Armed Conflicts And Impact On Oil & Gas Cost And Trade

Introduction:

Armed conflict has been a constant of human history, but the forms it takes have evolved constantly, and certainly this evolution has hastened since the end of second World War. For instance, the present Russian invasion of Ukraine (unlike previous wars in Asian country and African nation or sanctions against Iran) has an effect not only on energy costs but also on different commodities. The consequences of shipping disruptions through the Black and Azov Seas, and Russian banks being interrupt from the international payments system, are extending even to the global Agri-commodities markets. Oil and gas are essential, and stand high-value commodities for each industrialized and developing countries. Whereas discussions regarding oil dependence usually concentrate on the utilization of gas in private vehicles or oil for home heating, oil is equally important for a plethora of commercial processes and product, as well as electricity generation, the manufacture of artificial fibers, the operation of machine technology, pesticides, fertilizers, plastics, medicines, dyes, and solvents. Likewise, gas plays an important role in economic process and development, that contributes to the generation of electricity more than compared to oil, role in clean fuel production, and a crucial function because the traditional supply of energy for such sectors as metals, pulp and paper, glass, food production, oil refining, chemicals, and plastics.

The massive influx of petrodollar revenues when oil costs are high creating disposable incomes which will be simply distributed in regional arms races, particularly since oil-consuming countries like India are incentivized to extend arms sales as a method of finding oil import-related trade deficits. Besides transferring wealth from industrialized countries to oil producers within the Middle East and North African (MENA) region and Russia (and stimulating renewed drilling for oil and gas in North America), high international oil and natural gas costs additionally slow international economic process and encourage energy conservation. This causes petroleum demand to slow globally, lowering oil costs, which creates fluctuation across the world.

The recent war and also the covid pandemic have had a huge impact on the oil and gas costs and demand. The costs though had decreased in the past years have once again began to rise with Russia being the third-largest producer of oil. Firms like BP and Shell PLC, have proclaimed plans to exit Russian operations and joint ventures. Petrol costs have hit another record high as oil and gas prices soar amid fears of a worldwide economic shock from Russia's invasion of Ukraine. Oil jumped to US$ 139 per barrel, the highest level in fourteen years, whereas wholesale gas costs have over doubled.

Figure 1: Crude Oil Price Fluctuation (2018 to 2021, Quarterly)

Source: U.S. Energy Information Administration (EIA)

Historical Disruption of War on Oil and Gas Prices

Geopolitical events that disrupt the availability of crude oil and petroleum product to market will have detrimental an effect on crude oil and oil product costs. These events could produce uncertainty about future supply or demand, which may result in higher volatility in costs. The volatility of oil costs is tied to the low responsiveness, or inelasticity, of supply and demand to cost changes in the short term. Crude oil production capability and therefore the equipment that uses petroleum product as its main source of energy are comparatively fixed and the near term. It takes time to develop new supply sources or to vary production, and when costs rise, switching to different fuels or increasing equipment fuel efficiency within the near term is difficult for consumers to do. These conditions could need a large price amendment to rebalance physical offer and demand.

Most of the rock oil reserves within the world are located in regions that are susceptible to political upheaval or in regions that have had oil production disruptions attributable to political events. Many major oil worth shocks have occurred at constant time that political events caused offer disruptions, most notably the Arab Oil Embargo in 1973–74, the Iranian revolution, the Iran-Iraq War in the 1980s, and therefore the Persian Gulf War in 1990–91. In recent years, conflicts and political events within the Middle East, the Gulf, Libya, and Venezuela have contributed to world oil supply disruptions and will increase in oil prices.

One of the lesser-known conflicts was the Sudan disruption. Sudan has illustrious civil war almost without interruption since its independence to until date. The first civil war lasted seventeen years, from 1955 to 1972, and saw the south of the country fighting for bigger autonomy from the north due to ethnic and religious differences between the two regions. The second civil war started in 1983 and was finished only in 2005. The referendum held in January 2011 sanctioned the independence of southern Sudan. However, Sudan has remained a relatively small producer, although production has been increasing quickly.

