Editors' note: This column is part of the Vox debate on the economic consequences of war.
Energy security and the clean energy transition have been thrown off balance since Russia’s invasion of Ukraine (Gros 2022, Arezki and Nysveen 2022). Although Russian President Vladimir Putin has failed in his attempt to use the world’s dependence on natural gas and oil to divide and mute the response to his invasion, the costs of resisting Russia and its hydrocarbons are quickly adding up (Bachmann et al. 2022). Without urgent changes to their energy policies, Russia’s foes are likely to face stagflation (Malpass 2022), the clean energy transition is likely to be knocked further off course, and resistance against Russia is likely to unravel.
Since the war began, an array of energy-related and non-energy-related sanctions have crippled the Russian economy (Harrison 2022, Klein 2022). More sanctions are still coming online. The European Council recently agreed on a ban on seaborn oil imports from Russia, which is not due to take effect until the end of the year. In addition, although Hungary has held up proposals to ban Russian oil traveling through pipelines, Germany and Poland have independently stated that they will cut off Russian pipeline imports by the end of the year – effectively blocking 90% of Russia’s oil exports (Chepeliev et al. 2022). What may prove more important is that the EU and the UK have also agreed on a ban on European insurance for Russia oil cargoes, which could constitute a major turn in the global reach of sanctions against Russia.
As revenue from oil exports make up 40% of Russia’s federal budget, these measures are sure to put pressure on the Russian state (Gordon 2022). Coupled with bans on exporting critical military and industrial components, sanctions have seriously undermined Russia’s financial and material capacity to wage war (Harrison 2022).
Unfortunately, however, the pain and pressure of sanctions against Russia are spreading far beyond Russia alone. In June 2022, the World Bank warned that the global economy is headed towards ‘stagflation’ (Malpass 2022). To make matters worse, there is a growing risk of sanctions evasion, most notably through ship-to-ship transfers of Russian oil and through the shifting of Russian commodities trading to non-European jurisdictions, such as Dubai (Hunter et al. 2022). Taken together, this means that Russia’s foes may find themselves facing energy crunches and the accompanying macroeconomic problems while Russia’s friends enjoy cheap commodities and macroeconomic stability.
To offset the supply problems that have emerged and the stagflationary pressures Russian energy issues have created, many European countries have been racing to diversify their energy sources away from Russia. Yet it is not easy for large economies to switch suppliers in the midst of what was already a tight energy market prior to the invasion. The US, Canada, Qatar, Norway, and Algeria have been called to the rescue to supply Europe with energy, and new supply in liquified natural gas (LNG) has helped substitute somewhat for Russian gas. But Europe and the world are facing serious upstream and downstream constraints.
Upstream, it has been difficult to expand production for oil and gas quickly even though shale production has shorter production cycles, meaning that supply will remain tight for some time and subject to further price spikes. Downstream, there has been a troublesome crunch on both liquefaction and regasification terminals (Rashad and Binnie 2022, McCormick and Sheppard 2022). A recent explosion at one of the US’s most important LNG plants will cut the country’s liquefaction capacity by 20%, exacerbating the global energy crisis as the US will no longer be able to cool and transport all the natural gas the world needs. To make matters worse, the natural gas that is cooled and transported will subsequently encounter the world’s lack of capacity for regasification, the process that is needed to heat natural gas from the liquid state in which it is transported to the gas state in which it is used. Building new liquefaction and regasification terminals could take several years, making turning away from Russia more expensive and painful.
The Organization of Petroleum Exporting Countries (OPEC) initially did not respond positively to calls from Western countries to cool the oil market by increasing production quotas. OPEC explained its inaction by claiming that its spare production capacity was limited – despite the fact that it could augment global oil supply by 1.8 million barrels per day (Lawler 2022), double the amount the US is releasing through its Strategic Petroleum Reserve (SPR) to stabilise global markets (US Department of Energy 2022). Following more entreaties from the Biden administration, however, OPEC has recently signalled that it would increase production quotas.
While OPEC’s and the US’s releases are helpful, they are no solution to the world’s long-term energy security or transition goals. Releases from oil reserves will not drive much-needed investment to the energy sector, let alone supply the world with more clean energy. Indeed, the problem of underinvestment is long-running, dating back to the oil price collapse of 2014 (Tokic 2015). While industry experts often argue that “high prices cure high prices”, in that high oil prices attract more investment which in turn increases production and thus lowers prices, this does not appear to be the case today. The prospect of ‘stranded’ hydrocarbon assets – a situation in which a clean energy transition renders fossil fuels and their supporting infrastructure less valuable or perhaps unusable – may make investment shortfalls more pervasive. Even as oil prices have reached record levels above $120 per barrel, there has been no great surge in oil and gas investments. Remarkably, this oil super cycle may prove to be ‘hydrocarbon-investment free’.
