Energy, Geopolitics & Money - 2024.02.05
Providing our readers with unique insights based non-partisan, objective & neutral analysis of intersecting global developments in energy, business & geopolitics curated from leading global sources
In this roundup, we take a closer look at developments in the world of Geopolitics, because we believe a market opportunity has been created for those investors with a deep understanding of developments in this area.
We look at the situation in the Ukraine, where a number of important developments have taken place over recent days. The EU has approved of a €50B aid package, which ensures survival of the Ukraine state for the next few years. The military industrial reality, however, is creating a battlefield reality that is exactly as per John Mearsheimer’s predictions from 2023 – a classic war of attrition fought in both world wars). Basically, the West cannot match Russia’s ability to produce conventional military equipment or ammunition, and there are no “wonder weapons” on the horizon or currently in production that can offset this fundamental problem. Mearsheimer concluded Russia will eventually achieve all its military objectives, which now seems to be happening. This is why Russian president Putin has announced further objectives for his war in Ukraine, namely establishment of a “demilitarized zone” as deep into Ukraine as Odessa.
But more importantly from an energy market perspective, we also review the situation in the Middle East, where the US has launched the first of its series of responses to the attack on its military base in Jordan last week. Here, EPM repeats its view as to why we believe this will not lead to escalation between the US and Iran, and consequently why we expect the risk premium in energy prices to reappear only to subside again further down the road in February.
Furthermore, we look at:
Higher than expected fourth quarter earnings for ExxonMobil and Chevron
The fragmentation of the global crude oil market that has resulted from the conflict across the Middle East
The severe financial struggles of China’s small businesses, which directly affects 180 million Chinese
The massive increase in R&D spending in China over recent years, which has made the country the second largest contributor to global R&D following the US
Different approaches China and India have taken in their efforts to lead the Global South
Efforts by Japan-based Sharp and FDK to progress with zinc-based batteries
Why wind operators routinely overstate the amount of electricity they can produce
India’s bet on carbon capture, to enable it to maximize coal output
China’s enhancements of its Emissions Trading System
The future of electrification of transportation in the US; where EPM argues this subject is not political (as in, personal opinions and views determine the outcome) but purely commercial (as in, service offerings and economics determine the outcome)
General Energy News
Oil climbed as the US vowed more strikes against Iran’s forces and proxies while the Houthis promised to retaliate against bombardments over the weekend, writes Bloomberg. Last week EPM not only predicted this would happen, but also why this creates an opportunity for investors with a deep understanding of geopolitics. We delve into the subject more below in our section dedicated to the subject.
For the fourth quarter ExxonMobil reported a profit of $9.96 billion, that beat analysts’ estimates, compared to $14.04 billion a year earlier, writes Reuters. The results were driven by higher trading profits in its fuels business and increased oil and gas production in the US and Guyana. The result brought full year profit to $36 billion.
Chevron’s fourth quarter earnings were $6.45 billion, down 18% from a year earlier. This excluded a $3.7 billion charge to impair existing assets in California and to cover decommissioning costs in the US Gulf of Mexico, writes Reuters. This took adjusted full-year earnings to $24.69 billion, down from $36.54 billion in the prior year.
The global oil market is looking increasingly local as a result of the disruptions of Red Sea maritime traffic, writes Bloomberg. There is now very clearly one trading region centered around the Atlantic Basin, which includes the North Sea and the Mediterranean, and another encompassing the Persian Gulf, the Indian Ocean and East Asia. There’s still crude moving between these areas — via the longer and costlier journey around the southern tip of Africa — but recent buying patterns point to disconnection. In product markets, flows of diesel and jet fuel from India and the Middle East to Europe, and European fuel oil and naphtha heading to Asia have been most affected. This fragmentation is unlikely to be permanent, but for now it’s making it tougher for import-dependent nations like India and South Korea to diversify their sources of energy supply.
Macroeconomics
As to the current situation in China’s economy, small businesses, which are critical components of its private sector and big drivers of urban jobs, are facing severe struggles to survive, writes the South China Morning Post. Small and low-profit companies in China are defined as entities that pay less than 3 million yuan (US$422,000) in annual taxes, employ fewer than 300, and whose total assets are worth less than 50 million yuan. The small business sector affects the lives of 180 million people. One-third of 2,400 small companies surveyed were deemed financially unhealthy. About 80 per cent of those “financially unhealthy” firms reported delays in receiving payments.
Looking at what will drive the Chinese economy sometime out in the future, it has taken second place in overall R&D spending, writes Nikkei Asia. Europe has dropped to third, while the US continues to lead. Research and development expenditures by 2,500 leading companies worldwide totaled 1.25 trillion Euros ($1.36 trillion) in 2022. China accounted for 17.8% of this total, surpassing Europe's 17.5% and trailing only the US at 42.1%. The US’ figure has hovered around 40% for more than a decade. China's share was only 4.3% in 2012, but the country has gained ground year over year and of that Huawei is responsible for driving much of the increase. It invested 20.9 billion euros in 2022, up 11% from 2021, ranking first among Chinese companies and fifth in the world.
