Prof. ST Hsieh
Director, US-China Energy Industry Forum
June 5, 2022
Market forces are the base of free-trade capitalism or the so called invisible hand in contrast to socialism where party controls market. After decades of globalization and open market push by the west, maybe it is the time to shift. But the shift is full of uncertainties as it comes in a time the world is engulfed by the COVID-19 global pandemic as well the Ukraine war.
In fact, the shift already started by President Trump when he and President Xi reached the Phase-One Trade Agreement for the US-China in 2018. It was never meant to be a free-trade agreement rather it was a government mandated/agreed bilateral trade deal. For example, the agreement stipulated the amount of trade in dollar terms. It did not take into consideration global commodity price normally determined by the balance of supply and demand. It is still unresolved because Biden administration has not reached a conscientious China policy.
Of course, the three-year natural disaster of COVID-19 pandemic has made everyone’s life miserable. Aside from the tragic loss of human lives, we lost over one million in the USA, the global economy is interrupted by lockdowns. The world is left with a broken supply chain. Each nation is taking different measures to spur up the economy with different results. The threat of a global recession cannot be ruled out as the Pandemic is far from over!
On top of the challenges posted by the global pandemic, Russia invaded Ukraine on February 24, 2022. US led the West imposing extreme sanctions against Russia which caused further broken down of the global supply chain. High inflation becomes a norm. Unfortunately, there is no serious peace efforts, and the ground war continues. Both sides weaponized energy, Russia has the upper hand for the time being because West nations still depend on Russian oil and gas as it pays Russia almost one billion US dollars per day! Further, Russia insisted on being paid by Rubles as it has been kicked off the SWIFT system. While West works hard to build and maintain a unified sanction scheme, Russia has selectively cut off energy supply for some EU nations. For example, Russia has completely cutoff energy supply to Finland even includes electricity. Finland’s economy will suffer before alternative energy supplies can be secured.
From West’s perspective, Russian energy would be completely kicked out of European market in a few years. In fact, EU and Russia could reach a state of no commercial relation. If so, it would a unprecedent “divorce” between Russia and US+West. It never happened before but the consequence is dire.
The reality is that the global village has more households than the two major waring groups: Russia vs US+West. Two most populous nations of the world, India and China are NOT part of the current conflicts. US led sanctions against Russia should not apply to China, India, or other Asian nations.
As such the global oil and gas markets are already being greatly distorted by geopolitics. US+West imposed energy embargo against Russia, which caused rising global energy price and inflation. However, West is paying premium price for Russian energy every day. Russia sells oil and gas to China and India at a deep discount. US+West complained to China and India, but the complaint is not justified: buy low is for the best interest of her people.
Another major player in the global oil market is OPEC+, which since day one is not a free market player. Even recently, OPEC+ had mounted two price wars against US shale industry. But US and West tolerate OPEC+ because petro-dollar. OPEC+ benefitted significantly because of high oil price caused by the Ukraine war. There are suggestions that Russia should be kicked off OPEC+ but OPEC led by Saudi Crown Price MBS is not interested. One reason is that President Biden, even before he was elected, personally insulted MBS in public. It is reported that MBS won’t talk with President Biden by phone. Biden has had a hard time arranging a state visit to Saudi in June. This is another uncertainty of politics affecting energy trade: but this time it is personal, one politician’s speech or comment about another politician made the difference.
Market force is not rational, but it does take out the influence of personality.
WSJ: The End of Energy Free Trade
Welcome to a new era in oil and gas, prompted by Western sanctions against Russia, that gives geopolitics an edge over market forces
June 3, 2022 10:07 am ET
Russia’s attack on Ukraine is redrawing the world’s energy map, ushering in a new era in which the flow of fossil fuels is influenced by geopolitical rivalries as much as supply and demand.
Over the past half-century, oil and natural gas have moved with relative freedom to the markets where they commanded the highest prices around the world. That ended abruptly when Russian tanks rumbled across the Ukraine border on Feb. 24, triggering a barrage of trade sanctions by the U.S. and Europe targeting Russia that have plunged global commerce into disarray.
This week, the European Union agreed to its toughest sanctions yet on Russia, banning imports of its oil and blocking insurers from covering its cargoes of crude.
Whatever new order emerges won’t be fully clear for years to come. But traders, diplomats and other experts in energy geopolitics generally agree that it will be more Balkanized, and less free-flowing, than what the world has seen since the end of the Cold War.
Three likely axes of energy influence are emerging: the U.S. and other Western nations, which have used their massive economic and purchasing power as a political weapon; China and large emerging nations such as India, Turkey and Vietnam, which have rebuffed Western pressure and continued doing business with Russia; and Saudi Arabia and other Middle Eastern oil-producing nations, which have sought to maintain neutrality, and may stand to gain market share in the years to come.
