Germany’s Top Buyer Of Russian Gas On The Brink Of Insolvency
Germany’s Uniper SE is just “days” away from insolvency, deputy chairman of Uniper’s supervisory board, Harold Seegatz, told Bloomberg on Friday. Uniper is Germany’s largest purchaser of Russian natural gas, securing contracts with Gazprom. But as Gazprom cut flows of natural gas to Germany and Russia’s Nord Stream 1 pipeline undergoes maintenance, Uniper’s purchases of gas on the spot market have increased—a costlier scenario than its arrangement with Gazprom. The high costs are creating an untenable situation for Uniper, and it is taken to withdrawing gas from storage—gas that was destined to help Germany make it through the coming winter as the country tries to wean itself off of Russian natural gas. Withdrawing gas from storage helps Uniper save on natural gas purchases, but this is merely a game of kicking the can into an inevitable insolvency oblivion. “We are currently reducing our own gas volumes in our storage facilities in order to supply our customers with gas and to secure Uniper’s liquidity,” Uniper said, adding that it was clear “that Uniper cannot wait weeks, but needs help in a few days.” Uniper is already negotiating with the German government a possible bailout that could give Germany a stake in the utility. Uniper’s CEO Klaus-Dieter Maubach warned last Friday that the utility was unable to continue to refill storage ahead of winter, and could ultimately be forced to raise prices and even reduce supply. Germany has a plan to fill its gas storage by 90% ahead of the winter season, with a deadline to achieve this set for November. But early withdrawals during summer—a relatively tame demand season for natural gas—this plan is now in serious jeopardy, and Germany could stare down winter heating season with precious little inventory.
The West has yet to find a way to block Russian oil exports
As the war in Ukraine grinds on, Europe and the United States continue to search for tools to do the impossible: cut Russian President Vladimir Putin’s energy earnings without disrupting oil and gas supplies or driving prices through the roof. The latest option is a cap on the price of purchased Russian oil. But a better and more feasible plan languishes without sufficient advocacy. On May 31, the European Union reached an agreement to ban most Russian crude and refined petroleum imports by the end of 2022. Shipments by sea, which account for about two-thirds of Europe’s purchases from its eastern neighbour, will be forbidden. Poland and Germany also agreed to end pipeline imports. If both measures are implemented, the only Russian oil supplied to the EU will come via the southern Druzhba pipeline, which fuels Slovakia, the Czech Republic and pro-Kremlin Hungary. Last year, 56 percent of Russian crude and 70 percent of its refined product exports went to Western countries, mostly European nations such as Germany, the Netherlands and Poland. The US, Canada, Britain and Australia meanwhile, which buy little Russian oil, had already announced measures to halt Russian oil imports. With Western buyers closing their wallets, Russia has reoriented sales to Asia, particularly India, which was not previously a major customer and to some extent China. To sweeten these deals, Russia offers discounts of up to $30 per barrel, but prices have risen so much (they have been over $100 a barrel since March) that Moscow is earning at least as much as immediately before the war and 50 percent more than in the first four months of last year. For now, Russia’s new markets seem secure. If the West were to try to block these sales to Asia, for instance, via a shipping ban, it would anger important allies like New Delhi, invite avoidance (as has occurred for several years with sanctions on Iran and Venezuela) and, to the extent it was successful, drive world oil prices even higher than they already are. This could trigger a global recession, imperil the electoral fortunes of US President Joe Biden and several European leaders and create political pressure to concede to Russia. Aware of these constraints, Western allies, including Japan, have sought more nuanced instruments. At the G7 summit in Germany last month, leaders agreed to consider a cap on Russian oil imports sold above a certain price. This could be enforced by banning shipping or insurance for cargoes purchased above the limit. Figures discussed for the cap are in the range of $40 to $60 per barrel. But there are numerous problems with this approach. First, it would require the EU to revisit its own ban passed in May, laboriously crafted after long debate with Budapest. Second, the proposed price is too high, well above the likely production cost for Russian companies of $20 per barrel. The Russian state heavily taxes its companies at prices above $25 per barrel. Price caps on refined products would have to be set, too, inviting creative re-labelling. Third, insurers from China and India would likely step in. While Asian insurance providers do not have the same reputation nor coverage levels as European firms, they would still be adequate for sales to those destinations. Fourth, as with the “Oil-for-Food” programme in Iraq in the 1990s, the cap would invite under-the-table deals and kickbacks. Barring that, Russia would simply play divide-and-rule by selling above the cap to its geopolitical supporters. Finally, Russia may still cut back on oil shipments, as it has already done with gas to Europe and by invoking spurious technical reasons to limit Kazakh oil exports via its territory. Former President Dmitry Medvedev even threatened Japan that its adherence to a cap would see its access to Russian oil cut off and prices going above $300-$400 per barrel. More effective solutions have been advanced by Ricardo Hausmann, a Harvard economist and former minister of planning in Venezuela, Harvard Russian scholar Craig Kennedy and US Treasury Secretary Janet Yellen, among others. The best of these is a stiff per-volume tariff on imports of Russian petroleum. This would weaken the incentive for buyers to cheat as they would still face the end-user market price. China, India and other countries could be brought in by a combination of the stick of shipping sanctions and the carrot of retaining much of Russian oil earnings themselves. This would create a kind of buyer cartel. But such concepts have achieved oddly little traction despite their economic merits. Whatever mechanism is arrived at, the impact on rival oil producers will be profound. Currently, Moscow cooperates with OPEC and other leading producers in the OPEC+ alliance. Saudi Arabia is keen to retain Russia within this framework, even though it cannot currently live up to its production targets. An outright Western ban on Russian oil would drive up prices, thus benefiting Russia’s petroleum rivals. It would also lead to intense struggles for market share in the Middle East’s traditional Asian markets, even though Middle East producers would reorient to sell more to Europe. India, China and others would have tough choices on whether to buy as much as half their oil from Russia at attractive discounts but with major logistical and legal problems and at the penalty of dropping their long-standing and reliable Gulf suppliers. A price cap or tariff would be less disruptive, so long as Russia did not retaliate, but would still invite trading shenanigans. Russian oil output is also likely to decline in the longer term, weakening Moscow’s hand as a competitor to Gulf producers, and suggesting Gulf countries should step up expansion of their own capacity. As Western efforts to square the stubborn circle of oil prices continue, Middle East oil exporters will watch keenly from the sidelines.
