18.12.22 | Oliver Iskandar Banks
Good morning. It’s a sunny 25 degrees in Vietnam. I’m currently enjoying an iced coffee and free green tea. A woman has just pulled a pigeon out of a cardboard box behind me and is feeding it spam on the coffee shop floor.
Aside from these delights, I thought it fitting to review one of the key issues of the year – Ukraine and energy – seeing as 2022 is now drawing to a close.
Over the past 12 months the world has been rocked by a lot of secular shifts – a newfound occidental resistance toward Russia, a deepening bifurcation between the ambivalence of many Asian countries and the political signalling coming from Washington, and an equity market rout. All this has been on a background of a seeming transition out of the low interest rate environment we have seen since the financial crisis of 2008 into what is still, from a historical perspective, a very moderate borrowing climate.
“It’s understandable, then, that the tides have turned against globalisation – especially in wake of China“
A lot of what is driving world news right now has been coming out of the Ukraine war, but we need to put it all in broader context. We have seen supply shortages and supply chain dislocations on the regular over the past few years thanks to Brexit, Trump’s trade wars, and cooling sentiments toward globalisation. It’s important to remember that just a few years ago we were struggling with the situation in Syria and the social fallout from a massive influx of migration, not only from the Middle East, but also sub-Saharan Africa, as international people smuggling routes have matured and grown their business into a veritable global industry. A lot of the smuggling activity has been augmented by the collapse of the regime in Libya, in light of the campaign against Gaddafi, which has left an enormous power vacuum in Mediterranean North Africa. The absence of dictatorial leadership in the country has created a hotbed for anarchic, Russia-in-the 90s-style rule by mobs and mafias, who are now key arbiters in the trans-Mediterranean and even trans-Saharan migration routes that feed desperate and deprived people to the capricious governments of Europe.
I say capricious, because whilst some nations have extended open arms toward the migrants, asylum-seekers, and refugees that make it into their lands, others have turned increasingly nationalist, flouting EU rules about freedom of movement, and testing the resolve of the European Parliament. Regardless of what you think about the ethicality of accepting migrants, and the various ways different governments have gone about it (I’m talking about you, Rwanda), it has come to a point where even those comfortably on the left are concerned with the innumerable difficulties associated with integration. Ghettoization has become a problem for Europe; let’s hope it’s not one that’s here to stay.
It’s understandable, then, that the tides have turned against globalisation – especially in wake of China. The CCP’s experiment with a market economy, which in the mythology began with Deng Xiaoping some decades ago, has been a substantial driver of global growth. Hence the constant paranoia of CNBC commentators about growth slowing in China over the past several years. COVID has not begotten any higher a degree of certainty – many I suspect are still expecting China to return to pre-2020 levels of expansion once their Zero Covid policy blows over. Given the massive discounting of Chinese-listed assets in the wake of Xi Jinping’s crackdown on big tech, and particularly Alibaba’s Jack Ma, in the eyes of more than one analyst new opportunities are being created.
“One can hardly blame the Global South for holding this view when disclosure about soft power is so poor“
But a larger problem, which again fits into the globalisation debate, has been the methods and strategies used by the non-West to achieve its socioeconomic aims. In Qatar, and elsewhere in the Gulf region, we have seen glimmering cities of glass and gold built on the back of indentured servitude. In Australia, 27 years of continuous expansion have had the tremendous tailwind of commodity exploitation, which has once again put Canberra often at odds with the Aboriginal community (not to mention environmentalists). Regarding China, there has been regular chatter about the supposed strategic devaluation of the Renminbi, to make its exports to the US more competitive. But the lack of consistent global enforcement of intellectual property rights has presented even more of a challenge to the reputation of the country, as it has driven Chinese entrepreneurship’s ability to undercut Western market participants by taking ideas and replicating them cheaper.
I don’t agree with the story that China is a paper dragon: there is real innovation, and frankly it is not credible that a nation of 1.4 billion should be driven at several percentage points of GDP growth per year solely through intellectual property (IP) theft. It has become the world’s largest economy for myriad reasons, some of which might even be worth a moment of admiration.
