From Financial Subprime To Global Energy Subprime

By: Andrew_McKillop

Russian Sanctions and the Energy Subprime

The U.S. subprime crisis of 2008, although it was cast in stone by 2006-2007, was a dreadful surprise for political deciders. It sprang at them from the murky world of Wall Street's frenzied brewing of incomprehensible financial instruments with names like algos, swaps and derivatives. The crisis surged at them from outside, forcing deciders to make a panic recourse to more government debt and massive new borrowing, to shore up the financial economy and then the real economy.

We live with the enduring results, today. The “mature postindustrial democracies”, symbolized by the G7 group, are locked into slow growth-high unemployment for the long term. Sovereign debt goes on rising. The return of all-out panic on financial markets, for many analysts, is only a matter of time.

The subprime crisis was a “backdoor crisis” for political deciders. But today's still-backdoor global energy rout which is set to surge from the shadows with the fast-reviving, Cold War vintage, political standoff between Russia and the West is a politicians' crisis, manufactured and willed by them, not one born in the murky backrooms of the Financial Herd. The politicians, this time, have no excuses

The Coming Energy Subprime

To be sure, for politician, this will be another crisis they didn't expect. They will of course claim to a man and woman, from Barack Obama to Angela Merkel and back again that “we didn't know” but their predictable future claims of pure innocence will not wash. The signs that a global energy crisis is being politically manufactured are now popping up, everywhere.

Headline-grabbing statements are coming thick and fast about the so-called “switching” of European energy supplies, starting with frothy fantasist claims that Europe can “switch” to American gas, other LNG suppliers, and even to American and non-Russian oil supplies. In the US, this political fantasy is being fanned at the highest levels. US media is hailing the launch of Obama’s oil and gas offensive. New, impossible to finance, and even more impossible to build, pipeline projects to bring Central Asian, Middle Eastern and even West African gas or oil to Europe are being mooted. Europe's almost moribund nuclear power industry has been wheeled back on stage – using the shaky premise that atomic energy could loosen Russia's energy stranglehold on Europe.

The bottom line for Europe, every time, is the continent will have to pay more for its energy – despite European energy prices already being among the highest in the world. Whether this is remotely possible is presently unimportant to political deciders, as they engage in a bizarre remake and follow-on to the Cold War. The real world of energy is rigorously placed on the back burner of an emerging political fantasy, because the EU is not currently prepared, neither technically nor in energy-economic terms, to buy exported energy from the US which under the most extreme optimistic scenarios will not be available in anything but tiny, near-symbolic quantities until at least 2017 for gas, and far into the 2020s for oil. Other non-Russian energy supplies face similar and basic problems of credibility.

Political herd thinking is at least as skewed and dangerous as Wall Street herd thinking, enabling politicians to airily dismiss all “minor details”.  Europe's energy transport and oil refining infrastructures, for starters, have been adapted to and based on large, reliable supplies of Russian oil and gas, for decades. Claiming this can be “switched' in an eyeblink of time is nonsense but politicians operate in that cloud cuckoo domain, especially at times of panic.

 The consensus view of energy-economists, not politicians, is that it would take at least ten years for even the most industrially and technically advanced EU countries, starting with Germany, to significantly reduce Russian energy dependence and significantly diversify supply sources, including American gas supply. And this would be on the understanding that heroically massive financing was first made available, to satisfy the political fantasy.

Other LNG suppliers may “ramp up” a little faster than the US, but suggesting this can enable a major cut of EU dependence on Russian gas supply – anytime before about 2025 – is political dreaming. Russian oil supply to Europe (around 3.65 million barrels/day or 32% of total EU imports) will be yet more impossible to substitute and replace on a rapid basis.

Crisis and Triage

Energy price and energy financing impacts of a major shift in European energy away from Russian dependence presume that the US and Europe are ready and able to operate a new Marshall Plan. The fragile political notion that in a crisis, previously ignored or under appreciated investment opportunities will surge, almost from nowhere, carries its own major dangers because these opportunities are also imagined as offering a quick return on investment. The history of European nuclear power, starting with the Euratom Treaty of 1957, is a somber reminder that dreaming of energy “silver bullets” leads directly to politicians shooting themselves in the feet. There are no silver bullets, only lead ones.

Europe, since Dec 2008, is already engaged on a slow-moving and uber-expensive energy transition towards non-fossil energy, that itself has racked up energy prices in most EU28 countries at 5 to 10 times the official CPI. European politicians can claim the transition plan is working – oil and gas, and electricity consumption go on falling in most EU28 countries. Europe is less dependent on imported fossil energy. But the main real world causes of this are economic decline, deindustrialization and mass unemployment. Asking if German industry, for example, is now prepared to pay more for gas from overseas, as domestic-produced electricity prices grow at historic rates and gas prices stay high, for the dubious pleasure of “punishing Putin”, is a billion-euro-question and German industry says no.
 