Will the world face the seventies oil shock once more?
The International Energy Agency Executive Director Fatih Birol has said that the “worst of the energy crisis” is yet to come. In fact, he said it may be much bigger than the oil shock of the seventies. “Back then it was just about oil. Now we have an oil crisis, a gas crisis and an electricity crisis simultaneously,” he said in an interview given to Der Spiegel. In the seventies, two oil crises remade the world after countries faced severe fuel shortages, high inflation and violent civil protests. But the International Monetary Fund put out a view different to Birol’s. The IMF said that this oil crisis will not be as bad. A blog by its senior economist Nico Valcxx said that “lower oil reliance insulates the world from 1970s-style crude shock”. So, will it be seventies once more or are economies more resilient now? Deepak Mahurkar, leader-oil and gas industry practice at PwC India, does not see a repeat of the decade happening. “Then, there was no alternative to oil. Therefore, the kind of impact it (oil crisis) had in the seventies–with economies getting impacted and oil consumption going down, and so on–will not happen. Economies could continue to do not so badly but, if the situation persists for a longer period, then there is a definite possibility of oil consumption going down.” The steady climb in oil prices could be pegged to a “very unusual” situation today. Mahurkar said, “It is very unusual because all the commodity prices have gone up, therefore the impact of inflation on all economies is being felt severely. There is no alternative that people can switch to.” He sees prices for oil, gas and coal to remain firm for some time. Prashant Vasisht, vice president and co-group head at corporate ratings in ICRA, said that it is hard to predict if things will go as badly as they were in the seventies but added that they see crude price averaging somewhere between $100 and $120 in FY23 with an upward bias. “A lot will depend on whether the Russia gas (pipeline) will reopen because European and north Asian countries are heading towards winter,” he added. In the first half of the decade, the Arab nations stopped oil supplies to the US and its allies, accusing them of supporting Israel during the Yom Kippur War, and also raised the price per barrel from $3 to nearly $12. This led to acute shortage in the western countries, the US rationed supplies and people were lining up at fuel pumps. In the US, inflation was already running high, with policies that tried to tame unemployment by increasing the supply of money, and the oil crisis made it worse. In the late seventies, a revolution broke out in Iran, which further squeezed oil supply and forced countries to invest in alternate sources of energy. India thought that it would be protected from the oil crunch and resultant price rise, but it didn’t play out that way. In the first oil crisis, the OPEC countries raised the rates for everyone and India’s oil bill came to nearly half of its export earnings and twice its forex reserves. Food production plummeted with fertiliser shortage, and worsened a food shortage that came with the 1971 war with Pakistan. India was just recovering from a balance of payments (BOP) crisis when the second oil crisis from the instability in Iran hit. “The BOP situation changed dramatically in 1979– 1980 as agricultural growth suffered and industrial bottlenecks emerged owing to shortages of power, coal, cement and a deterioration of labour relations, difficulties with ports and railway transportation. Infrastructure inadequacies bedevilled the economy, and these were accentuated by a poor monsoon which affected hydel generation,” V Srinivas in his book India’s relations with the International Monetary Fund. Srinivas, who was Additional Secretary to GoI, worked as Advisor to the Executive Director of IMF. In the second half of seventies, inflation in India shot up from 3 per cent in 1978-79 to 22% in 1979-80. According to a speech given by former RBI governor YV Reddy, average inflation rate during the seventies was at 9%. “The external terms of trade worsened significantly owing to higher prices for imported petroleum and fertilisers,” Srinivas wrote. Why does the IMF think it won’t be that bad? The senior economist at IMF, Nico Valckx discusses a metric called oil intensity, which captures how many barrels are needed to produce $1 million in gross domestic product. He wrote, “this measure (oil intensity) was about 3.5 times higher than current levels when crude prices almost tripled between August 1973 and January 1974.” So any change in oil prices won’t be as disruptive as it was in the seventies. Besides this, wages today don’t automatically adjust to inflation–for example, your parents’ salary slip may have had a component called Dearness Allowance (DA) which yours may not–and central banks function differently. “More (central banks) are independent today, and the credibility of monetary policy has broadly strengthened over the intervening decades,” he wrote. The oil intensity measure is a good measure for oil demand, in fact it is the most reliable measure we have for predictions, said PwC’s Mahurkar. But, he added, there is a shift that is taking place in oil use. “Dual-fuel capabilities are being built into automobiles and, more importantly, in industries. Therefore, people are swiftly changing from one fuel to another and not for environmental reasons but for economic reasons,” he said. ICRA’s Vasisht believes that the drop in oil intensity does not really capture the oil demand scenario. “When you are selling more software than big machinery, then oil intensity would go down. But oil is still the primary source of energy. With American households spending around $1,000 per month on gasoline, which is a huge amount, oil prices are a big political issue. So the fall in oil intensity does not capture the reliance the world still has on the fuel,” he said. He also does