Energy, Politics & Money - 07 December 2022 (Pt. 1)
Independent, objective, and politically neutral analysis of interconnected global developments in the world of energy, geopolitics, and money curated to help you thrive or survive these chaotic times.
In this part 1 of EPM’s roundup, we continue to look closely at the Russian oil price cap. We’ve distilled all available information on how the price cap is affecting the market, and continue our analysis as to what the impact is likely to be. This time we’re focusing on what it will do to global competitiveness of the countries that adopt it versus those that don’t. Any country that allows its refiners to process Russian crude oil is guaranteed to have a lower cost of (liquid) energy than countries that don’t, providing its industry with a competitive advantage on a global level. This will be a major incentive for countries like China, India and Turkey to maximize imports of Russian crude oil, and increases their willingness to “absorb and resist” US pressure to not do so. As a result of these factors, it is likely that European industry will suffer significantly.
Furthermore, we look at:
The changing narrative in China around COVID, indicating the country is trying to find a way to reduce COVID related restrictions
The fears of the Bank for International Settlement regarding off balance debt, that could trigger another financial crisis
The German warning to Europe, to not take on additional debt to compete with the US for new energy investments – which we at EPM believe signals a “European surrender” and acceptance the continent will not be able to compete
BP’s bet on hydrogen to drive its lower carbon business
The United Nations negotiations over a treaty to end global plastic pollution, which we at EPM see as further evidence the plastics industry’s ability to grow via conventional ways will be limited, driving an urgent need for plastics players to move aggressively into new areas such as recycling and bioplastics, as well as plastics waste management
JPMorgan’s warning that green washing around emissions and decarbonization is likely to be hit hard by regulators over coming years
The plans of Chinese battery makers, which leave them set to dominate Europe’s car industry
General Energy News
Reuters reports crude oil prices rose after the Russian oil price cap came into force. During trading early morning on Tuesday Brent crude futures had risen 66 cents to $83.34 a barrel, while WTI had risen 70 cents to $77.63 a barrel.
In yesterday’s EPM commentary, we noted that China, India and Turkey are the likely destination for redirected Russian crude oil if Russia, indeed, lives up to its promise to stop selling to countries that adopt the cap. On that subject we discussed Russia’s ability to ship to these destinations, as well as the political willingness in the mentioned countries to take more Russian crude oil, as this will upset the US. These are three key variables that will determine how disruptive the price cap plan will be:
Russia’s response to the price cap
Russia’s ability to ship barrels
The willingness of countries to take Russian crude oil sanctioned by the US-European alliance.
As to the second point, Russia’s ability to ship barrels, Reuters reports on the interest in the maritime industry to move Russian barrels. Apparently, vessels that can make $80,000 per day for a normal voyage, can now make $130,000 if they move Russian barrels. As one would expect, there are quite a few things happening in the “grey circuit” caused by people trying to cash in on this opportunity. Meanwhile, in what is a first sign of disruption caused by the price cap, the news sanctions are causing a traffic jam of tankers of the Black Sea coast of Turkey, as Ankara demands proof of insurance before it allows the vessels carrying crude oil to pass through Turkish waters, writes the Financial Times. Apparently it is vessels with western insurance that are being held up, and vessels with Russian insurance papers are being let through.
As to the third point, political willingness by countries to take Russian crude oil that is sanctioned by the US and Europe, Nikkei Asia provides some good information as to what India could potentially take extra. November imports of Russian crude oil were over a million barrels per day, it says, which was 100,000 barrels per day more than during October. Indian refiners could possibly take a further 500,000 to 600,000 barrels a day from Russia, before running into bottlenecks in the domestic refining system. In connection with this, something we at EPM did not discuss yesterday, and would like to discuss with you today, namely the impact of the price cap on competitiveness.
There is no doubt that Russia is incentivized to provide additional discounts on its crude oil in order to maintain demand levels. Any refiner that can get its hands on Russian crude oil is thereby guaranteed to make a higher margin than refiners that don’t. But more importantly, any country that allows its refiners to process Russian crude oil is guaranteed to have a lower cost of (liquid) energy than countries that don’t, providing its industry with a competitive advantage on a global level. This will be a major incentive for countries like China, India and Turkey to maximize imports of Russian crude oil, and increases their willingness to “absorb and resist” US pressure to not do so. European industry, meanwhile, is likely to suffer significantly as a result.
Lastly, a look at one of the main drivers for short term demand: China’s COVID policy. At EPM, we mentioned last week that we did not expect the protests against “Zero COVID” to cause a sudden U-turn in Chinese government policy. Rather, we said, it was likely to cause further repression of opinion, coupled with a new push for vaccination of the most vulnerable groups in society, in particular the elderly.
