The crisis caused by Russia’s invasion of Ukraine is the most significant shock to world energy markets since the 1970s. Like the oil shocks of that decade, it is forcing a fundamental rethink of the economics and politics of energy, as governments and businesses reassess Russia’s role as a supplier to the world. In this edition of Horizons, Wood Mackenzie presents five lessons that can be learned from the recent upheavals in energy markets, highlighting the key trends that we expect to shape policy and corporate strategy for years to come.
As in the 1970s, the immediate crisis has been years in the making. The strong rebound in energy demand as the world economy recovered from the impact of the Covid-19 pandemic, combined with a series of disruptions to supply, helped drive up the prices of oil, gas, coal and power. Investment in upstream oil and gas has fallen sharply in recent years, from an average of nearly US$ 750 billion a year in 2012-16 to just US$ 400 billion a year in 2017-21, limiting the industry’s ability to respond as demand has risen.
The big difference from the 1970s is that, today, the world is trying simultaneously to address another problem: the threat of catastrophic climate change. To achieve the Paris Agreement’s goal of limiting global warming to within 1.5 °C from pre-industrial levels, global greenhouse gas emissions need to start falling very soon and drop to net zero around 2050.
There is an inescapable tension between the urgent problems of energy security and affordability, and the long-term challenge of climate change. Policies, investment decisions and corporate strategies intended to address the climate threat have so far had only a marginal effect in terms of reducing demand for fossil fuels, which still account for about 80% of global primary energy. But they have at times served to restrict supplies of those fuels and helped drive up the cost of energy,
sometimes inadvertently.
Soaring fossil fuel prices are a threat not only to consumers and the economies of energy-importing countries, but also to the energy transition itself. Governments in Europe and America say high fossil fuel prices strengthen the case for the transition to low-carbon energy. But high fuel costs and energy shortages can also stoke a backlash against climate policies. For people on low incomes struggling with fuel costs, it is not much help to be told that they should buy an electric vehicle. If governments want to continue to make progress on cutting emissions, they will need to show that they can deliver energy security and affordability at the same time.
Making decisions on these conflicts is not easy. They often involve questions of politics and morality, as well as technology and economics. The ideas set out in this report are a guide to help policymakers, companies and investors navigate these complex challenges in the
energy transition.
HORIZONS
Security alert:
Five lessons from the energy crisis
April 2022
Massimo Di Odoardo, Vice President, Gas and LNG Research
Contents
Security Alert: Five lessons from the energy crisis
A new era for energy security
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Five lessons from the energy crisis
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Get in touch with Massimo
Massimo Di Odoardo
Vice President,
Gas and LNG Research
Massimo brings extensive knowledge of the entire gas industry value chain to his current position as Vice President of Gas and LNG Research.
Massimo joined Wood Mackenzie in 2007 as a consultant, where he advised NOCs, IOCs and European utilities on global gas and pricing dynamics. He later transitioned to the research division, where he soon became the content lead for European gas, responsible for articulating our view on market fundamentals, pricing dynamics and corporate developments.
Before joining Wood Mackenzie, Massimo worked in the strategy department at Eni SpA, where he was responsible for developing European and global gas scenario analyses to support strategic investments.
Massimo is a regular speaker at conferences and remains deeply engaged with the industry. Travelling to see and discuss market dynamics with customers is at the heart of his job, enabling him to constantly challenge and evolve his own view of the global gas market.
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Ann-Louise Hittle
Vice President, Oils Research
Ann-Louise Hittle brings to Wood Mackenzie over 25 years of experience in analysing global oil markets. Her career began with Gulf Oil, where she focused on OPEC and markets in Asia. She then worked as a Middle East/Oil Markets research associate with Kissinger Associates and a Senior Oil and Gas Futures Analyst with Shearson Lehman Brothers. During her decades in the industry, Ann-Louise established an international reputation for her analyses of short- to long-term oil markets.
