The world’s three energy superpowers – the United States, Saudi Arabia, and Russia – are scrambling to acclimate to a new geo-economic landscape. Each country faces distinct challenges. Of the three, the U.S. probably has the brightest prospects, in part due to its substantial oil and gas reserves, its ability to export liquefied natural gas by ship, and a deep push into renewables. But there is no easy way around the challenge: Efforts to move towards zero emissions have hit a major geopolitical speed bump, and the emerging energy landscape is going to be volatile and disjointed. This reality is already reflected by a global surge in inflation and the looming possibility of slowed economic growth.
The most disruptive shift is taking place in Europe. While Russia is reaping substantial revenues from its hydrocarbon exports and is trying to make Western Europe suffer by slowing the supply of gas and oil, Europe is enacting a bruising yet necessary decoupling from energy dependence on its eastern neighbor. This entails a major restructuring of global supply chains, with implications that reach from the U.S. Permian Basin and Trinidad and Tobago’s offshore natural gas fields, to Qatar’s new $29 billion North Field East natural gas project.
After Russia invaded Ukraine, the U.S. banned all Russian oil and gas imports. The UK plans to phase out Russian oil imports by the end of the year, while in May the European Union announced a $220 billion plan to end its dependence on Russian fossil fuels in a span of five years and accelerate its transition to green energy. Russian countermeasures – including its threat to sever exports and let the Germans, Italians and Finns freeze through the winter – are likely to speed up the EU’s transition.
The Europeans were warned about their dependence on Russian energy during the Obama and Trump administrations, and European inaction on the matter is now putting the EU under considerable stress. Europe needs to find alternative sources of supply, an imperative reflected in the following developments:
- In May 2022, the EU and the U.S. signed an agreement by which the U.S. will supply LNG to European countries. U.S. oil has already been sent to Europe from the National Petroleum Reserve.
- The EU, Egypt, and Israel signed a deal under which Israeli gas will be brought by pipeline to Egypt’s LNG terminal, where some of it will be liquefied and shipped to European shores.
- German Chancellor Olaf Scholz visited Senegal, signing a deal to tap into that African country’s substantial gas fields. (An estimated 2.5 million tons of LNG is expected to be produced in Senegal’s transnational Greater Tortue Ahmeyim mega-development in 2023.)
- European countries are reopening mothballed coal electricity plants and are mining more coal.
- European countries are also importing more coal from a diverse set of nations. The EU has already imported 40% more coal from South Africa’s main export hub in the first five months of 2022 than it did over the whole of 2021. Colombia also received urgent requests for coal from Poland and Ukraine through the World Bank.
- In early July, the EU Parliament backed EU rules labeling investments in gas and nuclear power plants as climate-friendly. The new rules will add these sources of energy to the EU “taxonomy” rulebook from 2023, enabling investors to label and market investments in them as green.
- European governments are contemplating bailouts for hard-hit utilities and energy providers. It appears increasingly likely that the German government will bail out Uniper, one of the country’s largest utilities and the biggest buyer of Russian gas.
While Europe’s short-term energy outlook is problematic, the long term looks better, as Russia’s energy leverage will decline considerably. However, the next several years are going to be challenging. Rewiring Europe’s energy regime will not be easy, and European consumers will confront persistently higher prices and insecure supplies.
The weaponization of oil and gas also affects Russia’s economic life. In the short term, Russia has a strong hand to play. Although economic sanctions have hurt (real GDP is expected to contract by 10% this year), and Russia will suffer from the loss of European business, it is able to sell its oil and gas to other countries that have not participated in Western sanctions, in particular China and India. According to the Centre for Research on Energy and Clean Air, despite Western sanctions, Russia still earned $97 billion from fossil fuel exports in the first 100 days of the war (from February 24 to June 3). Of these earnings, $59 billion came from Europe.
Europe’s energy weakness gives Moscow leverage. The ruling coalition in Italy has already split over sanctions. In mid-June, Russia upped the pressure on Germany as state-owned Gazprom reduced flows of gas through the Nord Stream 1 pipeline under the Baltic Sea by 60%. EU governments are now left to consider rationing energy use.
