Energy Markets in Turmoil?

with Paul Stevens 03 May 2022 | Podcast
Downloads
In February 2022, Russia invaded Ukraine. Oil prices surged overnight – reaching their highest level since 2008. How will current events reshape the global energy agenda? To help us look beyond the fog of war, we sat down with Professor Paul Stevens – one of the brightest and clearest thinkers on the subject of energy economics.

Åsa Borssén:
“History doesn’t repeat itself. But it often rhymes.” We can take this Mark Twain quote as testimony to all those earlier events that now evoke the world of today: Another war, another energy crisis. What can we learn from the past? I’m your host Åsa Borssén and this is Highgrade.

***

Åsa Borssén:
Welcome to this Natural Resources Podcast. In late February 2022, Russia invaded Ukraine. And in a matter of days, the price of energy jumped, A passing glitch or a fundamental shift? How is this crisis reshaping the global energy agenda? To see amidst the fog of war, we have sought the help of a friend of Highgrade, a very clear thinker. Paul Stevens recently retired as Distinguished Fellow from Chatham House and is currently Emeritus Professor at the University of Dundee and a Distinguished Fellow at the Institute of Energy Economics in Japan.

Paul, it’s a pleasure to speak again.

Paul Stevens:
Thank you for having me. I’m looking forward to our conversation.

Åsa Borssén:
Four years ago, we spoke in the context of falling energy prices. And back then you explained that low prices were here to stay – absent of political upheaval. Well, political upheaval is precisely what we’ve got. And the oil price jumped to historic highs. Paul, tell me, is this a glitch? Or are we entering a new period of expensive energy?

Paul Stevens:
I think the point to start with is to remind you that it’s not just been the Ukraine that’s been going on. But we’ve just come out of a COVID pandemic. And the two are very much linked. During the COVID pandemic, prices of oil particularly went very low. And indeed, in April 2020, the price of WTI actually went negative; you had to pay somebody to take it away. And so, you’ve had a period of very low prices because of the pandemic and because of the lockdowns. Now, this has produced consequences. The first consequence is that there’s been a significant lack of investments in supply. But also, more recently, there’s been a sudden increase in demand as economies have come back online. And the result of this has been an extremely tight market. Now, if you then add to that, Russia’s invasion of Ukraine, then the price has shot up because of concerns over supply of oil and gas. So, the future – and we’ll talking more about this in a little while – is going to be much more volatile than it was. A lot will depend upon what happens in Ukraine. And again, we’ll come back and talk about that in more detail. But the reality is that we’re coming out of two major events.

Åsa Borssén:
And I’d like to explore the implications and what this means for energy policy. In the 70s, high oil price triggered a period of stagflation. For those that don’t know, can you explain what stagflation is?

Paul Stevens:
Well, Stagflation is a situation where the economy is not growing, but prices are rising. So, you have stagnation, but inflation at the same time.

Åsa Borssén:
Do we face that risk now?

Paul Stevens:
No, I think it’s very different today. In the early 1970s, the world was in the middle of a global economic boom. And that was brought to a rude halt by the oil price shocks – the first oil price shocks 73-74, the second oil price shocks 79-80 – which in turn lead to recession. Now, we’re in a position today, where the recession caused by COVID is ending. And we’re sort of almost reverting to a classic cost-push inflation situation. The difference again, though, is I think governments and particularly central banks are a lot smarter than they were in the early 70s. And they’ve had this sort of the banking crisis of 10-15 years ago to sort of practice how you get out of this. So, I don’t see we’re going to have a similar sort of story today.

“Gas molecules don't carry passports.”

- Paul Stevens

Åsa Borssén:
There have been rapid state interventions to try and contain prices. Unthinkable last year, the US rushed to lay down bridges with Venezuela and with Iran, for example. Is the crisis forcing the West to bend foreign policy?