Prior to joining Wood Mackenzie, Ann-Louise worked at Cambridge Energy Research Associates, where she was Research Head of the Upstream Oil Service with responsibility for world oil market analysis and writing long-term scenarios.
After joining Wood Mackenzie in 2003, she directed the development of the Macro Oils Service, launched in April 2005, and led it until her promotion to Vice President. In addition to overseeing the oils research team, Ann-Louise is a frequent contributor to numerous industry publications and conferences, where she shares her trusted insights on the futures of oil markets.
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Ed Crooks
Vice-Chair, Americas
Ed Crooks joined Wood Mackenzie in 2019 as Vice-Chair, Americas. Based in New York, he covers the full range of commodities, technologies and sectors, with a particular focus on climate policy, economics and the energy transition. He writes Wood Mackenzie's popular Energy Pulse newsletter, analysing the latest developments in the world of energy.
Before Wood Mackenzie, he was an award-winning energy editor for the Financial Times, first in London and then in New York. He joined the FT in 1999 as economics editor. He previously worked as an economics correspondent for BBC News, a reporter for Investor’s Chronicle magazine, and an economic researcher at the Institute for Fiscal Studies. He also served on the UK government’s Sustainable Development Commission
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there are several technologies in development that
have shown promising progress
Ann-Louise Hittle, Vice President, Oils Research
Prakash Sharma, Vice President, Multi-Commodity Research
Ed Crooks, Vice-Chair, Americas
Murray Douglas, Research Director, Multi-Commodity Research
Alan Gelder, Vice President Refining, Chemicals & Oil Markets
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Murray Douglas
Research Director,
Multi-Commodity Research
Murray’s extensive experience across the energy value chain helps to shape and reinforce his analysis of European gas markets.
Murray is a Research Director in the Europe Gas Research team and is responsible for analysing all aspects of the gas market to develop Wood Mackenzie’s supply, demand and price outlooks. He brings more than 13 years of experience working in a variety of roles across the energy value chain.
Previously, Murray has held positions leading our Global Supply and Modelling Research team, as well as the Energy Markets Research team. These teams were responsible for developing the company’s long-term oil and gas supply outlooks, and global inter-fuel analysis. Prior to joining the Energy Markets team, Murray spent over five years covering LNG. He focused on the analysis and assessment of LNG markets, liquefaction projects and shipping, and relocated to Houston to establish Wood Mackenzie’s LNG practice in North America.
In addition, Murray has worked on various consultancy projects advising on corporate strategy, resource monetisation, market fundamentals, project financing, asset valuations, opportunity screening and competitor intelligence.
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Alan Gelder
Vice President, Refining, Chemicals & Oil Markets
Alan is VP Refining, Chemicals and Oil Markets, responsible for formulating our research outlook and integrated cross-sector perspectives on the global downstream sector.
Alan joined the business as part of our Downstream Consulting Team in 2005 and later went on to lead the division. He has managed consulting assignments all over the world, focusing on major transactions (projects and M&A) and their alignment with key success factors for industry players and third parties. He then transitioned into research upon his return to London from Houston in 2011.
Prior to joining Wood Mackenzie, Alan spent 10 years as an industry consultant after working for ExxonMobil in a variety of project planning and technical process design roles.
Prakash Sharma
Vice President,
Multi-Commodity Research
Prakash has over 26 years’ experience in energy, metals & mining and climate change policy developments. His expertise ranges from operational management to commodity trading and business strategy.
Prakash joined Wood Mackenzie in 2006 and is currently based in Singapore. He leads integrated analysis, energy transition and cross-commodity discussions in
Asia Pacific.
Previously, Prakash spent two years in Beijing as head of China research guiding a team of analysts on China’s energy and economic trends, including supply-side reforms, inter-fuel competition and commodity prices. He has also led global coal markets analysis for five years delivering research on decarbonisation policies, impact of renewables, alternative scenarios and evolving patterns of supply and demand.
Prakash’s extensive experience in the commodity sector includes export of steel-making raw materials (metallurgical coal, iron ore and scrap) and energy coal to China for an established Canadian trading firm. He has also spent nine years in the mining industry specialising in technical services, international sourcing and ISO 9001 certification.
