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    The fog of war [Gas In Transition]

Summary

While the full implications of Russia’s invasion of Ukraine remain shrouded in uncertainty, many have described it as a tipping point for everything from energy supply chains to food production. [Gas in Transition, Volume 2, Issue 5]

by: Shaun Polczer

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The fog of war [Gas In Transition]

Thomas Jefferson once wrote: “The most successful war seldom pays for its losses.”

The same could be said for the war in Ukraine, which in three short months has upended the global energy balance and ushered in a new era of uncertainty for future energy policies – not just in Europe, but around the globe. This also holds true in North America as the European Union struggles to lessen its dependence on Russian energy supplies, especially natural gas, and considers an outright oil embargo.

The invasion was barely a month old as the captains of Canada’s energy industry gathered in Calgary for NGW’s Canadian Gas Dialogues conference on March 30. Though the full implications of the latest geopolitical crisis have yet to be fully understood, the potential fallout from the conflict was top of mind among delegates, running the gamut from production, policy and the implications for the energy transition to a net zero GHG world. 

What that means for Canada and the US, two of the world’s top five energy producers – Russia is the second largest after Saudi Arabia – is equally unclear. As is their ability to make up any shortfall from a potential embargo given already tight capacity constraints, especially in Canada, which has been unwilling or unable to build any new export pipelines to either coast. Not just for oil, but especially for gas.

It’s not for lack of resources. Both Canada and the US are awash in natural gas reserves. According to Natural Resources Canada, the country is the worlds fifth-largest producer and fourth-largest exporter, accounting for about 5% of global production. Its 38 trillion m3 of proven reserves is considered to be only a fraction of potential resources in tight rock and shale formations, especially in the Arctic, which is virtually untapped. Yet despite dozens of proposals, Canada has only one operating LNG facility – an import terminal – in Saint John, New Brunswick, which is disconnected from the country’s main pipeline infrastructure.

The fog of war

The full impact of the war in Ukraine remains unclear, but successive speakers at the Gas Dialogues conference described it as a tipping point that will impact the global economy in virtually all areas, from supply chains to food production. 

Not to mention global capital flows and investment. Since the invasion began on February 24, oil majors such as BP, Shell and ExxonMobil – BP has a 23% stake in Rosneft while Shell has 27.5% of the Sakhalin 2 liquefied natural gas (LNG) plant owned and operated by Gazprom – have announced plans to upend their operations in Russia and liquidate their assets there. It’s still not clear how much of a haircut they’ll take and where or how they’ll redeploy that cash, but the holdings are estimated to worth $20bn or more.

It’s also unclear if global capital flows will impact producers in Canada. Call it the fog of war. “Geopolitics has once again come to the fore,” said Tim Egan, CEO of the Canadian Gas Association, in his opening remarks to the conference. Egan further noted that fully 66% of Canadians feel Canada should be exporting natural gas to Europe – despite a lack of progress in building a single LNG export terminal. Even if it wanted to, that day is at least three years away: the Shell-led LNG Canada consortium is not expected to load its first cargoes from Canada’s west coast until 2025. 

According to Tim Gould, chief energy economist for the International Energy Agency in Paris, global gas markets – and specifically European supplies – were tight even before the invasion. Countries like Germany, which relies on Russia for about 40% of its gas supplies, are particularly at the mercy of Russian strongman Vladimir Putin and his armies.

It’s only going to get worse. On May 11, Ukrainian pipeline operator Gas TSO suspended Russian gas deliveries through its system after a compressor station was overrun. The pipeline handles about a third of Russian gas exports to Europe, or some 32.6mn m3/day. The week before, Russia cut exports to Romania and Bulgaria after it refused to buck up for deliveries in roubles instead of euros.

Not surprisingly, this has had the effect of driving up prices even further. According to the Centre for Research on Energy and Clean Air in Finland, Europe has imported about €22bn/month of Russian natural gas since the war began, nearly twice the €12bn in the same period a year ago. That cash in turn is being used to fund Russia’s war machine.

