Sanctions on Russia have been designed to allow energy trade to continue. But uncertainty is restricting flows and raising prices

Ed Crooks, Vice-Chair, Americas, Wood Mackenzie

Fighting between Russian and Ukrainian troops at the Zaporizhzhia nuclear power plant on Thursday night was an alarming demonstration of the chaos and confusion that war brings. Zaporizhzhia, the largest nuclear plant in Europe, has VVER reactors with more robust safety features than the RBMK reactor that exploded at Chernobyl in 1986. But even so, gunfire and explosions at a nuclear site are always worrying.

As the fighting at the plant raged, Dmytro Kuleba, Ukraine’s foreign minister, sounded the alarm. “Fire has already broke out.” he tweeted. “If it blows up, it will be 10 times larger than Chornobyl!” Rafael Mariano Grossi, director-general of the International Atomic Energy Agency, spoke to the Ukrainian authorities and warned of “severe danger” if the reactors were hit.

A few hours later, the message from Ukraine was calmer: the fire had been in a training building and had not affected essential equipment, and there had been no change in reported radiation levels at the site. But the IAEA still described the situation as “serious”.

Jennifer Granholm, US energy secretary, corroborated the assessment that there had been no elevated radiation levels detected, and said the plant, which in peacetime produced about 20-25% of Ukraine’s electricity, was being shut down safely. However, she warned: “Russian military operations near the plant are reckless and must cease.” As James Acton, co-director of the Carnegie Nuclear Policy Program, put it last week: “Nuclear power plants are not designed for war zones”.

Sanctions disrupt energy supplies, and put upward pressure on prices

Wars are inherently chaotic, and leaders are never fully in control of events. Movements in energy markets in the days following Russia’s invasion of Ukraine on February 24, have been a case in point. When President Joe Biden gave his State of the Union address this week, he argued that sanctions on Russia would punish President Vladimir Putin while minimising the cost to the American public as far as possible. “I’m taking robust action to make sure the pain of our sanctions is targeted at the Russian economy and that we use every tool at our disposal to protect American businesses and consumers,” he said.

To that end, the international sanctions on Russia, including a new round announced by the US on Wednesday, have almost all included specific exemptions to allow trade in energy to continue. Russia is too important to world oil, gas and coal supplies, and to European gas and coal markets in particular, for its exports to be cut off without causing severe hardship. So even as the fighting in Ukraine has intensified, flows of Russian energy exports have continued.

However, since the latest round of financial sanctions were announced last weekend, there have been signs that energy trade with Russia is starting to be disrupted. As a result, there has been upward pressure on oil, gas and coal prices. Brent crude came close to $120 a barrel, its highest level since 2008, and was trading at around $112 on Friday morning.

European benchmark TTF gas futures at one point hit €185 per megawatt hour, equivalent to about $60 per million British Thermal Units. In energy-equivalent terms, that is the same as about $350 for a barrel of oil. Coal prices have also been soaring: April futures for Newcastle benchmark thermal coal hit US$446 on Tuesday, more than double its level seven days earlier.

One of the main reasons is “self-sanctioning”: international customers choosing not to do business with Russian suppliers because there is too much uncertainty over transactions, particularly around the legal position for buyers making payments to Russian companies.

As a result, Russia’s energy exports are being affected by the sanctions, despite the best intentions of the US and other countries that are imposing them. There is a stark illustration of this in the price spread for Russian Urals crude relative to Brent. Urals typically sells at a small discount to Brent of about $2 a barrel in normal times. This week, that discount widened to more than $15 a barrel. There were reports of some Russian crude remaining unsold despite that deep discount.

The Biden administration seeks relief on fuel prices

Under pressure because of rising fuel prices, the Biden administration has been looking for ways to help American consumers. The OPEC+ countries have been no help. The group’s ministers held their regular monthly video conference this week and agreed to raise their production limit by 400,000 barrels a day, sticking to the schedule they set last year. The decision was widely expected, and had little impact on oil prices.

Oil-consuming countries, meanwhile, tried to use their strategic reserves to take some of the heat out of the market. The International Energy Agency announced on Tuesday that its 31 members had agreed a coordinated release of 60 million barrels of oil from their reserves “to provide stability to oil markets”. Half of that is coming from the US Strategic Petroleum Reserve. The coordinated reserves release is a tool that the IEA does not use often: there have been only three previous examples, in 1991, 2005, and 2011. But its initial impact seemed limited. Crude prices rose after the announcement.

One measure that the administration could use to put downward pressure on oil prices is supporting faster growth in domestic production. Questioned about that at a White House briefing, President Biden’s press secretary Jen Psaki dismissed the idea that the administration could be doing more to help the US oil industry. “There are 9,000 approved oil leases that the oil companies are not tapping into currently,” she said. “You think the oil companies don’t have enough money to drill on the places that have been pre-approved?... I would point that question to them.”

Rick Muncrief, chief executive of Devon Energy, told Bloomberg he was “mystified” that President Biden had not been in touch to discuss ways to boost oil output to control prices. Leading listed independent oil and gas companies such as Devon have been under pressure from investors to maintain capital discipline, prioritising debt reduction and distributions to shareholders ahead of growth. Muncrief said: “If [the administration] were to reach out and maybe be a little more collaborative, it might provide some cover" for ramping up investment and production.