“We are in a real hinge of history,” said Chas Freeman, a former U.S. ambassador to Saudi Arabia. Mr. Freeman, who is now a senior fellow at Brown University, said Europe can never again trust Russia to be its primary energy provider, and that even if sanctions are lifted, countries are proposing costly new infrastructure and endorsing long-term alternative supply contracts that will lock in the new energy map.
The new order promises to make the energy trade less efficient and more expensive, potentially putting commodities at the center of the next global economic crisis, said Zoltan Pozsar, a former official at the Treasury Department who now heads short-term interest-rate strategy at Credit Suisse Group AG.
A German embargo of Russian crude would likely mean that instead of Russian oil reaching Hamburg in a week or two, it would take several months to travel to China, he noted. Conversely for Middle Eastern oil, the embargo would trigger a longer voyage to Europe for crude that would have ordinarily gone to Asia. Such inefficiencies will drive up the costs of shipping, insurance, and financing that underpin the energy trade, he said.
Many predict Russia’s energy industry, the backbone of its economy, will contract because the loss of its largest market cannot be completely replaced. Western financial and technological sanctions will undermine Russia’s ability to maintain current revenues and production levels, these people say.
“Russia’s days as an energy superpower are over,” said Daniel Yergin, the vice chairman of S&P Global and a noted oil-industry historian.
But the new map isn’t without risks to American power and the country’s standing as the guarantor of global trade. Since the end of World War II, the dollar has been the default currency for oil transactions, which has helped maintain its centrality to the global economy.
Leveraging the might of the U.S. financial system to muster sanctions against Russia has called into question its reliability as a place to store wealth, Mr. Freeman said.
Now Saudi Arabia, India and other developing countries are exploring conducting energy transactions in non-U.S. dollar currencies. Russia has similarly begun seeking recompense in rubles for its fossil fuels.
“We may have had good reasons, but the U.S. has politicized the trade of energy,” Mr. Freeman said.
Geopolitics and energy have always been linked, and U.S. sanctions against Iran and Venezuela have disrupted global oil flows in recent years. But since the end of the Arab oil embargo of the early 1970s, the relatively free trade of commodities, backed by U.S. military and financial might, has been a hallmark of the international system.
That is now changing. During a speech in April, U.S. Treasury Secretary Janet Yellen said that in the wake of Russia’s invasion, it was time to redesign Bretton Woods, the system of trade rules adopted in 1944 that prioritized economic efficiency and international cooperation. Ms. Yellen advocated for “friend-shoring” supply chains of critical raw materials by deepening trade ties with “a group of countries that have strong adherence to a set of norms and values.”
Trade flows are already being redirected as Western energy companies pull out of Russia and shippers, lenders and insurers refuse to touch Russian exports.
The EU, in beginning to implement its embargo on Russian oil exports today, joins the U.S., U.K. Canada and Australia. Following concerns Hungary raised about the economic impact, the embargo will exempt oil delivered from Russia via pipelines. Still, by the end of the year, the embargo would cover 90% of previous Russian oil imports, EU officials said.
Russian oil exports to the EU, the U.S., the U.K., Japan and South Korea have already fallen by 563,000 barrels per day, or 32% from February to April. A full EU ban would mean some 2.8 million barrels per day of crude and 1.1 million barrels per day of products that normally flow into Europe will have to find a new market, according to investment bank Piper Sandler.
European leaders will find it more difficult to wean themselves off Russian natural gas, which typically accounts for more than 30% of the EU’s supply and mostly comes via pipeline. JPMorgan Chase estimates that by the end of the year Europe will still receive between 81% and 94% of the amount of Russian gas it took in 2021. The EU has said it would stop using Russian oil and gas by 2027, but ending its reliance on Russian energy could come at a heavy cost.
Amos Hochstein, President Biden’s coordinator for energy security, has worked with foreign officials and energy executives to bolster alternative supplies of oil and gas to Europe to blunt the pain.
But Europe and the U.S. are operating under an additional constraint: Mr. Hochstein said the U.S. won’t provide incentives for long-term fossil-fuel investments that run counter to its plan to encourage a transition to greener energy sources.
“We’re trying to help Europe, stabilize the market and protect U.S. consumers while making Putin pay the price and do that without cheating our overall goal of reduced fossil-fuel usage,” Mr. Hochstein said.
EU leaders have said they would now accelerate ambitious plans to build out renewable energy projects as a result of the war, but concede Europe will need more fossil fuels in the interim.
Increased demand coupled with Western energy sanctions against Russia that will cut its output may lead to physical shortages of global oil, according to Joseph McMonigle, secretary-general of the Saudi Arabia-based International Energy Forum.
“If Russia is removed from the export market, there will be a global recession that kills demand,” Mr. McMonigle said.