However, the furore over IP points to a broader philosophical battle between the Western desire to promulgate what it sees as universal values, and the non-Western response to challenge the terms of this universality. One can hardly blame the Global South for holding this view when disclosure about soft power is so poor: the WTO is an American plaything, the UN is a well-intentioned League of Nations on steroids, and then we have the ridicule that was the Iraq War. Sykes-Picot is still on the tip of one’s tongue for many.
China would like to insist that its expansionary policies are merely reactive, the Gulf would like to portray itself as a newfound West, and too many Sub-Saharan African politicians turn the conversation to reparations and repatriation to distract from the corruption, opacity, and bureaucracy that present the greatest drag on growth. As ever in international relations, the communication is rarely direct, clear-cut, or wholly honest.
“The planet can do the work for us in other ways; but we have not arrived at the situation yet where investment into innovation is high enough for renewable or semi-renewable energy to be genuinely affordable“
It would provide for a pleasing resolution, then, if this imbroglio of circumstantial factors were to stimulate green energy deployment on a larger and grander scale. With its dwindling North Sea oil reserves, the UK could amplify efforts to employ wind power. Cutting the umbilical cord of Nord Stream, Germany could exploit its massive capital base and heaps of technical expertise to pursue innovation in new, perhaps now-unimagined technologies. Setting aside France and the nuclear power debate, China is actually doing reasonably well on this front, arguably leading the push in EV adoption to move pollution out of cities where it has the worst human health effects. Brazil could do its part by replanting the deforested areas of the Amazon and restoring the country’s position as the lungs of the world, focusing on high value industries like services and using the untapped potential of their biodiversity for medical innovation in lieu of methane-intensive agriculture. The vast, sun-soaked deserts of North America might lead the push on solar, and Japan could utilise the tremendous tidal energy of the Sea of Okhotsk and the Pacific. Even Russia might think of doing the same.
But the squeeze on the oil industry over the past twelve months has not been tight enough to constitute a tipping point. Hydrocarbons are tremendously cheap, and enormously abundant sources of energy, because the bulk of the effort involved in getting what is needed out of them is extraction. We do not need to raise sea creatures for them to die one hundred million years ago and get compressed into fuel. The planet has done the work for us. The planet can do the work for us in other ways; but we have not arrived at the situation yet where investment into innovation is high enough for renewable or semi-renewable energy to be genuinely affordable. Moreover, a continually shifting regulatory scene and high volatility in fossil fuel-derived energy prices have led to investors’ biggest fear: risk. We need lower risk to generate a shift into better energy sources, and that requires higher certainty, and that requires a kind of amenable stasis in the policy and market situation that I believe only a true upheaval in energy costs could achieve.
“When oil and gas no longer present a fantastic deal for the bottom line, and that dynamic persists over an extended time horizon, this is where we see an energy source transition”
Put it this way. Without committing wholeheartedly to any figures, let’s say that when oil is at $50 a barrel, 99% of businesses can make money. Some businesses will make a lot of money – energy-intensive industries, like manufacturing. Others will make less money – the oil and gas industry itself (particularly in regions like the Arctic or North Sea where the extraction costs and capital expenditure required are high). Then, at $100 a barrel, 80% of businesses can make money. Supply cost increases can be passed on to consumers; the world only becomes a bit poorer. Less economically developed countries would have a hard time. But at $200 a barrel, 50% of businesses can make money, and at $300 a barrel, 20%. At some point, the costs are so high for using fossil fuels that it becomes cheaper to use new technologies, even if they have high setup costs, even if the sun doesn’t shine some days, even with the tremendous regulatory uncertainty.
There are still plenty of businesses that can turn a profit regardless of, or even because of, extraordinary price levels. In terms of the former, some tech or software firms use systems that sip power. As for the latter, the oil and gas industry would obviously stand to reap an immediate benefit from expensive oil.
