Energy is and will remain sensitive to geopolitics

by: Hans van Cleef

After oil and gas markets, power markets are also increasingly sensitive to geopolitics

Energy is synonymous with geopolitics. In the oil markets, this is common knowledge. International conflicts have resulted in production disruptions several times. The first significant example in modern history was in 1956, when European crude imports were disrupted by the Suez Crisis. The conflict between Egypt and the UK/France resulted in a temporary closure of the Suez Canal. A second crisis, the so-called ‘first oil crisis’, was the result of a boycott of oil transportation to Western countries by OPEC. In 1979, a new oil crisis was triggered by the Islamic Revolution in Iran. And a possible new oil crisis has just started, after the deadly attack of the US on an Iranian general, which has caused new geopolitical tensions. All these crises resulted in higher oil prices, with negative consequences for oil importing countries. In the past, this triggered a successful search for new oil fields in the US and Europe. The OPEC dependency was reduced and strategic oil reserves were built in order to be able to continue business, even in case of new trade disruptions.

The gas market, in contrast, was for a long time primarily a regional play. Gas pipelines are not built overnight and once they are installed, both the consumer and the producer have a mutual interest in the proper functioning of this pipeline. The last fifteen years, however, shows that tensions are also rising here, particularly with regard to renewing gas transport contracts between Russia and Ukraine. This has sometimes led to disruptions in the transit of gas from Russia to Eastern Europe. European gas demand will increase further in the coming years due to the closure of coal and nuclear power stations and the drop in European gas production. Extra import capacity is needed in order to be able to meet this increased demand. This capacity is being built in the form of liquefied natural gas (LNG) import terminals and an expansion of the pipeline capacity for gas from Russia: Nordstream 2 (a pipeline from Russia to Germany) and Turkstream (a pipeline through Turkey as a replacement for the previously planned Southstream via Bulgaria). Both pipelines are expected to be ready this year. However, they are controversial because both alternative pipelines could lead to less dependence on gas transit through Ukraine. At present, this accounts for about 80% of gas imports to Europe. The alternative gas pipelines would at the same time further increase our dependence on Russia.

“Gas market becomes more and more international”

With LNG as an alternative to pipeline gas, the geopolitical dimension has become increasingly pronounced in the gas market. The regional players are suddenly confronted with players and developments on the world market. The demand for gas from Asia and the supply of gas from the United States are suddenly factors that are important in the pricing of gas in Europe. On 20 December, we saw a new geopolitical development in the gas market. President Trump signed a law imposing sanctions on companies working on the construction of Nordstream 2. The US is thus trying to “limit the European dependence on Russian gas, and thereby limit Russia’s influence on European policies.” The US does come up with an alternative: “Freedom gas” – or LNG from the US. From a European perspective, the name choice was unfortunate, for several reasons. It also does not affect the absolute dependence on gas. However, there is a big difference between gas from Russia and gas from the US. The gas from Russia cannot go quickly to other consumers – such as China – as long as there is no pipeline capacity. In contrast, LNG from the US is much more flexible, and will go to Asia as soon as the price of gas there is a fraction higher than in Europe. Freedom gas may therefore mean a little too much freedom from the European point of view of security of supply.

“Renewable energy is not exposed to geopolitics…yet”

It is often argued that we should only focus on renewable energy sources. The overall task is to drastically reduce our CO2 emissions, but also to become less dependent on so-called “rogue states” and therefore no longer be sensitive to geopolitics. But is that possible? Renewable energy is normally generated locally and preferably also consumed locally. Renewable energy is therefore independent of any geopolitical interference – at least in theory. At the same time, we see that connectivity capacity between countries is being expanded considerably. This means that more electricity is traded and supplied between countries in order to better match supply and demand at greater distances. Electricity is therefore becoming less of a local market and more of a regional market.

We are increasingly seeing that the price of electricity is influenced by the demand for and, in particular, the supply of renewable energy. At times, the price of electricity in the Netherlands is even negative. The reason is that the production of renewable energy in Germany cannot be absorbed locally at that moment and is therefore exported to the Netherlands. This makes us wonder what would happen when an excess supply of electricity is generated not only in Germany, but also in the Netherlands and other neighbouring countries. The price of electricity would come under considerable pressure, unless sufficient storage capacity is available by then. If not, the production capacity must be limited temporarily. If the electricity price is under such pressure, will European politics accept that their national production may be limited to facilitate international production? And what if the situation is the other way around? That too little sustainable electricity is generated and that (probably gas-fired) back-up capacity must be used? Capacity that may not be available in every country. In that case, we are back to the aforementioned geopolitical risks in the gas market. Or maybe by that time we will have a hydrogen market with equal geopolitical risks. My view is that geopolitics will play an increasingly dominant role in the electricity market now that it is becoming increasingly important. Especially as long as, in addition to climate goals, economic interests and (national) security of supply are important factors that determine our final energy mix.

 

This blog was initially published in Dutch on Energiepodium.nl