Similarly, end of hostilities in second Gulf war did not mark a permanent end to the conflict. Sanctions against Republic of Iraq continuing for another twelve years till an international coalition led by the United States was formed to bring down the regime of Saddam. However, despite the raging wars within the region that also heavily depends on the oil and gas market, major fluctuation in the prices has a high impact on the global market. As an example, according to the international monitory Fund (IMF), the business breakeven worth per barrel for 2019 was: US$67 for UAE, US$83 for Kingdom of Saudi Arabia, US$45 for Qatar, US$53 for Kuwait, US$56 for Asian country, US$93 for Sultanate of Oman, US$106 for Bahrain and US$245 for Iran. Analysts typically inspect the fiscal breakeven price, that is that the minimum oil worth per barrel that an oil-producing country will afford to balance its financial budget. If the level of oil prices decreases, the country will face a budget deficit. An unprecedented oil price crash in 2020 saw the costs of the OPEC basket tumble from a price of US$71 in January 2020 to US$27 on May 2020. Non-OPEC countries have additionally been hit by a similar plunge.

Impact of the Russia and Ukraine War

The United States, Russia, and Saudi Arabia are the top oil producers in the world, which produces over 40 million barrels per day in total as of in 2020. In 2020, the United States produced about 18.6 million barrels of oil per day. Saudi Arabia produced around 10.8 million and Russia produced roughly 10.5 million barrels per day.

In late 2021, geopolitical tensions began, that had escalated by early 2022, which led to a 35% surge in the price of West Texas Intermediate (WTI). In the middle of December 2021, Russian officials had warned that the Ukraine government that it should not be involved in the North Atlantic Treaty Organization (NATO) and also stated that the NATO forces should be withdrawn from all of Eastern Europe. The U.S. and NATO refused which led to the tensions being stirred-up in the energy markets. In early 2022, Russia activated military operations in Ukraine, which centered about the nationalist regions in the eastern region and other targets in the country. Thus, WTI oil prices spiked from $74.32 on December, 2021, to US$100, while Brent crude shot up to more than US$105 during intraday trading in early 2022.

The economic sanctions have resulted in both geopolitical tensions and volatility in the energy sector. In February, 2022, U.S. President declared sanctions which included obstructive two state-owned Russian financial banks and its subsidiaries, which provide financing aid to the Russian military. The sanctions also banned the Russian sovereign debt purchases in the U.S. and targeted Russian elites and their families. However, in late February 2022, sanctions were expanded in scope to include other Russian financial institutions, including the two largest banks (Sberbank and VTB Bank) blocking access to the U.S. financial system. Sanctions also restricts U.S. individuals from buying both new and existing Russian sovereign debt that are available in the secondary market. The Russian elites along with their families have been monetarily targeted, while export controls were implemented in the place to restrict technological goods imports into Russia.

Additionally, according to trade economics, WTI crude futures extended gains to above $103 per barrel, rebounding from an over 1% loss, as the threat of additional sanctions on Russia. The US and its allies prepared new sanctions on Moscow over killing civilian in the north of Ukraine, with the European Union proposing to ban on Russian coal and to prevent the Russian ships from entering the European Union ports. Britain also urged the NATO and G7 countries to reach agreement to a timetable so as to phase out the oil and gas imports from Russia. Meanwhile, US crude inventories rose by 1.1 million barrels on March end 2022, defying market expectations for a 2.1million-barrel decline. Demand concerns in China also resurfaced after authorities extended a lockdown in Shanghai to cover all of the financial centers 26 million residents. Russia is not only the world’s third-biggest oil (after the US and Saudi Arabia) and the second biggest natural gas (after the US) producer, it is also the third largest coal exporter behind Australia and Indonesia. Thus, Russia’s war on Ukraine hasn’t stopped at driving up Brent crude to $110-15/barrel and international coal prices to unprecedented $440/ton levels. The closing down of ports in the Black Sea has also impacted the prices of corn and wheat traded at the Chicago Board of Trade futures which recorded the highest since the March of 2008 and December of 2012 correspondingly.

