both in full. Perhaps desert solar and wind with long distance electron transmission will evolve as a new energy source?

But as I look back over the past year, we can see that some of the outcomes are not some of the worst case scenarios that were envisaged by the Russian invasion of Ukraine. The humanitarian crisis remains a catastrophe, and I for one cannot see how it is resolved. Food inflation and supply remain a challenge with several areas of the world suffering critically. However, on the energy front, the view today is more optimistic than seen six months ago. While some forecasters predicted oil prices as high as $380 per barrel, they never reached anywhere near this. Those projections failed the ‘common sense’ test. At around $80 today, they are perhaps 20% above pre-Covid trends and still way below the real prices of the late 1970s and not far above longer-term averages. The European dependence upon Russian-sourced diesel and heating oil remains a concern, but from a personal perspective, I recently filled my heating oil tank at 78p a liter, compared with 63p just before the invasion – and prices have fallen further in the past month though not yet as much at the diesel pump. The fact is that since the 70s we have seen a massive reduction in the global economy’s dependence on oil – its GDP oil dependency. Natural gas is a different story. Gas prices in the UK and Europe peaked in July/August at prices around the thermal equivalent of $500 per barrel. The impact on domestic and industrial electricity bills was dramatic. However, prices have dropped by over 80% to an oil equivalent price around $80 but still 2 or 3 times higher than prices typical a few years ago. How has this happened? Benign winter weather in much of Europe (remember those green ski slopes across Europe at the turn of the year), the extended Chinese lockdown, and the dramatic expansion of LNG driven by the fracking revolution in the US. A decade or so ago, the US was building plants to import LNG – now it is a global exporter. I would not suggest that Europe has solved its dependency on Russian gas, but the reduction has been far greater than was foreseen mid-year.

Europe filled its gas storage and the UK recommissioned its Rough Field storage. However, the winter of 2023/24 remains a challenge as others have foreseen with rising demand for LNG in China and Southeast Asia. Markets do respond dramatically to the sort of shock that gas prices delivered in the summer.

Finally, where does it leave Russia? The human cost to the Russian and Ukrainian people is enormous, but what of the damage to the Russian economy? It may have maintained its oil production and exports but at lower prices due to the impact of European price caps and the need to generate new but discounted markets primarily in India and China. It cut exports of natural gas to Europe but the higher prices it achieved in the summer have now shrunk significantly. It weaponised its energy resources over the past two decades by systematically increasing Europe’s dependence on its oil and gas – we shall have to wait and see how effectively it can sustain the power of that weapon. Wars are started politically but we can see from history that they can only be won by overwhelming resources and finances, and Russia is surely on the wrong side of this equation?

March 2023