That move does not seem to be on the administration’s agenda at the moment. Psaki said the president’s answer was instead to press ahead with low-carbon energy. “What we can do over time… [is] reduce our reliance on oil. The Europeans need to do that, we need to do that,” she said. “If we do more to invest in clean energy, more to invest in other sources of energy, that is exactly what we can do to prevent this happening again in the future.”

The big question for the administration over the coming months will be whether that gradual shift to electric vehicles “over time” will need to be augmented by more urgent measures to help the great majority of consumers who have not yet made that transition.

The IPCC assesses the impact of climate change

While the world had been focused on the urgent crisis in Ukraine, there was a reminder from the Intergovernmental Panel on Climate Change about the longer-term threat from global warming. In 2021-22 the  IPCC is publishing its sixth Assessment Report, intended to sum up scientists’ current understanding of climate change, updated the fifth report published in 2013-14. The assessment is divided into three parts: Working Group I, looking at the physical science of how the climate is changing, published its report last August. This week Working Group II published its section, looking at the impact of that changing climate on ecosystems and human communities.

The headlines from the report’s summary for policymakers were that climate change is already causing widespread damage, and that the threat of more severe impacts will grow as temperatures continue to rise. If global warming even temporarily exceeds 1.5°C — the limit set as the stretch goal of the 2015 Paris climate agreement — “then many human and natural systems will face additional severe risks, compared to remaining below 1.5°C,” the report warns. The risks cited include the loss of land and assets in small islands and coastal communities, droughts, and the degradation of coral reefs.

The report also highlights the interactions between climate change and other threats such as local pollution and unsustainable use of natural resources, and warns: “Vulnerability is higher in locations with poverty, governance challenges and limited access to basic services and resources, violent conflict and high levels of climate-sensitive livelihoods (e.g. smallholder farmers, pastoralists, fishing communities).”

The Working Group’s conclusions were criticised by Roger Pielke Jr of the University of Colorado Boulder, author of The Climate Fix. He pointed out that some of the warnings of threatened damage from global warming were based on a scenario with very high greenhouse gas emissions, which is increasingly seen as unlikely. That scenario, sometimes referred to as RCP8.5, showed the world on course for average global warming of about 4.3 °C by the end of the century. Wood Mackenzie’s base case forecast, showing our view of the most likely outcome, puts the world on course for about 2.6 °C of warming.

As an illustration of the differences, the risk of “large, abrupt and sometimes irreversible changes in systems caused by global warming”, such as ice sheet disintegration or a slowdown in ocean circulation, is described in the report as “very high” in an RCP8.5-type scenario, but only “high” in the scenario close to Wood Mackenzie’s base case. If global warming could be limited to 1.5 °C, the assessed risk of those large and irreversible changes would be reduced to “moderate”. Wood Mackenzie recently published our updated 1.5 °C scenario, showing the rapid transformation of the global energy system that would be required to meet that goal.

The blowout offshore wind auction for the New York Bight

The auction of offshore wind lease areas off the coast of New York and New Jersey last week attracted an eye-popping $4.37 billion in high bids. That not only shattered the previous record of $405 million for a US offshore wind lease sale, set in 2018, but was also more than had ever been raised from  a US sale of oil and gas leases. Wood Mackenzie’s offshore wind team, led by Søren Lassen, has been digging into the details of the auction to explore some of the key conclusions for the industry.

One key point is just how competitive the auction was. Of the 14 consortia that started bidding, 12 were still active into the third day, as the maximum price per acre headed towards ten times the previous US record. Allowing for the fact that the New York Bight leases last for 33 years, compared to 60 years for the US, they are the most expensive acreage in the world in terms of dollars per square kilometre.

Many of the big names in global offshore wind were involved. Winners of the six lease areas included a consortium of Ocean Wind and GIP; another of Shell and EDF, and TotalEnergies. BP, Equinor, Iberdrola and Ørsted were among the unsuccessful bidders, opting to keep their powder dry for future sales. Even after the auction, Ørsted and Iberdrola remain the largest players in US offshore wind.

The winning bidders say they could develop a total of 12.7 gigawatts of capacity in the new lease areas. That represents a 34% increase in the US offshore wind pipeline to a total of 50 GW, well above the Biden administration’s target of having 30 GW online by 2030. Lease sale activity is set to remain high through the year, with five more auctions expected in 2022: three in Europe and two in the US.

Meanwhile, the Biden administration said it would not appeal against a court decision in January that invalidated oil and gas leases in the Gulf of Mexico that were sold last year. Green campaign groups argued that the lease sale had been based on a flawed environmental impact statement from 2017, which had failed to address properly the implications for climate change.

In brief

ExxonMobil and Shell have followed BP and Equinor in announcing they are exiting assets in Russia, in response to the invasion of Ukraine. ExxonMobil said it was beginning the process to discontinue operations and exit the Sakhalin-1 joint venture, and would not make any new investments in Russia. It said in a statement: “ExxonMobil supports the people of Ukraine as they seek to defend their freedom and determine their own future as a nation. We deplore Russia’s military action that violates the territorial integrity of Ukraine and endangers its people.”

Shell said it would exit all of its joint ventures with Gazprom, including its 27.5% stake in the Sakhalin-II LNG facility. It also intends to end its involvement in the Nord Stream 2 pipeline project to bring Russian gas to Germany. The pipeline is waiting for certification from Germany, and that process was suspended last week.

Shell’s chief executive officer, Ben van Beurden, said: “We are shocked by the loss of life in Ukraine, which we deplore, resulting from a senseless act of military aggression which threatens European security."