Middle Eastern producers look poised to be winners in the emerging energy map.
Saudi Arabia and other Gulf states had been under pressure to diversify away from fossil fuels in recent years due to growing global concerns about climate change. But President Biden called on the kingdom to drill more in the lead-up to war, a stark turnaround from his presidential campaign, when he called the nation a pariah.
Retired Adm. Dennis Blair, who served as President Barack Obama’s first director of national intelligence, said despite efforts to pivot U.S. foreign policy away from the region, the importance of the Middle East to U.S. interests has been elevated again by the war.
“We need to have a very eyes-open, transactional relationship with Saudi, where we do have to go back to being their ultimate provider of defense until we can electrify our transportation and transition to more diverse energy sources,” Mr. Blair said.
State-owned energy giant Saudi Arabian Oil Co., known as Saudi Aramco, which recently overtook Apple Inc. as the world’s most valuable company, is already receiving more requests for its crude from buyers in Europe. More broadly, Saudi officials say the war has shown that aggressive targets to reduce carbon emissions by rapidly cutting fossil fuel usage were unrealistic.
“The kingdom finds it laughable that last year, several countries, including the United States, have been pressuring them to stick to [plans to zero out carbon emissions by 2050] but now are asking them for more oil,” said a Saudi official.
After rejecting U.S. requests for more production for months, OPEC and its allies agreed Thursday to a bigger-than-expected output increase, allowing Saudi Arabia to potentially pump more crude and paving the way for a potential oil-for-security deal with the U.S. and a visit from President Biden later this month.
“The Russian invasion has taught the world one thing loud and clear: We need more Saudi oil,” another Saudi official said.
Challenge for Russia
Russia’s new imperative is deepening ties with Asia, and especially China, to offset the looming loss of its European market.
Such a pivot is particularly necessary for Russia’s natural-gas exports, which are less fungible than its oil, and will require a massive infrastructure build-out to find a new home. Russia previously exported as much as 200 billion cubic meters of gas a year to Europe, by far its biggest market. It sold about 33 bcm to Asia last year.
Russia has a handful of proposed pipelines and liquefied natural gas projects, which convert the gas to a liquid enabling seaborne trade, that would boost its ability to send gas to Asia, but many of the projects are technically challenging and expensive, and Western sanctions will hamper their progress, say analysts.
The most important planned project is a roughly 1,600-mile pipeline connecting Russia’s Yamal peninsula to China, called Power of Siberia 2. The first Power of Siberia project cost more than $50 billion and took more than five years to build. It will send nearly 40 bcm a year to China at full capacity and the second could send as much as 50 bcm.
When the two countries agreed to terms on the first pipeline in 2014, China extracted relatively cheap gas prices. “Our Chinese friends drive a hard bargain as negotiators,” Russian President Vladimir Putin remarked at the time.
A crude-oil terminal in China’s Yantai Port.PHOTO: CFOTO/DDP/ZUMA PRESS
China holds even more negotiating power this go-round, due to Russia’s desperation to offset European lost revenues, said Ed Chow, a senior associate at the Center for Strategic and International Studies. Russia could, at most, sell as much as 120 bcm of gas a year to Asia by 2030, and at a lower price than it fetches in Europe, according to CSIS.
“Everyone will try to take advantage of the fact that Russia needs them more now,” Mr. Chow said.
Russian diplomats are rushing to counter U.S. efforts to deter Russian energy from finding a new home. Russian oil cargoes bound for India, Turkey, China and other “friendly” countries increased by more than 1.2 million barrels per day from February to April, a 146% increase, according to JPMorgan Chase.
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Russian state-run natural gas giant Gazprom redirected several LNG tankers from Japan to China and India, an official said in an interview, a pre-emptive move in case Tokyo joins the Western embargo.
But Asian buyers are unlikely to fully supplant Europe as a market for Russian oil and gas over the long term, say analysts and traders. Though India has rebuffed calls to embargo Russian oil, it is buying Russian barrels at a steep discount in the same way China has sought natural-gas discounts.
Losing its nearest and largest market will cost Russia billions of dollars in energy revenues every year. Coupled with biting technological sanctions, this will seriously degrade the country’s ability to sustain its current oil-and-gas production levels. The International Energy Agency estimates the amount of Russian production offline could triple to three million barrels per day by the end of 2022 amid the EU oil sanctions, suggesting a nearly 27% decrease in prewar production levels.
Some Russian energy officials privately concede Russia will be unable to dodge prolonged Western energy sanctions.
“Russia was shocked at how united the West was on sanctions,” the Gazprom official said.
An LNG facility on Russia’s Sakhalin Island.PHOTO: YURI SMITYUK/TASS/ZUMA PRESS
Appeared in the June 4, 2022, print edition as ‘Russian Sanctions Signal End Of Free Trade in Energy’.