Nevertheless, amid US sanctions and other growing headwinds, the company is allocating 10% to 20% of its sales to R&D, focusing on areas like communications, artificial intelligence and semiconductors. Internet giants Tencent ranks second in Chinese R&D spending and Alibaba ranks third. Both are expanding investments in AI-related areas. China's other top-ranking companies include major infrastructure players China State Construction Engineering and China Railway Group as well as automakers like SAIC Motor and BYD. In the US Google parent Alphabet stands atop the global ranking, followed by Facebook parent Meta in second, Microsoft in third and Apple in fourth.
Geopolitics
A number of important developments in the Ukraine War. The EU has finally approved a €50B aid package for Ukraine, Politico writes as Hungarian president Viktor Orban dropped his opposition to the plan which allowed it to pass after months of negotiations. The aid is crucial for Ukraine, as it enables it to keep the administration running, pay pensions, and provide basic public services. According to Deutsche Welle, Olha Stefanishyna, Ukraine's deputy prime minister for the European and Euro Atlantic integration of Ukraine said the aid was “vital” to preserve Ukraine as a state over the coming 4 years.
But, that is just the social side of the equation. On the frontlines, from the Ukrainian perspective, things continue to look bleak. The US and EU are unable to send quantities of ammunition needed by the Ukrainian army to properly supply its troops, writes Politico. The European Union had promised to send a million shells by March but will ship only 524,000 shells by then, while political gridlock in Washington has stopped all flows of military aid to Ukraine from there. Defense Minister Rustem Umerov says:
Russia vastly outnumbers us in daily artillery attacks. At different areas of the front and stages of hostilities, they fired 5-10 times more artillery shells than the Ukrainian forces… Russian military industry enables its troops to fire tens of thousands of projectiles at Ukrainian positions. As the situation on the battlefield shows, there is no substitute for modern artillery.
EPM believes this realization is behind the opinion piece of Ukraine’s army chief Valerii Zaluzhnyi for CNN, in which he argues for a wholesale redesign of military tactics and an increased focus on technology, in order to turn the current state on the battlefield around – while dealing with an expected reduction in military aid from key allies.
But, there is no magical US weapon left to change the current battlefield equation, writes Responsible Statecraft. HIMARS didn’t do it and ATACMS didn’t either, as the Russians learned to disperse their munitions depots more effectively, jam Western precision missiles, and employ more sophisticated air defense practices. These Western-provided weapons systems can be used to impose operational costs on Russian forces, with strikes on high-value targets and infrastructure. But these attacks carry limited long-run strategic value. There is no indication that they can be conducted on a large enough scale so as to decisively defeat Russian forces in Ukraine, nor can they make the Russian presence in Crimea untenable if they are not accompanied by successful large-scale ground offensives to drive the Russians out of southeastern Ukraine, RI says.
All this is exactly what John Mearsheimer predicted over the summer of 2023, we at EPM note. And he ended his prediction with the statement that Russia will eventually achieve all its military objectives in Ukraine because of this military industrial and consequently battlefield reality.
This most likely is now also the Russian assessment, as president Vladimir Putin has announced an important adjustment to the Russian objectives for the war. Putin now says he wants to establish a demilitarized zone in the Ukraine large enough that it places Russian territory — including occupied parts of Ukraine — out of range of both front line artillery systems and Western-provided long-range missile systems, writes George Friedman for Geopolitical Futures. Practically, this means Russia would have to capture the cities of Kharkiv, Kherson, Mykolaiv and even Odessa (whereby Ukraine would be cut off from the Black Sea).
As to the Middle East, the US launched air strikes on Syria and Iraq over the weekend, in retaliation for the attack on its military base in Jordan. Reuters writes this first US response, against more than 85 targets linked to Iran's Revolutionary Guard (IRGC) and militias it backs, has killed around 40 people, including a significant number of civilians. Additional US military operations are expected in the coming days. How is this going the play out, you may wonder.
EPM noted last week that there are clear signs of behind-the-scenes conversations between the US and Iran to avoid escalation, most notably the formal statements from Kataib Hezbollah, Iran and the US. Furthermore, the US has repeated that it does not seek escalation. Again over the weekend, in response to the first round of US strikes, US Defense Secretary Lloyd Austin said “We do not seek conflict in the Middle East or anywhere else, but the president and I will not tolerate attacks on American forces”. Additionally, as noted by The War Zone, the time the US took to act gave any potential target ample opportunity to prepare to avoid the worst consequences and impact – something that US planners and decision-makers certainly were cognizant of, and as such should be considered as part of the reason why the decision was made to strike only after a week.
From EPM’s perspective, therefore, two things in response. As to the shorter term, the alignment between the US and Iran makes our base case outlook “no escalation”. We expect the risk premium in energy prices to increase over coming days in response to the US attacks (and accompanying language from the US and Iran), but then to subside again as we move further into February. As for the long term, if we take a step back from the here-and-now, in our view everything the US is doing worsens its image around the globe. Everything it says about “not seeking escalation” and “only responding” is deemed hypocritical by audiences around the world, especially in the Global South, as long as the US actively supports the Israeli War on Gaza. As we mentioned before, we believe this will significantly weaken US standing and its soft power, which will have broader ramifications as it tries to preserve its position of hegemony in the face of a rising China.
