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What’s the Plan to Counter Russia’s Energy Squeeze?

By Nick Sargen
Economics
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Russian oil refinery

Are you taking comfort from the recent drop in gasoline prices, hoping the worst is over? It mainly reflects a slowing in the global economy that is expected to soften demand for oil.

If so, you should also consider developments on the supply side that could boost energy prices as winter approaches. Last week, Russian state-owned gas company Gazprom announced it would cut in half flows of natural gas through the Nord Stream 1 pipeline to Germany, to 20 percent of capacity. According to CNN, a U.S. official said the move was retaliation for western sanctions and to put the West in “unchartered territory” about whether Europe will have enough gas to get through winter.

This threat was previously flagged by Daniel Yergin, an acclaimed energy expert, in a commentary in which he stated that today’s energy crisis will probably become worse than the 1970s oil shock. Among the factors Yergin cites, the most important is the risk that Russian President Vladimir Putin will cut back on the contracted supplies of natural gas to Europe. He believes the next six months will be a critical test of whether Europe can maneuver through the coming winter. 

The International Monetary Fund (IMF) is also concerned about this threat. The baseline forecast for its updated outlook calls for world growth to slow from 6.1 percent last year to 3.2 percent this year and 2.9 percent next year, downgrades of 0.4 and 0.7 percentage points from April. The main risk the IMF sees is a sudden stop of Russian gas exports to Europe. In that case, inflation would rise and global growth would decelerate to 2.6 percent this year and 2 percent next year—a pace that has been breached just five times since 1970. 

Can Countries Lessen Their Risks?

The IMF’s assessment is that a reduction of up to 70 percent in Russian gas could be managed in the short term, but supply bottlenecks could reduce the ability to re-route gas within Europe. It calls on governments to secure supplies from global sources across the EU and to prepare gas rationing programs.

Following the Gazprom announcement, officials from EU member countries agreed that each country should voluntarily cut natural gas consumption by 15 percent from their average over the past five years. The Economist, however, contends that rationing alone will not solve the problem. The reason: Conditions facing member countries are diverse, and some EU countries are not reliant on Russian gas or have practiced energy conservation.

Many EU members blame Germany for relying on inexpensive Russian gas to power its industries while closing coal-burning power plants and phasing out nuclear power plants. It now appears that Germany has no choice but to increase its production of coal, which would mean temporarily abandoning its commitment to green energy. Meanwhile, Germany plans to increase imports of LNG (liquified natural gas), which are more expensive than gas supplied via Nord Stream 1.

Fortunately, the U.S. is in a position to assist, as its LNG export capacity has grown rapidly since 2016. According to the U.S. Energy Information Administration, the U.S. has become the world’s largest exporter of LNG so far this year, and it has potential to expand further once new capacity comes on line by the end of this year.

Global Energy Shortage is Not Improving

Beyond this, the U.S. and EU need to recognize that the global shortage of energy that surfaced last year (which The Economist called the “first big scare in the green energy era”) is not going away. It noted that investment in alternatives was well below the estimated $4 trillion – $5 trillion needed to meet the Glasgow Summit target of becoming net carbon neutral by 2050. 

Since then, the problem has become more acute owing to Russia’s actions and a host of factors in the U.S. that have caused fossil fuel plants to close faster than green alternatives can replace them.

A potential breakthrough last week was the proposed legislation brokered by Sens. Chuck Schumer (D-N.Y.) and Joe Manchin (D-W.Va.) that revive parts of the Build Back Better bill. The proposal would allocate $369 billion to climate and energy programs, including tax credits for buying electric vehicles and incentives to accelerate wind and solar farms and to store output of large-scale batteries. In return, Manchin garnered provisions that benefit fossil fuel companies that require the Interior Department to offer them millions of federal acres onshore and offshore over the next decade.

Nonetheless, while proponents have hailed the proposal as the most important climate change legislation of in U.S. history, it will take considerable time to reap the benefits of the plan if it is enacted. 

What Can be Done to Alleviate the Energy Shortage in the Near Term?

A proposal being floated by Treasury Secretary Janet Yellen would cap the price of Russian-sourced oil both to tackle inflation and to ensure Russia does not benefit from higher prices. For this idea to work, a critical mass of market participants would have to go along with the terms. So far, China and India—the key buyers of Russian oil—have not been willing to abide by existing sanctions on Russian oil, because they already benefit from a $30-$40 a barrel discount. Now, Yellen is asking them to exert greater market influence, hoping that Russia will agree to the lower prices.

The editors of The Wall Street Journal, however, are skeptical that Putin will acquiesce. A recent editorial warned that he could retaliate by reducing exports, and it argues that the better way is to boost Western energy production. It criticizes the Biden administration for imposing regulations to limit U.S. oil and gas production while threatening oil companies if they don’t reduce gasoline prices.
 

The West Will be Tested

Weighing all that has happened, my take is that policymakers in the West now face one of the most difficult challenges in the post-war era. Previously, they had to trade off the goal of tackling climate change through environmental regulation with the need to support economic growth by assuring there are adequate supplies of energy.

Now, a third policy consideration has come into play in the realm of national security. Putin’s actions indicate that he is willing to broaden the conflict into the economic sphere and test the capacity of the West to support Ukraine. It should be readily apparent by now that the West must be prepared for a long-term struggle.
 
 

A version of this article was posted to Forbes.com on August 5, 2022.


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nick sargen

Nick Sargen

Senior Economic Advisor
Nick is an international economist, global money manager, author, and contributor on television business news programs. He earned a PhD and MA from Stanford University and BA from UC, Berkeley.

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