Table 1: How global commodity prices have moved

Source: IndustryARC

Importance of Russia in the Oil Market

One of the world’s top oil producers, exporters and a giant in natural gas markets is Russia. According to International Energy Agency (IEA), Russia is a major player in global energy markets. Russia is one of the top three crude producers in the world, competing for the top spot with the United States and Saudi Arabia. Russia relies deeply on incomes and profits from oil and natural gas, which made up to 45% of their federal budget in 2021.

Russian crude and condensate output had reached 10.5 million barrels per day in 2021, which makes up to 14% of the total supply globally. Russia has production facilities for oil and gas across the country, however bulk of its main fields are concentrated in eastern and western Siberia. In 2021 Russia exported 4.7 million bpd of crude to countries across the world. China is the largest importer of Russian crude (1.6 million bpd), however Russia also exports to a large volume to buyers in Europe (around 2.4 million bpd). Russia produces different types of crude oil; however, its main export blend is Urals, that is a medium sour crude. Russia also exports large volumes of ESPO blend crude to Asian countries through the East Siberia-Pacific Ocean (ESPO) pipeline. Other grades include Sokol, Siberian light, Arctic oil, Novy Port, and Sakhalin blend. The Russian oil industry has consolidated in recent years, while there are still several major players remaining. State-owned Rosneft is the largest oil producer in Russia followed by LUKOIL, which is one of the largest privately-owned oil companies in Russia. Gazprom Neft, Surgutneftegaz, Tatneft, and Russneft also have significant production and refining assets.

Russia has wide crude export pipeline capacity, which allows them to ship huge amounts of crude directly to the European as well as to the Asian countries. For instance, the 5,500 km pipeline system of Druzhba, is the world’s longest pipeline network which transports around 750,000 bpd of crude directly to refiners in to the central and eastern Europe. At present, Russia supplies around 20% of the entire European refinery crude amounts. In 2012, Russia opened the 4,740 km and 1.6 million bpd ESPO pipeline. It sends crude directly to the Asian markets including China and Japan. This pipeline was an act to expand the reach of Russian oil across continents. Russia also exports crude by rail. Russia ships crude by tanker from the Black Sea port of Novorossiysk, Kozmino in the Far East, and the Northwest ports of Primorsk and Ust-Luga.

Russia has a refining capacity of 6.9 million bpd and produces a large amount of oil products, such as diesel and gasoline. Russian companies have spent the last decade investing heavily in primary and secondary refining capacity to take advantage of favorable government taxation, as well as growing global diesel demand. As a result, Russia was able to shift its the vast majority of motor fuel production and meet the Euro 5 standards. In addition, Russia is a major exporter of vacuum gas oil and heavy fuel oil. Russian refineries, in 2021, processed around 5.6 million bpd of crude and exported about 2.8 million bpd of oil products. Thus, Europe remains a potential market for the Russian oil products. For instance, in 2021, Russia exported over 750,000 bpd of diesel to Europe, while meeting 10% of its demand.

Why Russia is Important for the Global Natural Gas Market

After United States, Russia is the second largest producer of natural gas globally, and has the largest global gas reserves. Russia is also the largest gas exporter globally. In 2021 the country had produced 762 bcm of natural gas and exported around 210 bcm via pipeline.

Gazprom and Novatek are Russia’s main gas producers, however many Russian oil companies, including Rosneft, operate gas production facilities. State-owned Gazprom is the one of the largest gas producers, nevertheless its share of production has declined over the past decade, as Rosneft and Novatek have expanded their production capacity. However, in 2021, Gazprom accounted 68% of Russian gas production. Historically, the production was concentrated in West Siberia, however over the past decade investment has shifted to Eastern Siberia, the offshore Arctic, the Far East, and Yamal. Russia has a wide pipeline network for exporting gas, via both transit routes through Ukraine and Belarus, and also through pipelines that send gas directly to Europe that includes Blue Stream, TurkStream, and Nord Stream pipelines. In 2021, Russia had completed work on its Nord Stream II pipeline, however the German government had decided to approve against the certification in the wake of the Russian invasion of Ukraine. In 2021, Russia held 45% of imports and around 40% of European Union natural gas demand. The share has increased in recent years, due to decrease in European domestic natural gas production. The largest importers of Russian natural gas are Germany, Italy, and Turkey.