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The world is still reliant on fossil fuels, and the energy transition needs to be focused first on cutting demand rather than supply. Curtailing supply while demand remains strong is a recipe for crisis.
The Covid-19 pandemic and the war in Ukraine have highlighted the central importance of fossil fuels to the global economy and how finely balanced these markets are. Whenever that balance is upset, commodity prices undergo large and rapid changes, as the financial and physical markets seek a new equilibrium where supply and demand broadly match.
When the economic impact of Covid-19 was at its greatest, in April 2020, global oil demand fell by 20%, as the mobility of over one-third of the world’s population was restricted to curb the spread of the disease. Gasoline and jet fuel demand were hit hard, but there was less impact on diesel, as commercial activity continued. Petrochemical feedstock demand was even more resilient, as plastics were essential for personal protective equipment such as face masks, the ubiquitous symbol of the pandemic.
The decline in demand triggered a precipitous fall in oil prices, which even turned negative on one day for WTI in Cushing. Oil prices recovered and stabilised only when the OPEC+ group took unprecedented action to restrict supply.
The war in Ukraine has driven another sharp move in prices, upwards this time. Disruption to exports of crude and refined products from Russia, caused by sanctions and “self-sanctioning”, have highlighted the relatively limited available spare capacity in supplies. Coal prices have also risen and gas prices have soared, highlighting the lack of viable alternative sources of supply available to Europe in the short term. The only short-term mechanism for bringing demand into balance with reduced supply is for it to be destroyed by high prices.
The pandemic and the war have shown wild volatility in prices resulting from market imbalances that are small compared with the ambitious projections for declines in oil, gas and coal consumption included in net-zero emissions scenarios. If policy and investment decisions constrain supply, for example by discouraging investment in upstream assets or new pipelines, while demand remains robust, that volatility will threaten consumers with periods of high prices. To avoid exacerbating the risk of future price spikes, the emphasis needs to be on reducing demand, with supply following as higher-cost, higher-emissions sources are no longer needed.
The technologies for curbing fossil fuel demand vary from sector to sector. In transport they are electric vehicles and advanced biofuels; in power generation, renewables, hydrogen and nuclear power; for heating, heat pumps. A transition that is focused on deploying these technologies, as fast as is practicable, would help spare consumers in the future from the crushing burden of energy costs that many are facing today.
Source: Wood Mackenzie
Figure 1: Changes in energy demand can lead to much sharper moves in prices
Lesson 1
The linkages between energy markets have become stronger, in particular because of the growth of a global LNG market. Shocks in one sector or region can be rapidly transmitted to another, increasing the need for resilience.
Oil and coal have long been globally traded commodities, with regional price differentials defined by shipping costs. The globalisation of gas, however, has only really emerged in the past 10 years, as liquefied natural gas (LNG) increased its share of global trade from 35% in 2010 to 50% in 2021. Flexible US LNG has emerged as the marginal LNG supplier, linking pricing dynamics in the US, Europe and Asia.
That globalised market makes energy systems more efficient. But the current crisis has shown how interconnected global markets can transmit shocks between sectors and between regions, increasing the need for flexibility in supply and demand to
provide resilience.
As economies emerged from the pandemic and demand surged last year, reduced Russian pipeline exports helped push European gas prices to record highs on concerns about availability through the winter, dragging Asian LNG prices up as well. The upward pressure on prices was reinforced by multiple regional weather dynamics, including a cold winter in the northern hemisphere, low wind in Europe and a severe drought in Brazil. Coal-fired plants in Europe and oil-fired plants in Asia have in the past helped put a ceiling on surging global gas prices, by providing alternatives for power generation. But squeezes on coal and oil capacity, driven by climate policies and economics, have limited their ability to play that role.