Another factor to consider is that economic sanctions are not going to dissuade Moscow from conducting its war against Ukraine – at least not in the short term. Russia will continue to pump oil and gas, it just travels to different destinations. Moreover, popular support in Russia for the war remains strong, and the government’s fiscal position has been strengthened by hydrocarbon revenues. Russia can probably endure the pain from Western economic sanctions. It will continue to grind away at Ukraine, much in the same way it did in Chechnya in 1999-2000, leveling cities in battles that seek to dismantle its neighbor’s nationalism brick by brick. The Russian strategy is to slowly eat up Ukraine, use oil and gas as weapons against the West, and push European publics to accept some type of appeasement – preferably peace for land, leaving Russia to control a large part of Ukraine.
But there are a few factors that will hurt Russia over the long term: Its oil and gas industry is largely structured to service Europe; much of the Western technology that Russian industry leans on will no longer be available; and Moscow’s dependence on China will grow, both as an export market and for its technology. As the Financial Times’ Gideon Rachman noted: “Russia can find alternative markets for its oil relatively easily – witness the eagerness with which India and China are increasing imports of its discounted oil. But its gas is exported by pipeline and the major pipelines head towards Europe. Constructing new ones to China will take years, so Russia could soon be faced with a stranded asset.”
Russia should also worry about the global economy stalling, and possibly falling into recession. Another extended lockdown in China could decrease demand from that key market. Such developments would probably take oil and natural gas prices lower, and that would make the war in Ukraine more expensive.
The weaponization of energy is also profoundly affecting Saudi Arabia. On the positive side for Riyadh, it benefits from higher oil prices, and the Persian Gulf country’s international position as a swing producer has been strengthened by U.S. efforts to isolate Russia, Iran, and Venezuela. It also remains a key player within OPEC, though the cartel’s power has diminished over the past two decades.
On the negative side, discounted Russian oil is taking away market share in Asia – especially in China. Cheaper Russian gas is also forcing Iran to discount its oil, which was already cheap because of U.S. economic sanctions. Like Russia, Iran remains a major seller to China.
The Saudis are also keenly aware that the long-term trend is decarbonization, and that the speed bump the green revolution has hit is temporary. Saudi Arabia needs to maintain enough market share to put money aside for the transition to a post-fossil-fuel future.
Another consideration is that the Kingdom sits in a dangerous part of the world. It is at war in Yemen, has only recently smoothed out relations with Qatar, and is locked in a cold war with Iran. Indeed, the memory of the 2019 drone and missile attack on the Abqaiq-Khurais production facility – one of the world’s largest – is fresh in the minds of the Saudi ruling class. The attack was particularly worrisome due to the likely involvement of Iran.
On top of its prickly relations with Iran, the Saudis’ relationship with the U.S. is in poor shape. During the U.S. presidential campaign, President-to-be Joe Biden (with oil in the $40 per barrel price range) referred to Saudi Crown Prince Mohammed bin Salman as the dictator of a pariah state. A major point of tension was Riyadh’s human rights violations, in particular the 2018 murder of Jamal Khashoggi, a well-known Saudi dissident and a journalist for the Washington Post. It is believed that orders for the murder came directly from MBS. The situation was not made any better by a 2021 meeting between the crown prince and Biden’s National Security Advisor, Jake Sullivan. During the meeting, MBS reportedly yelled at the American official after the latter brought up Khashoggi’s death, and threatened to move the Kingdom closer to Russia. U.S. requests to pump more oil have been generally rebuffed.
The Saudis have also sought to improve relations with China. MBS and Chinese President Xi Jinping in May had a lengthy phone conversation, during which the two leaders discussed high-level cooperation in energy. China is a major customer of Saudi Arabia, and the two countries have little friction over human rights. Indeed, Saudi Arabia has defended China’s actions in the Xinjiang region, with the Persian Gulf country prepared to deport several Uighurs back to China. Further, Chinese and Saudi defense officials met in June to discuss bilateral relations in the defense and military sectors.
The U.S.-Saudi relationship goes back more than 80 years, and Washington and Riyadh have worked through serious problems before. Watch for efforts at a restart when Biden visits Saudi Arabia later in July. A renewed relationship makes geopolitical sense, despite the friction over human rights. The U.S. leader needs more oil in markets to help reduce inflationary pressures, especially with mid-term elections looming in November, and the Saudis enjoy the considerable U.S. military presence in the Persian Gulf that helps deter more overt Iranian aggression.
