When War, Energy and Politics Collide

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Oil and natural gas markets have always been operated and analyzed as separate universes, conjoined only at a few places, such as the oil-indexed pricing in some gas and LNG contracts. Amid the energy transition and the concurrent split between Russia and the West, however, the industry needs to be viewed from a higher-level perspective: One that encompasses both fuels, Atlantic and Pacific Basin markets, and geopolitical drivers. A convergence of Chinese and Russian interests — and perhaps intentions — in oil markets becomes apparent at this level, as do coincidences of timing — or perhaps purposeful overlaps — across different fuels that maximize the West’s economic turmoil. Is it energy warfare of previously unimagined sophistication? Or simply a matter of complex human motives and decisions that are rarely clear from high levels?

What detail can you see in fossil fuel markets and maneuverings from 40,000 feet? The initial dislocations in oil markets that accompanied the Western response to Russia’s invasion of Ukraine are easing. Crude markets are no longer all that squeezed for physical supply. Yet crude and, even more, oil product prices remain at demand-destroying heights — especially diesel. Why?

An obvious answer is that demand has to be destroyed until it aligns with lower product supply. But if crude is ample, why are products in short supply? Allegedly premature refinery closures in the West simply aren’t big enough to explain the situation, and, so far, some Russian products are continuing to flow west. Hesitancy among market participants to touch what is evidently Russian crude or products is doubtless a factor.

But another big finger can be pointed at China, where refining rates have languished all year and are now creeping up only slowly, keeping exports at relatively low levels. That goes for diesel exports, too, and is happening despite margins that are at economically irresistible levels on discounted Russian crude. Domestic factors running the gamut from Covid-19 closures to President Xi Jinping’s preference for state companies over the private refiners that control much of China’s spare capacity have been cited in explanation.

However, Covid-19 closures are now easing. And, in any case, domestic factors never fully explained why Chinese refiners weren’t allowed to let exports rip in order to reap the benefits of lofty margins — in the same way their Indian counterparts increasingly appear to be doing. Even at ground level, it’s difficult to figure out what is going on, judging from the vagueness of on-the-spot reporting.

Is Beijing extending a helping hand to its “no-limits” friends in Moscow? Or is China’s leadership happy to see Western central bankers — and politicians — squirm as they try to contain the inflationary impact across their economies of sky-high product prices without causing a serious recession? Or is some other, different, dynamic at play? Who can say?

Gas Games

Coincidentally or not, last week also saw a steady drip of reductions in Russia’s already slimmed-down natural gas supply to Europe, in the wake of news that the Freeport LNG terminal in Texas would be closed for three months at least, not the three weeks claimed immediately after an explosion and fire ripped through the plant in early June. Gas prices soared in Europe and, embarrassingly for advocates of more US gas exports, fell sharply in the US, just as they had been poised to top the $10 per million Btu mark. The US could lose its appetite for additional LNG export projects as a result, congressional comments suggest.

So far, China has visibly provided little help to Russia in gas, although Gazprom has claimed some unquantified increase in pipeline gas flows to China. In any case, the Freeport terminal outage is probably providing all the help Gazprom needs for now to curtail the robust stockbuild the EU had managed to engineer earlier in the summer.

Come late summer or autumn, however, a brisk resumption in Chinese LNG purchases could provide just the reinforcements Russia’s anti-inventory campaign needs to bring Europe into the heating season without the gas inventories it wants and had seemed to be getting.

By then, the Western central banks’ interest rate-led assault on inflation should be nearing its full fury, leaving Western economies in a weakened condition, if not in early, unofficial recession. But even a middling recession and a September restart at Freeport wouldn’t allow European economies to gracefully accommodate reduced Russian gas flows, especially if inventories are meager.

That leaves Brussels and Berlin more than slightly vulnerable to cutoffs or reductions in Russian gas supply. The German gas rationing system that is now in stage one prioritizes home heating. That’s hardly surprising, but it means Moscow could potentially be in a position to turn off big sections of German and Eastern European industry. Informing a supplier such as Gazprom that you are planning to phase out all purchases of its product within fairly short order undermines any incentive to demonstrate reliable service.

It could be a nasty winter in Central Europe, with the pain spreading out from there via another round of fractured supply chains to the wider EU and rest of the world. While it’s hard to know, it’s easy to suppose that marketers and their political bosses in Moscow have this potential for extreme economic pain in mind as they lower Russian summer gas flows that could go into inventories.

Altered Landscape

How concerned is China about the impact of all this on its economy? Could Beijing have decided a little pain at home is acceptable if the West hurts a lot more? That is unknown and, from a Western vantage point, probably unknowable.

What you can see, even from 40,000 feet, is that — behind all this turmoil — the landscape of energy is changing fundamentally. You can see a lot of new electric vehicles coming onto roads in Europe, China and, increasingly, even the gasoline-guzzling US. You can see solar panels going up in fields and on rooftops. You can see windmills out on the water, as well as in the prairies and deserts. You can’t see many new oil and gas wells being sunk or new refineries being built at anything like the rate that high prices might once have spurred.

As economic growth threatens to crumble, the game is to cut fossil fuel use to match supply, not to grow supply to meet demand. And there’s nothing like a severe recession to cut oil and gas demand — except maybe a war.

Sarah Miller is a former editor of Petroleum Intelligence Weekly, World Gas Intelligence and Energy Compass.

Security Risk , Macroeconomics , Oil Demand, Gas Supply
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