The war in Ukraine has intensified those pressures. Europe relies on Russia for about 35% of its gas, 18% of its oil and 15% of its coal supply. Gas and LNG prices have risen much more sharply than oil and coal, not just because Russia’s market share is larger, but because supply is less flexible. Russian gas piped to Europe cannot be diverted to other markets, unlike the seaborne trade. And the lead times required to develop new supply, including LNG, can take several years.
As the global gas market becomes more integrated, customers and policymakers need to do more to provide flexibility in both supply and demand, to cushion the impact of this type of shock. That can mean a range of measures, including broadening their sources of supply, sometimes under long-term contracts, increasing the availability of storage and import infrastructure, and creating flexibility in the power market through demand response programmes.
Lesson 2
Globalisation creates geopolitical risks for energy security. Consuming countries need to manage those risks, including through stronger domestic production.
Russia has been a reliable energy supplier to Europe through the Cold War, the breakup of the Soviet Union and the leadership of President Vladimir Putin. The war in Ukraine has shattered that relationship. European governments are working on a plan to end the EU’s imports of Russian oil, gas and coal by 2027. Along with other shifts, including a general reassessment of the vulnerabilities of international supply chains following the disruption caused by the pandemic, it is part of a reconfiguring of energy trade flows around the world.
The process can be thought of as “re-globalisation” rather than “de-globalisation”. International movements of trade and capital will continue, but will be increasingly influenced by security considerations. Links between allies are likely to strengthen, while links between rivals or potential rivals are eroded. Russia will still find buyers for its oil and gas, with China and other emerging economies likely to replace European customers over time, as infrastructure constraints allow. European countries will buy more LNG from the US and elsewhere and meet more of their energy demand domestically with increased production of renewable natural gas and hydrogen.
The crisis has also put a spotlight on other potential threats to energy security, from low-carbon technologies as well as fossil fuels, and from countries other than Russia. China has a dominant global position in the production of lithium-ion batteries, solar modules and wind turbines, and their associated supply chains, and its low costs give it a competitive advantage in those sectors. Losing access to solar modules or batteries would not have the same immediate impact as losing access to oil and gas, but would ultimately have damaging effects on importing countries’ economies and their efforts to cut emissions.
The benefits of globalisation should not be given up lightly, and governments need to be clear about which products really create strategic vulnerabilities and which do not. But there is an overwhelming case for doing more to support diversity of supply in key sectors such as the electric vehicle and battery supply chain, all the way to the mines for critical minerals.
Source: Wood Mackenzie
Figure 2: European price rises have been much stronger for gas than for coal or oil
Lesson 3
Resilience and security can be expensive, but the costs are worth paying as insurance against price volatility.
Electrification is central to cutting both emissions and vulnerability to commodity price shocks. But to realise those benefits, electricity systems themselves have to deliver power reliably and with low emissions, and that can be expensive.
Solar and wind power have made significant inroads, but fossil fuels still dominate power supplies in most markets, accounting for about 60% of electricity generation worldwide in 2021. Renewables have not always delivered the hoped-for benefits in terms of energy security. The EU and the UK have in total developed an impressive 428 gigawatts of wind and solar capacity this century, but over the same period, their reliance on imports has increased from 44% to 60% of their primary energy.
The variability of solar and wind generation means that to ensure reliability they need to be supported by other technologies, including at times the continued use of fossil fuels. There are other options for managing variability, including demand response and energy storage, but they have limitations and further technological innovation is needed. Lithium-ion battery storage, for example, can provide backup for a few hours, but is inadequate for the regions of Europe and North America where weather conditions can be still and dark for many days, cutting renewable generation. Although the costs of wind and solar generation have fallen rapidly and are likely to decline further in the long term, the cost of maintaining a stable grid is often rising.
Nuclear power can be part of the solution and is attracting significant attention once again in countries including the UK and France. Keeping existing plants open as long as possible usually makes sense in terms of emissions, security and economics, but new construction raises cost issues. Delays and cost overruns have dogged nuclear projects in Europe and the US. The UK is pursuing a regulated asset base model that allows developers to charge consumers ahead of start-up and has a mechanism allowing them to pass through justifiable cost overruns. Small modular reactors may have lower costs, but are
as-yet unproven.
