Russian Sanctions Signal End Of Free Trade in Energy --- Geopolitical calculations are starting to rule market, raising costs

"Sanctions on Russia are 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 sanctions on Russia 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. 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 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 sanctions, 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 sanctions, 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 sanctions, 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 sanctions.

"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 sanctions have 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 sanctions has taught the world one thing loud and clear: We need more Saudi oil," another Saudi official said.

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.” [1]

China and politics are the elephants in the room that could change the calculations. If China's power will grow as robustly as China wants, the West might decide to stop political fights with Russia. Backlash to inflation, induced by the sanctions, might wipe out during elections the Western governments that introduced the sanctions (see the changes in the mood of US Republicans) even before China's problem becomes acute.

 1. Russian Sanctions Signal End Of Free Trade in Energy --- Geopolitical calculations are starting to rule market, raising costs
Matthews, Christopher M. 
Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 04 June 2022: A.1.