Paul Stevens:
Yes, very, very much so. I mean, another good example – you mentioned Venezuela and Iran – but just look at the way Washington is now behaving with Saudi Arabia, and Joe Biden desperately trying to mend fences having been very rude about MBS and not wanting to have anything to do with him. He’s now sort of courting him, almost, in a strange sort of way. And the reason for this is very simple. They’re trying to marginalise the loss of Russian oil and gas in anticipation of more serious sanctions. Because at the moment, oil and gas exports from Russia have been impeded, but they haven’t actually been sanctioned. If you’re going to do that, then you need to build up or develop alternative sources of supply. And you mentioned Venezuela, Iran is the obvious one, all of a sudden, people are talking about the renewal of the nuclear agreements. And the reason for this is very simple. Iran can put a couple of million barrels a day into the markets in a very short space of time.

Åsa Borssén:
Is this weakening the West?

Paul Stevens:
Yes, for sort of good news and bad news from that point of view. I mean, in a way it’s weakening because we’re now dancing to other people’s tunes. But having said that, there are sort of options there to try and do something about this.

Åsa Borssén:
I recently read a tweet that put it perfectly. “In a month, we went from furious anti fossil fuel slogans, to subsidising oil consumption.” The much-predicted end of the oil era looks very distant again. Will the energy transition be another casualty of the war?

Paul Stevens:
That’s a very good question. My short answer is to say no. I think if anything, it’s likely to speed up the energy transition. Because one of the consequences of both the COVID pandemic and the Ukraine is that energy security of supply has moved up the policy agenda in the West. Now, if security of supply is top of your list, then the solution to that lies largely in renewables, because renewables small scale, low cost, they’re ideal. As the policy switches towards security of supply, then more renewables are going to be used. And this is going to speed up the transition. And of course, that is going to be reinforced, as the price of fossil fuels is rising as well, as we’ve seen over the last few months. So, I think the short answer is to say, no, it’s not going to necessarily change the energy transition. It’ll just speed it up. But it may take a while for that to happen. So, for example, if you look at Europe, a short-term solution to the shortage of gas and oil is to use coal again, which is not good news. But on a short-term basis, this will help to solve some of the problems.

Åsa Borssén:
So, a short-term solution for a long-term crisis.

Paul Stevens:
Absolutely. I mean, the energy transition, which was going on well before the pandemic and the war in Ukraine, was speeding up quite significantly, in large part, because the cost of renewables was coming down dramatically, as a result of technology and technological improvements. And that process, as I say, I think is going to continue when the COVID pandemic is gone as a pandemic, and irrespective of what happens in Ukraine. So, the short answer is no, it’s not going to be another casualty of war.

Åsa Borssén:
The green energy transition has been mostly about reducing emissions. Is this shifting the attention?

Paul Stevens:
Probably, yes, security of energy supply was a big deal in the 1970s, following the Arab oil embargo, the oil price shocks etc. But gradually, it sort of moved off the policy agenda and other issues took over. But the situation now is that energy security of supply really has shot back up the agenda. And this happened in the COVID pandemic as well, in part because what the COVID pandemic was doing to things like supply chains. But obviously, with the Russian invasion of Ukraine, it really now is very much top of the agenda.

***

Åsa Borssén:
In this fast-changing world, what a pleasure it is to find wise voices of reason. Paul Stevens is joining me to help us make sense of this troubled energy market – and beyond.

***

Åsa Borssén:
And where does this leave climate change? Is the energy crisis going to derail the commitments made?

Paul Stevens:
In theory, no, for the reasons, I’ve just explained that the energy crisis will encourage the development of renewables. But I think it’s worth pointing out that it’s already derailed. Governments are not taking it seriously, which is why you’re starting to see, popular action, direct action, because the governments are just messing around with this. They’re not taking it seriously at all. They’re making lots of statements. There’s a lot of hot air out there. But they’re not translating it into policy. And, of course, this is serious, because, as I say, climate change commitments have already been derailed. I mean, we’re talking about 2.5, we’d be lucky to get to two degrees. I mean, it’s just not happening because governments are not taking it seriously.

Åsa Borssén:
And can they now hide behind the veil of energy security to push those commitments further back?

Paul Stevens:
Absolutely. Because all of a sudden, people are getting very concerned and upset about the higher cost of energy. And people are saying, oh well, it’s the problem of all these renewables, which is silly, of course, because renewables have been coming down in cost. But if the popular view is that the situation is causing increased energy prices, then you’re going to start seeing arguments saying, well, do we really need to get rid of coal, etc, etc?