The BBC and the Financial Times have articles looking at the question why the vaccination of this most vulnerable group in society has lagged so far behind in China. It has to do with the focus of the vaccination program, but also past scandals around vaccination that has left the elderly weary of participating. The result is, as Nikkei Asia writes, that although more than 90% of China’s 1.4 billion people have had at least two shots of the local vaccines, not even 70% of those over 80 are double-vaccinated and just 40% of them have received booster shots. And indeed as we at EPM forecasted, the Chinese government now aims to raise the two-shot rate among those 80 and older to 90% by January, up from 66% at the end of November.
At the same time, the Chinese government appears to be considering how it could relax restrictions on the Chinese public if this effort succeeds. Nikkei Asia writes that Sun Chunlan, China’s vice premier with responsibility for COVID management, has changed the narrative. “With the weakening of the pathogenicity of omicron, the popularity of vaccination, [and] the accumulation of experience in prevention and control, China is facing a new situation and new tasks”, she said to Chinese media. This clearly opens the door to a managed relaxation of COVID restrictions in China over coming months, which would support economic growth in the country and, consequently, global energy demand.
That potentiality hinges, of course, on the success of the current vaccination push. Because if that fails, Chinese government officials believe a reopening could cause 1.3 million to 2 million COVID deaths, which is unacceptable to China for both social stability and international reputational reasons.
Macroeconomics
There’s a hidden risk to the global financial system embedded in the $65 trillion of dollar debt being held by non-US institutions via currency derivatives, according to Bloomberg, based on a Bank for International Settlements report. Foreign-exchange swaps were a flashpoint during the global financial crisis of 2008 and pandemic of 2020, when dollar funding stress forced central banks to step in to help struggling borrowers. The BIS estimates that banks headquartered outside the US carry $39 trillion of this debt -- more than double their on-balance sheet obligations and ten times their capital.
Geopolitics
An opinion piece on Forbes argues that Europe’s concerns about the IRA are valid, and that there can be no question that a significant amount of new investment capital will be flowing into US projects that will be able to take advantage of those incentives.
At the same time, Germany has warned Europe against borrowing additional money to compete with the US for new energy investment, writes CNBC. At EPM we are of the opinion this is most likely because Germany is of the opinion cannot afford to take on more debt – following COVID recovery programs and now energy market interventions. We also believe this signals a “European surrender” and acceptance the continent will not be able to compete with the US.
Energy Transition & Technology News
BP chief executive Bernard Looney is betting on hydrogen to power future low-carbon businesses, reports Reuters. It also says that the main reason for BP doing is that “the governments of major economies stump up cash to develop the fuel to decarbonize”; in other words hydrogen is appealing because subsidies are up for grabs. At EPM we are aware the thinking behind the subsidies is that it will drive demand by keeping prices artificially low, and thereby incentivize the investments needed to bring actual costs down. We just note, that all this is theoretical and speculative – it could indeed happen, but it could also not. We warn against “going all out hydrogen”, therefore, and recommend that any hydrogen engagement is very specific as to segments of energy demand it wants to supply, prioritizing existing centers of hydrogen demand over potential new centers of demand.
Climate Politics
Bloomberg reports on the United Nations negotiations last week over a treaty to end global plastic pollution. It says the meeting in the coastal city of Punta del Este, Uruguay, was the first of a number of planned sessions that include 160 countries. Many ideas were raised but few decisions were taken. But, the direction of travel is clear, and explained by UN Secretary General António Guterres who called plastics “fossil fuels in another form”. At EPM we have mentioned before that we expect a Paris Accord-like agreement to be adopted by the UN on plastics, which will affect the industry’s ability to grow via conventional ways. EPM’s recommendation? Plastics players should move aggressively into new areas such as recycling (is it even possible?) and bioplastics (its still plastic), as well as plastics waste management (a very low margin business).
Regulators look set to reserve their harshest interventions for firms caught making misleading statements about climate strategies, according to an assessment by JP Morgan, writes Bloomberg: “Climate change is likely to become the ESG theme where the crackdown on greenwashing will be the hardest.”
The Electrification of Transport
China is turning itself into the battery workshop of the world, writes the Financial Times. By 2031 it is projected to have more production capacity in Europe, the second biggest market for EVs, than any other country. Some 40 per cent of the value of an electric vehicle is in its battery, this leaves policy makers on the continent worried, since it means Europe trades on dependency (fossil energy from abroad) for another (battery technology and manufacturing from China).