We can note that Merkel's government is, to date, most definitely not calling into question any long-term energy contracts with Russia or the future of the South Stream pipeline. Russia currently supplies about 40% of total German gas imports, and annual growth rates of Russian gas supply have been at double-digit rates for at least 18 months. Within the EU, in pure-theory-only, Germany would be one of the most-able countries to significantly cut Russian energy dependence, but in fact the call to “punish Putin', from other EU countries, and from Brussels and Washington means that the EU countries nearest to, and most dependent on Russian gas and oil supply would be the real sacrificial victims of a political showdown with Russia, leading to deep cuts in Russian energy supply.

The Baltic States, Poland, Romania, Bulgaria and Hungary, the Czech and Slovene Republics and other heavily Russian-dependent countries, with energy infrastructures often exclusively designed, built and operated using Russian gas and oil, would be the first to go. Germany's political elite knows this, and members of Merkel's cabinet, notably Sigmar Gabriel have already said that adapting energy infrastructures in Europe, away from Russian supply, will firstly need a massive seaboard LNG terminal-building programme to decompress and store the gas, followed by a major programme of building new pumping stations, with a sure and certain knock-on to prices for consumers and users.

To date, showing the fragility of politicians' thinking, only Russian gas is targeted by “calls for switching supplies”. When Russian oil is added to the mix, Europe will shoot itself in the feet a second time. Oil prices, at least in Europe, will have to significantly grow for the continent to even begin a supply diversification strategy. With no surprise therefore, US president Obama's mounting calls for Europe to “switch energy supplies' coincided with his visit to Saudi Arabia. Obama publicly claimed that he came to Riyadh with an offer to help speed up the development of Saudi and Gulf state LNG export capacity in return for GCC countries bringing down gas export prices for delivery to Europe. This can for starters be called fantasist or very unlikely, but a major reduction in Europe's energy dependence on Russia will also need action to raise oil supplies from outside Russia.

Global Gas OK, Oil Not OK

Due to the subject being “technical” and therefore of no interest to politicians when they are in panic mode, global gas resources and supplies, including LNG, are most certainly growing. This implies prices can be cut and probably will be cut. World oil supply capacity has none of that political elbow-room. Even a cut by 15% or 20% in Russian oil supply to Europe would dramatically raise European oil prices but – also not obvious to politicians – a sharp drop in European oil consumption will inevitably reduce global oil prices.

Oil prices are currently at least $10 to $15 per barrel above their energy-economic equilibrium price, for a host of reasons featuring Wall Street meddling with “financial oil assets”, but a cutback in oil prices to even $80 per barrel, and possibly much less if Europe shot itself in both feet with a crisis program of oil saving, would have devastating impacts in the oil sector. This would not only affect oil-sector investment, exploration, and development, but also directly impact several major oil exporting countries. Iraq tops the list, and Libya is another, followed by a long list of others including Nigeria and Venezuela, all of them dependent on economic life-support from high oil prices.

Russia, almost certainly, would not cut its oil production, or exports, and would shift them to Asia as fast as it could, while Europe imposed “oil austerity”. The global impact would include a relatively steep drop in world oil prices – while European oil prices soared. This would trigger a potential runaway process of oil sector, and oil producer country turmoil, quickly leading to global cuts in oil supply. Oil price volatility would be a traders' dream and meal ticket, but the result would end with much lower oil prices.

The Energy Subprime of 2014 would have begun. Spinoff and collateral energy-sector impacts would be followed very closely by financial and economic collateral damage. One simple example would be the increasingly probable use by the US of its SPR, strategic petroleum reserve, to export oil to Europe and to try capping the initial uptick in global oil prices resulting from sharply increased sanctions against Russia. The US would then import more oil to rebuild the SPR, again enabling and ensuring massive fluctuations of global oil prices, before they dropped like a stone.

The US SPR currently contains about 700 million barrels of oil, and showing the direct political linkage, five million barrels were unloaded onto the market during the Washington visit of the acting interim Ukrainian Prime Minister Arseniy Yatsenyuk. Vastly larger amounts of the SPR's stock would need to drawn down then rebuilt, if the Punish Putin Programme was truly launched.

Finally, by an almost supreme irony, Russia's economy would also be dealt a massive blow – certainly harming its oil and gas-sector investment and export capacity, if global oil prices even fell to $85 per barrel. The Russian national budget in 2014, saddled with $50 billion of expenses for the Sochi Olympics, was drawn up with an average price of $93 per barrel. The growing likelihood of oil and gas exporters, everywhere, shifting away from the dollar for their sales, would certainly be intensified by the knock-on of huge volatility of the US dollar's world value as the Energy Subprime surged.

The really supreme irony, perhaps, is that throughout the 1948-1991 Cold War it almost never produced anything like the current menace to global energy security.

As already noted, this is a politicians' crisis. It is manufactured by politicians – so in theory they should take all responsibility for its sequels, which will be massive.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

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