Energy and Commodities Outlook 2022

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Russia’s invasion of Ukraine is a watershed geopolitical event, the impact of which will be felt for years if not decades. Although the war is just over two months old, its fallout is reshaping the contours of international relations. The foundations of the post-Cold War security architecture in Europe have been upended, U.S.-Russia relations have entered a new period of enmity and distrust, divisions between China and the West have widened, financial flows have been disrupted, and trade patterns are being altered. These far-reaching impacts are pulling down global economic growth and driving up inflation. With Moscow showing no signs of retreating, and the risk that sanctions will become more stifling, the eventual economic impact could be greater and longer lasting.

Authors: Raad Alkadiri, Eurasia Group

The energy sector is also feeling the shock. The most apparent energy impact is the spike in oil and gas prices, as a combination of self-sanctioning, supply concerns, and uncertainty over possible future trade restrictions have driven up prices and led to unprecedented levels of volatility. With the war still ongoing, and growing pressure on European states to formally sanction imports of Russian energy, high prices and volatility are likely to be a feature of markets for some time to come.

A new energy world is emerging

But the impact of the war will be felt beyond prices. The conflict is prompting structural shifts in energy flows, investment, and consumption patterns that will have a lasting impact on the sector and alter geopolitical balances in the process.

Changes in gas flows are one of the most evident signs of these developments. Europe’s newly found determination to decouple from Russian pipeline gas will not only create new markets for LNG; it will also force Moscow to look for new buyers for the gas that is displaced, with China likely to take a large proportion of any surplus. The switch cannot happen overnight: It will require new pipeline infrastructure that will take time to build and cost tens of billions of dollars. But the long-term effect will be to erode Moscow’s political influence both west and east, as Europe’s gas dependency on Russia is reduced, and the importance of the Chinese market increases for Russian companies that lack other outlets for their commodity.

This shift also illustrates how LNG is altering gas-market dynamics and the politics of this energy source. Gas markets have traditionally been regional, constrained by the geography of pipelines. However, the flexibility and marketability of LNG compared to pipeline gas give the fuel a fungibility more akin to crude oil, with flows now able to be redirected to meet demand. This has given consumers and policy-makers in Europe options that they have not previously had to diversify their gas supplies, again altering political balances in the process. True, this diversification comes at a higher cost, but the political and energy-security benefits are deemed to outweigh the increased price burden, in the short term at least.

The politics of oil is also changing in significant ways. For the first time since the 1970s, consumer nations have become swing producers in oil markets, using their strategic reserves to replace lost barrels and to influence prices in the short term. Since late November 2021, the United States and other International Energy Agency member states have pledged to release a total of 350 million barrels in a bid to ease high prices. By contrast, OPEC – which traditionally has played this swing role (and jealously guarded its prerogative to do so) – stuck to its July 2021 quota agreement, promising incremental increases of 400,000 barrels per month (although delivering significantly less due to production constraints).

OPEC has prioritized medium-term concerns over fundamentals, and its policies – or at least those of Saudi Arabia, its most influential member –also have been shaped by political animus toward Washington. But in doing so, Riyadh and its allies have squandered the credibility of their commitment to being the producer of last resort, while also allowing a new precedent to be set by consuming states, which may henceforth continue to intervene actively in physical markets based on price concerns, thereby undermining OPEC’s market-management effectiveness.

Key takeaways
  • Russia’s aggression is causing Europe to relook elsewhere for gas imports
  • Opportunities open up for LNG exporters
  • Boycotts might speed up adoption of renewables
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