In the long term, declining costs for low-carbon energy should ease the burden on consumers, but that will take time. Until then, the only real answer to help people struggling with energy costs is to use tax and spending policy. Cuts in taxes on energy may be politically unavoidable at times, but they obscure the price signals encouraging people to reduce consumption. A better solution would be to use flat-rate rebates to help
relieve hardship.
Source: Wood Mackenzie
Figure 3: Green hydrogen is expected to become cost competitive for power generation
Lesson 4
Innovation in new technologies is crucial for energy security, as well as for tackling climate change.
Ultimately, the only way to achieve a largely electrified energy system based on zero-carbon generation will be through advances in technology. There is good news on this front: there are several technologies in development that have shown promising progress in recent years, including small modular nuclear reactors, advanced geothermal, long duration energy storage, and the combustion of ammonia or hydrogen.
Hydrogen, for example, is looking increasingly attractive as an option for power generation, helped by higher gas prices. It offers both reduced emissions and increased security: it can be produced locally, but also be imported from a much more diverse set of exporters than for natural gas. The European Commission has set a goal of importing 10 million tonnes of low-carbon hydrogen by 2030, matched by 10 million tonnes of its own production, so that net import position can shrink over time.
Other technologies will be essential to reaching net zero. Carbon capture, use and storage (CCUS) and nature-based solutions could also play a vital role, allowing continued use of fossil fuels in sectors where they are difficult to replace. We estimate that, globally, there are about 200 CCUS projects — with total removal capacity of about 700 million tonnes of CO2 per year — vying for permitting, funding and offtake support. To be on a path to net zero in 2050, we think the world could need 5 billion tonnes a year of carbon removal capacity
by 2035.
Energy efficiency can be an important way to curb demand and reduce vulnerability to price shocks, but only if there is a comprehensive policy to unlock it. Natural gas accounts for 33% of the energy consumption of the residential, commercial and agricultural sectors in Europe, mostly for heating. Consumers can be incentivised to adopt advanced thermostats and other technology to cut wasted energy, and to move to heat pumps that are three times more efficient. Businesses can be encouraged to use better insulation in new construction. But there has to be a strong enough price signal for them to change behaviour.
Policy support is also crucial for innovation. If it is left to the private sector, it will not make progress fast enough to address the challenges of climate and energy security on the urgent schedule that is required. Government backing has played a key role in previous breakthroughs, including shale gas and solar power, and it can do so again. The technologies in the design, prototype or demonstration phase need to receive regular government funding to establish commercial viability. They also need regulatory and legal frameworks that encourage development, so the private sector can invest, scale up
and deploy.
Source: Wood Mackenzie
Figure 4: Emerging technologies can decarbonise difficult sectors
Lesson 5
Conclusion:
A new era for energy security
For governments: Climate policies need to be rooted in long-term planning for the energy transition, not responses to short-term pressures. The focus should always be on shifting demand away from fossil fuels rather than trying to curb supply. Obstacles to investment in low-carbon energy should be removed as much as possible by streamlining regulatory approvals to accelerate development. But policies should also be in place to cushion the impact of price volatility for fossil fuels during the transition.
For investors: Like governments, investors should review their climate strategies in light of concerns about energy security. As they move to align their portfolios with the Paris climate goals, investors should be aware of the dangers inherent in putting pressure primarily on companies in the private sector in developed economies. If they choke back the flow of capital into the fossil fuel industries only in those countries, they risk undermining energy security while having little net overall impact on global greenhouse gas emissions. But at the same time, there is a historic opportunity in the technologies to provide reliable energy supplies with low emissions.