Gould said the situation is complicated by “systemic under-investments in energy,” including for clean energy on the European continent. To fully displace Russian fossil fuels, Europe would need to quadruple its clean energy investments, to as much as $3-$4 trillion by the end of the decade. “It’s a worrying deficit…it does add up to a worrying near term picture,” he added.

Any scenario in which Europe has to reduce its reliance on Russian gas opens up a debate on the role of safe, reliable suppliers, he said. “Canada is a party to that conversation.”

Longer term, it’s still unclear whether the war in Ukraine will speed up Europe’s energy transition out of sheer necessity – or delay it for purely strategic considerations, as NATO nations look to reorder and bolster their respective national and economic security priorities.

LNG to the rescue?

Conventional wisdom would suggest that the war presents a golden opportunity for Canadian LNG producers to step up. But more than a decade of government waffling has meant that the needed facilities and pipelines have either been shelved or interminably delayed. 

Despite abundant resources, Canada has been late to the LNG party. Luke Schauerte, asset vice-president of LNG Canada, noted only one of 24 proposed LNG projects – his – is presently under construction. But the C$14bn (US$10.8bn) first phase of the project won’t come on stream until 2025, which takes it out of discussions surrounding near-term European energy security. “If you want to compete in the global LNG market, you have to be relevant,” he said.

The CGA’s Egan said the Russian invasion has merely “amplified” the multiple crises of climate change and supply at home and abroad. “We need, more – a lot more (supply),” he said. “These crises, not to be crass, are an opportunity…crises are inflection points and the game is changing.”

Added Bryan Cox, CEO of the Canadian LNG Alliance: “What’s our role as a helper nation?”

The long and short is that Canada couldn’t be a reliable energy supplier to Europe even if it wanted to. “Much of this is self-inflicted,” said Dan McTeague, president of Canadians for Affordable Energy, who blamed the environmental policies of the present Liberal government in Ottawa. “We have lost our way in this country,” he said to a round of applause. Which is to say, when times are good the upside is big; when times are bad, the upside is huge.

Net Zero or Not Zero?

The altered geopolitical landscape has also raised questions about the role of climate policy – both before and after the invasion – and whether the transition to a net zero future is feasible in a time of war. And moreover, whether it is morally and ethically responsible given that the war in Ukraine is likely to result in food shortages, especially in less developed parts of the world.

According to the US Department of Agriculture, which on May 12 released its first world estimates for the 2022-23 crop season, Ukrainian wheat production is expected to fall 35% from last year to 21.5mn mt. Ukraine – commonly referred to as ‘the breadbasket of the world’ – is one of the globe’s largest food producers. Similarly, Russian wheat production is expected to fall another 10%, according to the report. Natural gas is a common input for fertiliser production. As is diesel fuel in agricultural field operations – tractors which are now being used to fight tanks. Consequently, wheat futures are up nearly 50% since the start of the invasion. 

While the IEA’s Gould suggested the ensuing energy shortages in Europe could actually speed up the energy transition there, Mac Van Wielingen, the founder of Viewpoint Group and co-founder of Viewpoint Capital Partners, argued it could easily have the opposite effect. Net zero may not be realised until the end of the century, if at all, he said, amid calls for a rebalancing of environmental and economic policy.

Rather than doubling down on climate change and speeding up the shift from fossil fuels – which he described as “dangerous” – Canada should instead be using the balance sheet of the national government to get export infrastructure built in order to circumvent future geopolitical crises that feed the aspirations of dictators.

“In my view, we walked into a tripwire,” said Van Wielingen, who termed the so-called Green New Deal as the “Great Regret”.

“Climate policy has failed in Europe,” he said. “The problem is not climate and ESG, the problem is that climate and ESG became untethered from reality… the harm is not in the underlying ideals and aspirations, but in the narrowness and politicisation of those ideals”.

Indeed. And Ukraine continues to burn.