However, where it gets interesting is over longer time scales. At $300 a barrel, one might think that energy producers would be incentivised to continue spending on exploration and extraction, seeing as the margins would be fat and potential gains are so high. But the often overlooked potentiality is that in an environment with such high cost pressures, decision makers are more likely to start switching en masse to other sources of energy. This would therefore erode the target market of those fossil fuel producers, thus ultimately disincentivising further exploration and production investment.
“Since the raised prices arrive in an emergency register, they inspire panic”
When there are medium-term price elevations, some consumers may only switch to renewables for the interim, still others will move toward a hedged or hybrid strategy. When oil and gas no longer present a fantastic deal for the bottom line, and that dynamic persists over an extended time horizon, this is where we see an energy source transition. The temporality of price elevation is therefore crucial.
However, we can understand this temporal impact a little more subtly in terms of volatility, as the knock-on effect of time on how energy prices are digested is more a function of certainty than of durations. When things change quickly, it always creates certainties and uncertainties. The onset of the Ukraine war, for instance, created the certainty that ordinary supply chains and trade routes throughout the region would be disrupted. However, it also created a big uncertainty over whether these chains and routes would be restored, and when. It is perhaps an esoretic way of thinking about things, but bear with me. When the war began, first-order certainties became rarer: we could be less sure of assumptions about free movement and free trade than we were before. However, second-order certainty operated differently: we could be certain of high uncertainty, because of what we know about the common effects of war. We can translate this into assumptions about volatility. Industries or activities which are positively affected by volatility would flourish, fed by the chaos of a proxy conflict. Industries and activities which are negatively affected by volatility would do less well.
Energy market volatility has had a negative impact on the green transition, because it had scuppered the potential of elevated prices to have epochal production method impacts. Energy prices have only been elevated to comparably lofty figures when volatility has been very high. Usually, the elevation is due to a supply crisis, or geopolitical tensions, or a combination of both. Since the raised prices arrive in an emergency register, they inspire panic. Yet of course, the sober are often slower to change tack. An emergency oil supply crisis is likely to stimulate a release of global reserves, or some hastily put together solution, like adding ethanol to fuel, which dampens the macroeconomic effects. If volatility was low, and high prices were combined with high certainty, we would see a very different picture. Reserves and hasty solutions only work against the macroeconomic winds over the short-run. But if the world swallowed high energy prices whole, rather than effectively leaving them on its plate, the transition would have arrived.
I do not want to be the bearer of bad news. But instead, in this hybridised situation we only see backsliding. Coal plants reopening. Increased drilling. A “temporary” default to the means of energy production that we had otherwise been on a slow and painful path to abandon.
Aker BP, a Norwegian oil field exploration and development company, has just submitted plans for an almost $20bn investment across 11 sites in the North Sea, to bring up 900 million barrels of oil and countless cubic metres of natural gas. No doubt geopolitical concerns and the limitations of the American ability to deliver LNG to Europe played a part in the pre-submission discussions. Despite being heralded as a major stepping stone toward energy autarky for NATO, the new Esperanza LNG terminal in Germany, the first of its kind, is expected to deliver just 5 billion cubic metres of gas per year. For a population of 83 million, this will power fewer than 50,000 households. In fact, Europe consumed roughly 100 times more gas in 2021 than Esperanza is slated to supply. As such, gas imports from the US and Qatar will hardly make a difference: it’s a measure that won’t sate Europe’s appetite. On the other hand Norway, which already exports 2/3rds of its oil to Europe and meets a quarter of the EU’s natural gas needs, will become even more pivotal.
“As the more accessible reserves are depleted, the centres of production will move from the Gulf to Venezuela, Canada, and likely the Arctic, creating its own genre of geopolitical fallout“
However, one unusual dimension of energy markets which is rarely discussed is the surpisingly low proportion of global oil produced that is actually exported. Our crude oil and products consumption hovers around 100 million barrels per day (bpd), but only one country – Saudi Arabia – exports more than 5 million bpd. Yet there are three countries in the world who produce more than 10 million bpd: the US, Russia, and Saudi again. It seems, then, that the largest producers – the US and Russia – consume rather than export the majority of their oil.