In 2019, Russia launched a major eastward gas export pipeline, which was around 3,000 km and had a capacity of 38 bcm, that sends natural gas from far east fields directly to Chinese provinces. Gazprom exported over 10 bcm of natural gas through the Power of Siberia pipeline in 2021 which is expected to ramp up to 38 bcm in the future. Russia is expected to develop the Power of Siberia-2 pipeline, which would hold a capacity of 50 bcm/y, that would supply China from the West Siberian gas fields. Furthermore, Russia has been expanding its liquefied natural gas (LNG) capacity, to compete with growing LNG exports from the United States, Australia, and Qatar. The Russian government released a long-term LNG development plan in 2021, which targets to have by 2025, 110-190 bcm/year of LNG exports. Russia exported 40 bcm of LNG, making them the world’s fourth largest LNG exporter in 2021, and accounting for around 8% of LNG supply globally.

In recent years, Russia has gradually started to focus on the Arctic region as a way to escalate the oil and gas production and offset the declines at older and existing production sites. The Arctic holds for around 80% of Russia’s natural gas production and a projected 20% of their crude production. While the climate change threatens the future investment in the Arctic region, it increases Russia’s opportunity to increase the access of the Arctic trade routes, which would allow more flexibility for seaborne deliveries of fossil fuels, specially to the Asia region.

Covid-19 impact on Oil & Gas Industry

The entire ecosystem had come to a halt, putting a halt to the production and sale of oil and gas around the world due to COVID 19. The global oil market has rebounded from the huge demand shock that was triggered by the Covid-19 pandemic however, it still faces a high degree of vagueness. According to IEA, the world’s oil production capacity is projected to increase by 5 mb/d by 2026 and Asia will continue to dominate growth in global oil demand, amounting to a 90% increase between 2019 and 2026. On the demand side, economic disruptions and containment measures related to the pandemic outbreak has led to slowdown of production and logistics globally, while producing a substantial drop in global oil demand. The International Energy Agency (IEA), in 2020, estimated that the demand had decreased by 30% when compared to 2019, which reached its lowest since 1995. As COVID-19 caused unprecedented declines in demand, wars between Middle eastern and European countries have caused crude oil prices to fluctuate. In early March 2020, during the pandemic's peak in Asia, OPEC opened its taps which flooded the world with cheap oil. This continued into April as OPEC amplified its production by 2.3 million bpd, although the demand losses globally were of around 28 million bpd.

Figure 2: World Oil Production by Region, 2017-2020

Source: International Energy Agency

However, new infrastructure projects and products are expected to come alive as growth trends will fall short of projections which will bolster the likelihood of overcapacity and low prices across the globe. Thus, future investments are likely to be shroud, which will require the producers to maintain the adoption of newer technologies by the major oil and gas industry players in the market in the coming years.

Summary

The impact of armed conflicts from the late 1950s to the present has had a significant effect on the oil and gas sector over the years. The sector is seen to have a highly fluctuating pricing over the past few years. The fluctuation of oil prices not only affects the consumption of oil but also affects other commodities too. For instance, with brent at $110-115 per barrel the prices of cotton; as they are made of synthetic fibers are becoming costlier and agricultural commodities that are derived from the production of ethanol (sugar and corn) or biodiesel (palm and soyabean oil) are also impacted. Additionally, the Ukraine crisis has led to an increase in the prices of vegetable oils and oilseeds rising steeply. This has impacted sunflower, soybean, and other intermediates. Recently, palm oil in Malaysia has hit an all-time high, scaling to 7,000 ringgits per tonne. Thus, the dependency on a single source of energy has now urged the governments to shift toward a more sustainable source of energy. In comparison to oil, high prices improve the economics of substitutes like hydrogen or electric vehicles. For instance, 65% of all the vehicles sold in 2021 were electric in Norway, simultaneous the oil demand has fallen less than 10% since 2013. Similarly, Germany is also considering extending the life of its nuclear plants and reversing the trend of phasing out coal mining. Thus, huge cost fluctuation and trade is allowing countries to shift toward greener source of energy which in turn will help the goal of sustainability and green corridors for the future.

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