These days energy has become a weapon of war. Russia’s attacks on Ukraine strategically point to nuclear power plants, a key piece on which to address the control of the country: Moscow yesterday secured control of the largest nuclear power plant in Europe. Energy is also the great playing field in which Russia and the West measure their forces and it contains a high destructive potential for their respective economies.
Russia is Europe’s largest energy provider., without the fact that in the long years of Putin’s iron government the euro zone has reduced its great dependence on Russian gas and oil. At the same time, Russia’s sweeping military campaign over Ukraine needs energy export revenues, even more so as harsh sanctions imposed by the US, EU and UK are strangling the country’s economy. The flight of Western companies is incessant and the debt market already considers Russia de facto as an insolvent country.
For the moment, the Russian energy industry has not been left out of those sanctions in a not accidental way. The boycott deployed by Western governments does not include Russian energy companies and the decision to disconnect the Russian financial system from the swift payment system – the messaging that facilitates banking transactions worldwide – has avoided including the entities Sberbank and Gazprombank, leaving a way open with the West for bank payments for energy exports. However, the reality of the raw materials market is ahead of the sanctions and they have begun to anticipate worrying supply cuts.
Russia’s raw material production figures are staggering and give an idea of the magnitude of the scope of the conflict over energy. Moscow exports 40% of the gas and 26% of the oil consumed by the EU. The country that Putin governs is in fact the third oil producing country, behind the United States and Saudi Arabia. In addition, it is the second largest producer of palladium, with 37% of world production, according to data from the US Geological Information Survey. This raw material is basic for the sensors and memory of computers and key for electric cars.
Russia also controls 13% of the global production of titanium sponge, an important component for the aerospace industry, and has a 7% production share in aluminum and nickel. in cereals, Russia and Ukraine add up to the largest wheat production block in the world, with 28% of the total, and with Russia controlling 18% of world trade. Until now. The outbreak of the war in Ukraine has shaken the market for all these raw materials and catapulted their prices, despite the fact that the supply from Russia has not stopped so far.
According to Andreu García Baquero, an expert in raw materials at AFI, “in the last two weeks the supply of Russian gas has increased compared to what we had at the beginning of the year. In particular, the Turkstream route is rising a lot, as it is the least geographically affected, but there has also been an increase in flows through the gas pipelines that pass closer to Ukraine.” The rise in gas prices in Europe, which reached new highs this week at 200 euros per megawatt houris an incentive not to stop pumping.
This continuity of supply, however, does not serve to relax prices and the daily trading in the gas and oil market is de facto causing interruptions in supply, although it is not the political option of either party. “The commercial relationship between the EU and Russia is bidirectional, there is a need for gas in Europe, and Russia needs the resources that are generated from this transaction, a supply cut is detrimental to both parties”. But for commodity brokers, Russian gas and especially Russian oil is now a very high-risk asset.
The logistics problem
Russian crude oil shipping is being affected these days by the Operators’ reluctance to trade an asset for which a risk premium is requested due to armed conflict, while looking for alternative providers. The commodity broker Trafigura, a global giant, this week demanded a record discount to sell Russian oil, of 22.70 dollars a barrel when Brent futures have reached close to 120. Goldman Sachs estimates that of the 7.3 million barrels per day that Russia exports, 6 of them are through freighters that now face the greatest risk of starring in this supply cut because they have no outlet on the market.
“Markets are going beyond sanctions, either out of fear or conviction. Brokers reject Russian oil trading”, points out Julián Cubero, an expert at BBVA Research. Despite the maximum uncertainty surrounding the war in Ukraine and its economic consequences, the central scenario handled by the firm is that of a sustained rise in oil and gas prices, but not a cut in supply. “If that path has not already been undertaken, it is because the effects are very negative,” explains Cubero.
The political decision to cut off the energy supply has been avoided for the time being. Even the United States has acknowledged that it is not planning to extend the sanctions to Russian gas imports, which barely account for 7% of the total. This despite the fact that Washington is very far from the energy dependency that the EU has on Russia. The US produces crude but also imports it, mainly from Canada, for 52% of the total, along with another 10% from Mexico, according to data from the US Department of Energy.
In any case, even if Europe manages to avert the danger of an energy blackout –with Germany and Austria as the most exposed countries–, it is not going to get rid of an environment of very high gas and oil prices, which are going to trigger the cost of electricity and further fatten inflation. The conflict has pulverized the price forecasts that were estimated for this year. In a scenario in which Russia were to reduce its exports to Europe as a measure of pressure, it could reach 150 dollars, according to Moody’s.
Goldman Sachs acknowledges that its forecast of $115 is in question and believes that oil prices will be structurally high. “Demand destruction alone, following further price hikes, is now probably the only way to give price stability. Supply elasticity is not relevant enough in the face of a potential immediate supply shock”, assured this week in a report. In the case of wheat, Citi assures that a closure of exports through the Black Sea could make it more expensive by another 35%.
strong dependency
The International Energy Agency announced this week its decision to release 60 million barrels of oil a day from its strategic reserves, in an attempt to contain rising prices. The relief will not be enough, according to Goldman Sachs, which recalls that this amount is only equivalent to the loss of 10 days of Russian oil exports. The bank recalls that more than 80 million barrels per day have been released from strategic reserves since the beginning of 2021 without this having prevented prices from doubling.
In his opinion, the only answer in the short term to make crude oil cheaper could come from an increase in OPEC production, which the cartel is resisting, and from the return of Iranian crude to the market. “However, the current shadow sanctions on Russian raw materials, with freighters and buyers reluctant to transport the barrels, has created a major disruption in production”
In the coming months, the radically different geopolitical scenario imposed by the war in Ukraine hardly predicts price drops in raw materials. And for the medium term, the EU faces the challenge of how to reduce its energy dependence on Russia. According to the IEA, in just one year it could reduce its gas imports by a third if it implements measures such as resorting to other suppliers, buying more liquefied gas or promoting renewables more intensely.
Citi points out that “strengthening renewables will be part of the strategy, but politicians cannot be so naive as to think that they can live without any fossil energy from Russia.” And he points to the opportunity posed by the six liquefied gas plants that are underway in the US and which he assures could replace Russian gas imports by 2026.
While the energy transition is being consolidated, in an increasingly costly process that will take years, liquefied natural gas is the great asset for Europe, where Spain stands out, with 25% of European regasification capacity. “Spain is one of the countries in the world with the greatest diversification for the entry of gas from any point in the international market”, highlights Carlos Solé, partner responsible for Energy and Natural Resources at KPMG in Spain. The country is therefore very far from the risk of an energy blackout in Germany, although the war is leaving new highs in the price of electricity.
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