The U.S. Tops the Energy Powers
One of the major twists in the energy realignment is that the U.S. has returned as the central actor. The U.S. is one of the top three natural gas exporters in the world and a major supplier of LNG to Europe, and it is important in terms of other oil-derived products. As Europe and Russia decouple, the U.S. and Europe are strengthening their ties.
The unexpected greater U.S. energy role comes under a Biden administration that came into office with strong anti-fossil-fuel views and an eye to seriously tackling climate change. However, geopolitical reality is prevailing. To deal with rising inflation and tightness in global supply, the Biden administration has made record releases from the Strategic Petroleum Reserve (leaving the Reserve at its lowest level since 1986). It is cajoling and threatening American oil and gas companies to produce more. It is also making overtures to Venezuela’s authoritarian regime, while possibly signaling to Iran that it could turn a blind eye to more oil exports from that country.
What makes the U.S. a pivotal actor in the newly forming energy landscape? In the short term, the U.S. has the capacity to meet both domestic and foreign demand (though this is putting pressure on prices). The Biden administration has already tapped U.S. reserves to supply Europe and Asia. Equally important, the U.S. has greater flexibility as an exporter: Its terminals process and liquefy natural gas and make it available to be shipped anywhere. Russia’s energy makes extensive use of pipelines, and these run in the wrong direction – to Europe. The other factor is that there is a stronger effort to promote renewable energy in the U.S. than at any time in the past. Although the Biden administration is pushing wind and solar, these energy sectors should be put on a war footing.
As the world’s largest energy importer, China is greatly impacted by changes to the energy landscape. While it benefits from cheaper Russian oil and natural gas, higher commodity prices are forcing Beijing to double down on the production of its chief domestic energy resource, coal. At the same time, there will be spillover to the Chinese economy, as the EU is one of China’s major trade partners. If nothing else, the changing energy landscape adds another unpredictable factor to an economy already grappling with Covid, real-estate sector upheaval, rising debt, and trade tensions with the U.S. Considering the often tense nature of historical relations between China and Russia and the risk of further decoupling from Western economies – a risk enhanced by Chinese refusal to go along with sanctions on Russia – it is questionable how close the two countries can draw over time.
The shakeup in global energy markets is also likely to benefit a small group of countries. These include Qatar, one of the world’s largest producers of LNG; another LNG producer, Trinidad and Tobago; the new petro-state Guyana; and Guyana’s neighbor, Suriname, which is moving to tap its offshore oil reserves. Qatar is home to a large U.S. military base and is working closely with Europe on new energy projects.
As for the rest of the world, the new energy landscape signals upheaval. Higher energy costs are adding pressure on food and other goods throughout much of the world. Those higher costs are being felt in transportation, fertilizer, and daily staples. As noted in the World Bank’s April 2022 Commodity Markets Outlook, “the war in Ukraine has altered global patterns of trade, production, and consumption of commodities in ways that will keep prices at historically high levels through the end of 2024 exacerbating food insecurity and inflation.”
Looking ahead, an energy transition to a greener future is taking place, but Russia’s invasion of Ukraine has taken it down an unexpected path. Indeed, the transition to a world less dependent on fossil fuels will probably be more costly and more disorderly than hoped, as global supply chains are being radically restructured. At the same time, the energy shakeup could accelerate the development of renewable fuels, especially since the will to do so has grown in most advanced countries. The words of Lord Palmerston, British Prime Minister in the 19th century, are probably most apt in the emerging global energy system: “We have no eternal allies, and we have no perpetual enemies. Our interests are eternal and perpetual, and those interests it is our duty to follow.” That is a dictum the U.S., Russia, and Saudi Arabia are likely to heed going forward.
Dr. Scott B. MacDonald is Chief Economist at Smith’s Research & Gradings. Prior to this, he was Senior Managing Director and Chief Economist at KWR International, Inc (KWR). Prior to KWR he was the Head of Research for MC Asset Management LLC, an asset management unit of Mitsubishi Corporation based in Stamford, Connecticut (2012-2015) and Head of Credit & Economics Research at Aladdin Capital (2000-2011) and Chief Economist for KWR International (1999-2000). Prior to those positions he worked at Donaldson, Lufkin & Jenrette, Credit Suisse and the Office of the Comptroller of the Currency (in Washington, D.C.). During his time on Wall Street, he was ranked by Institutional Investor magazine as one of the top sovereign analysts.