A lack of investment in traditional energy might sound good for the world’s climate goals, but unfortunately clean energy has long been starved of capital too. Prior to Russia’s invasion of Ukraine, the International Energy Agency reported that investment in clean energy must triple to achieve a global energy transition (Wilson 2021). While public and private sector investments seem to have accelerated since the invasion of Ukraine – with notable announcements in offshore wind, solar, and nuclear – these investments will be slow and insufficient to meet the world’s energy security and transition goals. There are three main problems that need addressing.
First is the ‘backwardation’ of energy markets: not just that prices are very high at present, but also that they are very low in the future. This means investors lack the stability and future growth they need to undertake investments in the energy sector. The Biden administration has attempted to alleviate this by pairing SPR releases with future oil repurchases so as to prevent an energy price crash later on (US Department of Energy 2022). However, it would be better for the US and other countries to establish a longer-lasting infrastructure for energy price stability that smoothes out the rough-and-tumble of the energy transition and makes the sector more investor-friendly (Amarnath et al. 2022).
Second is the lag between investment and production of renewables. France’s impressive nuclear projects, for example, will take until 2035 to produce its first reactor – the other five will materialise sometime before 2050 (Le Monde 2022). There will also be difficulties and delays with structuring the financing of renewables at scale, particularly in developing countries. Governments should do the best they can to cut red tape, fast track production, and prioritise projects with shorter lag times (such as small modular reactors). However, governments should above all recognise that investments today are necessarily long-term, and that short-term policy interventions are still sorely needed.
The third problem for energy security and the energy transition is that the emerging clean energy era will not allow for the dispersion of energy producers and consumers that the world enjoys today given the technical difficulties associated with transporting renewable energy. This means that all countries, particularly high-consuming rich countries that have long imported their energy needs, will have to accept the ‘deglobalisation of global energy markets’ and redouble their investments in domestic energy production. While hydrogen fuels might allow us to make use of existing oil and gas pipelines in the future, there is still great uncertainty regarding the viability of this technology. If we are ever able to return to the normalcy of globalised energy markets, it will not be until new technologies and a new infrastructural landscape emerge.
Waiting for markets to stabilise and investment to pour in, for investment to yield production, and for new technology and infrastructure to come about will be difficult. Fortunately, there are short-term measures that can be undertaken now. One such measure emerged this month as the Biden administration announced it would exercise the Defense Production Act to catalyse the manufacturing of solar panels, heat pumps, fuel cells, and transformers (White House 2022). Other countries with the capacity to channel resources towards similar ends ought to follow suit. Bringing back energy-saving initiatives from the 1970s, such as promoting carpooling and public transit, establishing car-free days, and upgrading standards for insulating buildings should similarly be considered.
Short-term measures on the demand side that support (and coerce) consumers can also help accelerate the energy transition. Economists have long argued that carbon pricing could help shift incentives in the necessary ways, yet the political backlash from hiking prices further in both advanced and developing economies has proven hard to navigate. A better idea may be to impose a windfall tax on today’s elevated oil and natural gas profits, with the revenues earmarked for the acceleration of the energy transition. If pursued, such an ad-hoc tax would have to be implemented in a clear and fair way that does not scare off future investment in the energy sector and undermine future energy production, but instead incentivises ever-greater private sector investment and innovation in clean energy.
Fortunately, there are likely to be many such private sector ‘champions’ of the energy transition in the coming months and years. Supporting and steering those champions through an appropriate mix of public sector investments, taxes, and regulations will reliably create the conditions for the game-changing technologies that we need. Such a revival of technological innovation would be akin to what happened following OPEC’s oil embargo in the 1970s, which spurred a number of energy breakthroughs – both conventional and renewable. At the time, it was the rise of offshore drilling that proved most impactful, leading to massive oil discoveries in the Gulf of Mexico and North Sea, which in turn allowed Western countries to diversify their supplies and ensure energy security. Fast forward to today, greater support for far-reaching things such as small modular reactors and hydrogen fuels could similarly ensure energy security whilst accelerating the energy transition.
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