The latter point is not a perspective unique to EPM. In fact, we believe it is widely held among diplomatic circles in the US and the broader West, as a BBC report on the “transatlantic statement” indicates. This statement is a protest by over 800 serving officials in the US and Europe against the West’s stance in the War on Gaza. It says heir administrations risk being complicit in "one of the worst human catastrophes of this century", and that their expert advice has been sidelined. "The voices of those who understand the region and the dynamics were not listened to," said one official. “Our current approach does not appear to be in the best interests of the UK, the region or the global order", said another.
The South China Morning Post notes an important difference between the Chinese and Indian diplomatic efforts vis-à-vis the Global South. China describes itself as “a natural member of the Global South”, in line with what it calls itself, a developing country. India has not formally declared itself a leader of the Global South, its ambitions to in this regard is hardly veiled, it says. An example is Prime Minister Narendra Modi’s convening of two Voice of Global South Summits for 125 developing countries last year, without inviting China, Brazil or South Africa.
Energy Transition & Technology News
Japan-based players Sharp and FDK are testing zinc for their battery products, as the metal that could reduce costs by half compared with common lithium-ion batteries, writes Nikkei Asia. Zinc already is used in the negative electrode of disposable alkaline batteries, but the element has gone largely unused in rechargeable batteries as repeated charging and discharging can cause needle-like crystals to form on the electrodes, resulting in short circuits. Sharp is now developing a zinc-air rechargeable battery, aiming to start trials in 2025. Energy density per unit volume is similar to that of mainstream lithium-ion batteries, but its roughly 20-year service life is about twice as long. The company aims to use this technology in stationary storage batteries that store surplus power from solar, wind and other renewable energy sources. FDK is developing a nickel-zinc battery that uses nickel hydroxide for the positive electrode and zinc for the negative electrode. FDK currently limits shipments to samples but intends to triple production capacity to 30,000 units per month by the end of fiscal 2024.
Dozens of British wind farms run by some of Europe’s largest energy companies have routinely overestimated how much power they’ll produce, writes Bloomberg. The dynamic at play is related to so-called “curtailment”, which is when wind electricity producers are paid not to produce so as to avoid overloading the system. In order to maximize curtailment payment, producers routinely over-estimate their production capacity. Bloomberg analyzed 30 million records from 2018 through June 2023 to compare wind operators’ daily forecasts of the energy they planned to generate to their actual production when they weren’t curtailed. Out of 121 wind farms in the analysis, 40 overstated their output by 10% or more on average, and 27 of those overestimated by at least 20%
Climate Politics
India is set to launch a carbon capture policy that it says will allow it to keep exploiting its vast coal resources and deal with its growing emissions, writes Bloomberg. The policy is expected to be unveiled later this year. “The power sector generates 42% of India’s total emissions”, says one official. “We have abundant coal and we want to use it, in a sustainable way.”
China is in the process of changing its Emissions Trading System, writes Bloomberg. It currently covers about 2,200 utilities that are responsible for roughly 4.5 billion tons a year of greenhouse gas emissions. But, the intention is for the system to cover about 70% of the nation’s emissions by 2030. On the journey to that goal, Chinese regulators have announced an increase in fines for system participants found to have withheld or misreported emissions data of as much as 2 million yuan ($278,000), as well as deductions from their future allocation of free emissions allowances. They are also looking at measures to reduce the free allowances, are continuing to study plans to expand the market to additional industries this year, including aluminum and cement production.
The Electrification of Transport
An opinion piece over at Project Syndicate (PS) argues that while electric vehicles have been aggressively promoted by presidents, governors, tax authorities, and tech wizards, sales trends indicates the American public remains skeptical of this form of transportation. To support this conclusion, it points to the Hertz decision to step back from its 2021 plan to significantly increase the share of EVs in its fleet, and the fact that US EVs sales grew by just 1.3% during Q4 2023, despite an EV price war that saw prices slashed significantly. Disappointingly, PS does not delve into why this might be the case such as an analysis of consumer preferences and thinking. Elon Musk argues it has nothing to do with the EVs themselves, but more with the general economic environment of which high interest rates in particular are making car purchases very expenses for the average American (who mostly need to buy on credit). In EPM’s view, PS’ article is of poor quality. The electrification of transport is commonly pulled into the “tribal” conversations that seem to define the US public sphere these days. We would argue that this is simply not a case of “VHS versus Betamax” where personal preferences will decide who wins. The electrification of transportation (or the lack thereof) will be decided by economics and comfort factors. If EVs are able to offer equal or more comfort (range, ease of recharging, driving comfort, reliability) than ICEVs, and can do so as economically at a lower cost (purchase price, maintenance costs, insurance costs, fuel costs) than ICEVs, then transportation will electrify. Whether polarizing influencers or politicians like it or not. So look at those indicators if you really want to know if the US will electrify its personal cars or not.