Ukrainian War Threatens to Fracture a Globalized Energy Sector

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Written by Daniel Graeber for Industrial Info Resources (Sugar Land, Texas)--The war in Ukraine left a deep impact on the commodities sector, facilitating both a realignment of the global order and the fracturing of a globalized energy market.

Russian military forces entered Ukraine one year ago Friday in what was initially expected to be a short campaign that would allow Russian President Vladimir Putin to send a brief, but powerful message to his Western adversaries to stay out of what he sees as the Kremlin's sphere of influence.

Looking at the absence of assertive response to the annexation of the Crimean Peninsula in 2014, Putin likely saw Ukraine as low-hanging fruit. For all intents and purposes, he was wrong.

"The attack on February 24 last year was a major miscalculation on Putin's part, with Russia having suffered one military and economic defeat after another," wrote Ole Hanson, the head of commodity strategy at Saxo Bank in Denmark.

Russia's economy was among the worst performers last year, with consumer-level inflation flirting with 12% on an annual basis. But economists at the Organization of the Petroleum Exporting countries said Russia has managed to avoid an extraordinarily deep contraction.

"The counterbalancing measures undertaken by the government have compensated, at least to a significant extent, the slowdown over the past year," OPEC economists wrote in the monthly market report for February. "However, near-term developments are dependent on the ongoing geopolitical tensions in the region and these uncertainties related to the impact of sanctions make forecasting economic growth challenging."

Russia had managed to pull off a coup of sorts before the war by securing a seat at OPEC+, a group coordinated on production allotments ostensibly for market control. But OPEC had largely taken a backseat to the likes of the United States as markets adjusted to sanctions that restricted the flow of Russian oil and gas in the Western economies.

Western sanctions had something of a contagion effect, however, with the price for Brent crude oil flirting with $140 per barrel. Coupled with inflationary strains left over from the COVID-19 pandemic, and global economies were buckling under the pressure of war.

Crude oil prices are now rangebound, with Brent trading at around $82 per barrel on Monday. Russia crude oil continues to flow, though markets have realigned so that the likes of Norway and the United States are taking Russia's market share in the European economy.

Russia this week will make good on a pledge to trim its production by 500,000 barrels per day, but it remains to be seen if that's already factored into the market equation. While the appetite for Russian crude remains strong, analysis from consultant group Wood Mackenzie finds it's only a matter of time before sanctions catch up and create further headwinds for the Russian economy.

"Oil prices, after spiking in the early months after the invasion, have fallen all the way back to below pre-war levels, suggesting the global market is currently adequately supplied," Wood Mackenzie's report read.

Meanwhile, U.S. data show total crude oil exports for November, the last full month for which the government supplied data, was around 4 million barrels per day (BBL/d), some 33% - or 1 million BBL/d--higher than in November 2019, to discount both the war and the COVID-19 pandemic.

The situation is even more pronounced for natural gas. Russia was the main supplier of natural gas for the European economy before the war, with countries such as Poland almost entirely dependent on its piped natural gas. Much of the market focus last year was on the possibility of a gas crisis in the European market, but there too, it was the United States that helped provide a measure of energy security by way of liquified natural gas (LNG).

"An attempt to reduce the resolve of Europeans through higher gas prices remains Putin's biggest economic miscalculation," Hanson at Saxo Bank wrote.

LNG in particular has emerged as a key source of energy security. No other nation represents that more than Germany. It usually takes five years or so to develop LNG import technology, but Germany seemingly brought capacity online overnight.

"Germany is in final commissioning of two LNG terminals and a third FSRU at Brunsbuettel on the North Sea coast will arrive next week," said Shane Mullins, Industrial Info's vice president of energy products and product development. "Eight FSRUs are expected to be operational in the next year, which will increase Europe's import capability by 20%."

Meanwhile, we've gone from crisis to complacency. Wood Mackenzie finds that the war has shown that Europe can get by without Russian natural gas, a substantial blow to a Kremlin that used its gas reserves as a geopolitical tool for much of Putin's tenure.

"There's growing confidence that Europe can muddle through the next three years, albeit with relatively high and volatile prices," analysts at Wood Mackenzie wrote. "New supply volumes, mainly U.S. and Qatari LNG, arrive from 2025, helping prices to ease back to 'normal'."

But the largest conflict in Europe since the end of World War II is more profound than just a potential energy crisis. It's largely reshaped the global order in similar fashion to the wars of the early 20th century.

After the end of World War II, the United States was the only global power with the capacity to support the rebuild necessary in Europe and, as such, established itself as the hegemonic power largely through the Marshall Plan. With the war in Ukraine entering its second year, it looks again like the United States is doing the heavy lifting, and doubling down on its containment strategy against Russia in the process.

But shifting dependencies carries its own risk. The real solution, according to Wood Mackenzie, is a diverse, all-of-the-above energy policy that is less global in nature.

"No country can ever again allow itself to become reliant on imported energy from a single supplier," its research showed. "In the future, energy security will be about the diversity of fuels and sources, and the primacy of domestic resources."

Industrial Info Resources (IIR) is the leading provider of industrial market intelligence. Since 1983, IIR has provided comprehensive research, news and analysis on the industrial process, manufacturing and energy related industries. IIR's Global Market Intelligence (GMI) helps companies identify and pursue trends across multiple markets with access to real, qualified and validated plant and project opportunities. Across the world, IIR is tracking more than 200,000 current and future projects worth $17.8 Trillion (USD).