For companies: The crisis has demonstrated the urgent need for increased investment in energy across a range of sectors and regions. Getting on a path to reach net zero emissions around 2050 will require US$60 trillion of investment, Wood Mackenzie has calculated. The energy security imperative strengthens the case for the rapid expansion of low-carbon infrastructure, while also pointing to the need for spending on fossil fuel production to meet continuing demand. Technologies that offer dual benefits for both the climate and energy security, including renewables, storage and hydrogen, will present the greatest opportunities. And as the political pressure from high prices increases, companies will find governments more willing to work together on policies to support that investment in energy.
The 1970s saw a wave of innovation and investment in energy. Construction of the Trans Alaska Pipeline System began in 1974 and the first deepwater well in the Gulf of Mexico was drilled the following year. The Forties field, the largest in the North Sea, came into production in 1975, followed by the Brent field in 1976. It was also the most active decade for construction of new nuclear power plants. Solar power made important progress towards being commercially viable. Spurred by fuel economy standards, the US vehicle industry was transformed. We are already seeing signs of a similar wave building, across all sectors of the energy industry.
The lessons from the crisis can guide decision-makers in directing those efforts most effectively.
The crisis has been a wake-up call, exposing weaknesses in energy systems that have been building for years and, in some cases, for decades. There is an opportunity now for the private and public sectors to work together to fix some of those flaws.
Edition 10 | October
can be part of the solution
Nuclear power
can transmit shocks
interconnected
global markets
of energy trade flows around the world
a reconfiguring
the current crisis has shown how
with supply following
reducing demand
the emphasis needs to be on
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HORIZONS
The blue-green planet:
How hydrogen can transform the global energy trade
OCTOBER 2021
Jonny Sultoon, Vice President, Energy Transition
Gavin Thompson, Vice Chair APAC Energy
Noel Tomnay, Global Head, Hydrogen Consulting
Prakash Sharma, Research Director, Markets & Transitions
Prakash Sharma, Research Director, Markets & Transitions
Jonny Sultoon, Vice President, Energy Transition
Feb 2022
Power Play: How China's boom year is changing the path of the energy transition
Jan 2022
No Pain no gain: The economic consequences of accelerating the energy transition
Dec 2021
Back to the future: the Horizons year in review
Nov 2021
Plastic surgery: reshaping the profile of the plastics industry
Oct 2021
The blue green planet: How hydrogen can transform the global energy trade
Sept 2021
One giant leap: President Biden's vision for repowering America
Aug 2021
Commit and collaborate: squaring the carbon circle for oil & gas
July 2021
Champagne supercycle: taking the fizz out of the commodity boom
Jun 2021
Location, location, location: the key to carbon disposal
May 2021
Swimming upstream: a survivor's guide
April 2021
Reversal of fortune: oil and gas prices in a 2-degree world
Mar 2021
Tectonic shift: China’s world-changing push for energy independence
Feb 2021
Fast and Furious: Europe's race to slash emissions by 2030
Jan 2021
Total eclipse: how falling costs will secure solar’s dominance in power
Missed our previous editions of Horizons? Download them here.
Get this insight as a PDF
Mar 2022
Utility 3.0: How Africa is remaking the grid
Feb 2022
Power Play: How China's boom year is changing the path of the energy transition
Jan 2022
No Pain no gain: The economic consequences of accelerating the energy transition
Dec 2021
Back to the future: the Horizons year in review
Nov 2021
Plastic surgery: reshaping the profile of the plastics industry
Oct 2021
The blue green planet: How hydrogen can transform the global energy trade
Sept 2021
One giant leap: President Biden's vision for repowering America
Aug 2021
Commit and collaborate: squaring the carbon circle for oil & gas
July 2021
Champagne supercycle: taking the fizz out of the commodity boom
Jun 2021
Location, location, location: the key to carbon disposal
May 2021
Swimming upstream: a survivor's guide
April 2021
Reversal of fortune: oil and gas prices in a 2-degree world
Mar 2021
Tectonic shift: China’s world-changing push for energy independence
Feb 2021
Fast and Furious: Europe's race to slash emissions by 2030
Jan 2021
Total eclipse: how falling costs will secure solar’s dominance in power
Missed our previous editions of Horizons? Download them here.
Get this insight as a PDF