Åsa Borssén:
Do you think that in the end, we can find the balance between energy security and climate change and consumer prices?

Paul Stevens:
I’m sure we can, if governments are sensible, but unfortunately, for the most part, governments are not sensible. They’re only looking to the next election. They’re not concerned with the long term, there is no cost to delay. And if a government is uncertain what to do, then delay is the default policy option.

Åsa Borssén:
As you alluded to earlier, despite the rhetoric and the sanctions, the West has continued to buy fossil fuels from Russia. Are western consumers that dependent on Russian oil and gas?

Paul Stevens:
It depends on which Western consumers you’re talking about. I make a distinction here between the US and the UK, and the rest of the European Union. The US and the UK use very little Russian oil and gas. The EU uses a great deal of Russian oil and gas. But in a way, that’s not relevant. What is relevant is the fact that oil is a global market. So, if the price is very high, because of shortage in the US or the rest of the European Union, then it’s high everywhere else. In other words, the threat is the macroeconomic consequence of very high prices. And so, the dependency is there, but as I say, not in necessarily in terms of barrels of oil or cubic metres of gas. I mean, for somewhere like the UK, for example, we actually don’t know how much Russian gas comes in because gas molecules don’t carry passports. So, once the gas crosses into the EU, nobody really has a clear idea of where it’s likely to go. And so, you can say that, yes, the West is dependent on Russian oil and gas, if not in a physical supply sense, certainly, in terms of a macroeconomic sense.

Åsa Borssén:
There’s no better example than Germany.

Paul Stevens:
Yeah, I mean, I never really understood German energy policy. If you run out of gas. The first thing that you stopped using it for is manufacturing and industry. The last thing you start using it for is domestic heating. And the reason for that is technical: you cannot turn gas on and off. Because if you turn it off, and you want to turn it back on, you have to have a gas engineer at every burner tip to make sure that the gas has been switched off. Now, if you’re a manufacturing plant, that’s easy, but if you’re talking about residential areas, it becomes a big deal. There was an infamous study done in Britain in the early 1980s, when the then nationalised utility, British Gas, asked the question, what would happen if Birmingham – the main second city in the UK – was cut off from gas supplies, how long would it take to reconnect? And the answer came back three years. Now, clearly, this is going to have enormous political implications if you start cutting off residential areas from gas supply, so to me it never made a great deal of sense. We then face the situation in the UK, for example, where they’re now saying, okay, we’ll solve the problem by building nuclear, which is a stupid idea. I mean, you’re looking at, you’re looking at plants that have a lead time of 15 to 20 years. The only really private sector, nuclear plant that’s come on stream recently, it was one in Finland a few weeks ago, that was 15 to 20 years late. And God knows how much over budget it was. So unfortunately, the governments are not doing very well on this.

Åsa Borssén:
We’ve now discussed European dependency on Russian oil and gas. On the flip side, to what extent do fossil fuels underpin Russia’s economy?

Paul Stevens:
I think my short answer to that would be to say totally. They’re completely dependent on oil and gas exports, they don’t have much else to be able to export. They’re probably in the process of default on their debt. They’re looking around for alternative buyers. But then I ask the question, you know, who is going to sign a long-term contract with Russia, for oil and gas in the present context? So, Russia is going to end up with a lot of stranded assets. And of course, that’s going to have very serious consequences for the domestic situation in Russia.

Åsa Borssén:
But some large countries like India are, in fact, increasing purchases from Russia.

Paul Stevens:
Yes, certainly some, India you mentioned, are still buying Russian oil, but I make a couple of points. First of all, they are one of the few countries that will be buying Russian oil. And secondly, they’re probably paying a heavily discounted price. It’s for Russia to make it worth the while to actually do so. But who else is going to buy?

Åsa Borssén:
I will have to mention China, you don’t think they will step up?

