Comment: What’s to come of the current chaos over energy?

By Liam Denning / Bloomberg Opinion

The lamps aren’t yet going out all over Europe. But they are dimming in a real sense in Russia’s shadow. With the invasion of Ukraine, tight energy markets are now fracturing, raising the prospect of not just high prices but actual cutoffs.

In response to the invasion, the United States, the European Union and other allies are waging a surprisingly cohesive and aggressive form of financial warfare. Russia’s access to capital along with numerous goods and services has been severely curtailed both by official sanctions and by foreign firms’ self-sanctioning.

That includes Russia’s economic lifeblood: energy exports. Millions of barrels of heavily discounted Russian oil cannot find buyers. And Western oil majors including BP Plc and (gasp) Exxon Mobil Corp. are walking away from multi-billion-dollar investments in the country. The dislocation and sheer discombobulation are evident, with Brent crude oil topping $135 a barrel at one point this weekend even as the discount on Urals crude blew out.

For many of us, the nearest comparison is the embargo placed on oil from Iraq and occupied Kuwait in 1990, which led gasoline prices to almost double within a couple of weeks. Yet that episode was relatively brief and happened at a time when oil inventories were high and Saudi Arabia was ready to make up for shortfalls. Russia is a bigger exporter of both oil and gas (as well as metals, coal and grain). And Saudi Arabia and the rest of OPEC+ now seem to prefer risking global economic turmoil to crossing their partner in Moscow. We — especially those too young to remember even the Gulf War’s imperfect parallel — are in deeply unfamiliar territory here.

One big difference concerns time. Russia’s attack on Ukraine represents a broader war on the international order by a nuclear power spanning two continents. It has probably dealt a fatal blow to energy trade with Europe, which endured the Cold War, post-Soviet chaos and prior spats with President Vladimir Putin. A European summit later this week will discuss extraordinarily ambitious proposals to sever the relationship altogether; and Russia now threatens to do it first. This isn’t, as they say, transitory.

Added to this is the imperative for countries to decarbonize their energy systems in the face of climate change. The EU already has net-zero targets that imply a sharp reduction in Russian energy imports over time. The attack on Ukraine shifts priorities. Coal-fired power, for example, will probably make a comeback in the near term to help offset pricey or absent gas imports. But anyone thinking that this would spell the end of the EU’s climate ambitions is perhaps unaware that there’s a war on. Today’s exigencies, while demanding some compromises on emissions, also add a pressing security dimension that strengthens the green impetus. It’s become simply unrealistic to any longer tie Europe’s fate to Russian energy exports.

In some respects, high and volatile fossil-fuel prices are a boon for alternatives like renewable energy. Yet today’s mayhem also portends trouble for clean technology.

The entire energy system is a product of an era of globalization that began at the end of the Second World War and expanded at the end of the Cold War. The diversification of oil and gas supply chains, linking even adversaries, kept prices remarkably stable and affordable for much of the time. For things like renewable energy and batteries, technology transfers and the muscle of Chinese manufacturing married with subsidies elsewhere have spurred a sharp drop in costs.

Well, goodbye to all that. Years before Russia’s attack, globalization generally and specifically in energy markets had come under attack. Former President Donald Trump’s “energy dominance” agenda explicitly linked U.S. oil and gas exports with geopolitical leverage. Energy of all types featured prominently in his trade war with China. President Biden may not be a proponent of freedom fracks but he has certainly cast his green industrial policy as a weapon in that same confrontation. For its part, China has worked assiduously to build leading positions in several areas of clean tech and, with a wary eye on Ukraine, warns against the creation of a Pacific version of NATO. Meanwhile, German economy minister Robert Habeck, in comments to Reuters this weekend about a 200-billion-euro fund for industrial transformation, spoke of the “need to invest in our energy sovereignty.”

The underlying logic here extends back perhaps to the 2008 financial crisis and governments’ largesse in seeking to mitigate it. As ClearView Energy Partners, a Washington-based analysis firm, concluded in a report last summer:

To the extent that fiscal stimulus promotes protectionism, we have argued that the recent spate of green recovery outlays could transform prevailing trade war into carbon trade war.

In other words, if you’ve already spent big on your domestic economy and now you’re going to spend big on decarbonizing it, maybe you don’t want other countries undercutting you with cheaper exports that don’t factor in the cost of emissions. The EU, now contemplating an enormous issuance of joint bonds to overhaul its energy and military capabilities, won’t want that all spent elsewhere. This is the thinking behind the EU’s proposed carbon border-adjustment mechanism, and such tariffs have a way of spreading, even to the carbon-tax shy U.S.

Russia, whose economy is a relative furnace, always stood to lose more than most if these tariffs become commonplace. And that was before it gave the West added reason to isolate it. Yet tariffs, like sanctions, are weapons of mutual destruction. Cutting off Russian oil and gas, officially or not, is plainly inflationary for energy costs, as any trading screen today will tell you. But deglobalization will do the same to clean tech, or at least the harder bits of it. Look at what’s just happened to nickel, a critical ingredient in many battery technologies, for which Russia is a major supplier. Sure, it’s a short squeeze; but it’s being squeezed for a reason.

One lesson relearned this past year is that surging demand combined with disrupted supply results in something that anyone under the age of 30 also won’t remember: inflation. We are poised at a moment when governments propose to radically reconstruct their economies to address climate change; even as international trade in energy commodities and technology is rupturing. On the way to the transition, we somehow stumbled into the energy partition.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal’s Heard on the Street column and wrote for the Financial Times’ Lex column. He was also an investment banker.