Export and production figures are messy, because they refer to a vast constellation of products that go well beyond the black liquid we usually have in our mind’s eye, but the fact that so much of the fossil fuel supply is used in situ should give us food for thought. One of the reasons why energy prices fluctuate so wildly is because of how inelastic demand is – many consumers can’t simply do without oil, and the potential for short-term cutbacks is minimal. From a national security perspective, it is therefore almost trivial that the best way to guarantee economic stability and prosperity is to put a lot of effort into minimizing fuel consumption. The expenditures required to make that happen are certainly more consistent than the impact of energy prices on profits.
So where does this take us? To a frustrating discussion about long-termism.
In some senses, the impacts of climate change have not been priced into the markets. The EU is trying very admirably, with its new carbon border tax, that aims to level the playing field for carbon-intensive industries and prevent asymmetric taxation burdens. A functioning international market for carbon requires these kinds of policies, in which major global consumers hold global producers to the same ethical and environmental standards they have at home.
But at some point, they will be priced in, and it will cause a far greater socioeconomic shock than is necessary. Annual oil consumption is around 2% of total proven reserves, meaning we have 50 years of crude left even if our dependency on the black gold does not grow.
“There are coordination problems and accountability problems everywhere, and up until a certain point, tight supply of fossil fuels only bolsters the longevity of the industry”
One factor which may accelerate the trailing off of crude supplies is the heterogeneous mix of reserve oils, that may begin to cause price elevation well before total reserves run dry. A large proportion of proven and unextracted reserves are in the form of long-chain hydrocarbons, which are expensive to refine into the lighter and shorter-chain hydrocarbons we mostly consume. As the more accessible reserves are depleted, the centres of production will move from the Gulf to Venezuela, Canada, and likely the Arctic, creating its own genre of geopolitical fallout. As such, long durée price elevation may kick in to a limited degree even before dwindling supplies severely curtail consumption.
In combination with the decades of technological advances in green energy we would have experienced, the move toward careful rationing of remaining supplies is the only credible driver I see of a majoritarian push toward alternatives. Facing absolute rather than economic limits to fossil fuel extraction won’t come overnight, and there is likely to be a lot of stop-start action due to sporadic new discoveries. And so long as publicly traded companies operate on quarterly time horizons, and governments live for elections, the simplicity and predictability of continued hydrocarbon reliance will prevail.
What’s more, a cultural shift is unlikely to challenge the development path of Asia and Africa, the latter of which is expected to increase to a population of over 4 billion by 2100. Those 9 or 10 billion people total will come to dominate international decision-making – or at least, from a critical post-colonial perspective, we might hope so. Yet African GDP per capita will remain below $15,000 PPP in 2050 under a pragmatic business-as-usual scenario.
Although Asia might escape the middle income trap and rise well above this, the 40% of the population which will be African is likely to act as countries in that GDP per capita range are acting now. Up until a certain point of wealth, the trade-off between climate change impact, pollution, and social advantages to development favours quick and dirty means of progress. One might look to China, with $13,000 per person this year and Poland, with $18,000 per person, and their steadfast commitment to coal, and get an idea of how progress on renewable energy in the second half of the 21st century is going to proceed.
On Earth we are briefly lofty, but we can take our sweet time hitting the ground. No reconfiguration of human civilisation at the scale that environmentalists propose was ever going to be easy, nor was it likely to quickly generate consensus. There are coordination problems and accountability problems everywhere, and up until a certain point, tight supply of fossil fuels only bolsters the longevity of the industry. Nonetheless, I think that the issues we’ve faced this year can provide some valuable lessons. One of them should be that politics and energy are inseparable. Another might be that ethics and economics are too. We can’t expect the world to change if it can’t make any money out of it. Asceticism needs to find another outlet.