Paul Stevens:
Well, they certainly will continue to buy Russian oil and Russian gas. But as I say, it’s all going to be done at discounted prices. Otherwise, why would they do it? Okay, there are terms of contract. We don’t know what the terms of the gas contract are. Oil they’re buying it sort of hand to mouth, I suspect. So again, it means that they’re buying it at lower prices. So, the oil and gas revenue that Russia is getting is very vulnerable and very much under threat.

Åsa Borssén:
When we think of rent-seeking states, we tend to think of the Nigerias-of-the-world. Is Russia a rent seeking state?

Paul Stevens:
Yeah, it’s been dependent very much so on the rent that is embodied in the oil price, which comes from two sources. One is the sort of what economists call producer surplus, which is the difference between what they have to pay and what they will pay, and also supernormal profits arising from the manipulation of the market – more recently, OPEC plus. And so yes, it is very much a rentier state with many of the characteristics of a rentier state, such as corruption.

Åsa Borssén:
Paul, last time we spoke, you warned that low oil price risk social unrest in producer nations. The irony today is that high oil prices risk social unrest in consumer nations. I’m interested in your historical perspective. How does this crisis end?

Paul Stevens:
That’s the 40,000-million-dollar question. A lot will depend on the outcome of the war in Ukraine. Now, my view, and I’m not an expert on these things, suggests it’s probably going to be a lot long drawn-out process. It’s not going to happen overnight. And it will continue. But meanwhile, if the energy prices continue to stay high, and all the evidence suggests they will, then eventually supply and demand will come to the rescue. So alternative suppliers will emerge. I mean, a good example is US shale, which was wiped out by the fall in price as a result of the COVID pandemic. But it’s showing signs of beginning to come back again. At the same time, demand is also going to respond to higher prices. So eventually the market will sort it out. But a lot will depend upon what happens to the war in Ukraine. And as I say, I don’t know, I think it’s probably going to be a long-drawn-out process.

Åsa Borssén:
And until we see that rebalancing of supply and demand, is there a risk of social unrest?

Paul Stevens:
Yeah, I think this is likely to be true. I mean, people are facing, you know, a major crisis in terms of their cost of living. UK is a good example, people are saying, you know, do we heat the home, or do we feed our kids? If that builds up, then you’re going to start to see a degree of social unrest. There’s no question of that. The question is what are the governments going to do about it? What can they do about it? Well, some of the governments were quite effective during the COVID pandemic, but that effectiveness seems to have disappeared. So, it’s difficult to know where we go from here. But it wouldn’t surprise me to see a sort of a popular backlash, shall we say? In the West, particularly in Europe, against what’s going on.

Åsa Borssén:
For example, we saw the far right in the French elections.

Paul Stevens:
Yeah, absolutely. I mean, I think without the events of the last few months, I’m not sure Marine Le Pen would have got anywhere near possibly being elected. If you look at the UK, where the current government is incredibly unpopular for a variety of reasons. And we just have to wait to see how that is going to pan out.

Åsa Borssén:
If you could pass on advice to governments, what wouldn’t that be?

Paul Stevens:
Well, the first thing I would pass on is to, for heaven’s sake, start taking climate change seriously, which they haven’t been doing. Secondly, try and introduce policies to affect the lowest paid, the poor. Give them some degree of protection, which to some extent they did during the COVID pandemic during that recession. But they do need to do more on this. And the other advice is, for God’s sake to invest in improving energy efficiency, which is really the best, the cheapest solution to the problem.

Åsa Borssén:
Paul, thank you so much. It’s been a pleasure to talk to you again,

Paul Stevens:
I enjoyed it.

***

Åsa Borssén:
And thank you for listening to this Natural Resources Podcast.

The price of oil has spiralled on a combination of renewed demand and supply concerns. COVID recovery struggles on top of the Ukraine war have shaken the global economy – and the energy market, in particular. For now, energy security has displaced climate change from centre stage. Although, an accelerated shift to renewables will ultimately support both agendas. As we close this podcast, Paul left a new plead to governments to step up and face the energy challenges head on.

This podcast was done with support from the German Federal Ministry for Economic Cooperation and Development through BGR. Make sure to subscribe to our channel on whichever podcast platform you’re using. Until next time, so long!