Energy prices are not all down to Putin’s war - Ashley Kelty

It is a popular misconception that the surge in energy prices and its impact on inflation and the cost-of-living crisis is down to the Russian invasion of Ukraine.

Ashley Kelty
Ashley Kelty

In reality, the current situation has come around due to the culmination of years of underinvestment in oil and gas, political hubris, and the rise of ESG investment.Energy prices actually started to rise in 2021 – natural gas prices rose 400 per cent – triggered by increased gas demand for power generation due to the ‘wrong weather’ (in this case an anticyclone over NW Europe) meaning there was little wind, resulting in renewables making a negligible contribution to the wider energy complex – all before the first shot was fired in Ukraine. While the conflict in Ukraine has clearly made the situation worse – removing the world’s second largest energy producer from markets was always going to be painful – the increased demand for oil and gas will continue to outstrip supply for the next few years, thus ensuring prices will remain high.The lack of investment and development of oil and gas projects since 2014 is the primary driver for the situation, along with a misguided belief that renewable energy could fill the gap created by lower usage of fossil fuels. The energy crisis has shown that renewables are not contributing sufficiently to the energy mix to remove dependence upon fossil fuels and the need for energy security has been pushed to the forefront of the political agenda. Political hubris has been driven by the relative peace around the world since World War Two and the blithe assumption by policy makers that cheap energy could be sourced from anywhere in the world and that renewables could deliver all the energy we need. The current situation has shown that this is no longer the case, and examples of this folly include Germany becoming totally dependent upon Russia for its energy needs, and the UK closing its gas storage facilities.The underinvestment in fossil fuels started in 2014 when the oil price collapsed and exploration and development activity fell sharply. While activity has now started to return, the rise of ESG investing and the demonisation of fossil fuels led many companies to return cash to investors rather than invest in new projects. The pandemic also halted a lot of projects, and due to the long time to develop an oil and gas project, even if every identified project in the world was to start production tomorrow, there would still be a shortfall of more than one million barrels per day by 2024.The need for a switch to renewable energy sources is of paramount importance but it should be recognised that it will take decades to wean the world off its need for hydrocarbons. However, achieving net zero is never going to be possible without a major shift in people’s behaviour to reduce energy usage until technology catches up sufficiently to replace traditional energy sources. In addition, the ‘just transition’ will see developing nations having to develop fossil fuels in order to advance their economies to the point where they can substitute renewable energy sources for fossil fuels. This is less well understood by the environmental lobby, and they fail to appreciate that stopping fossil fuels immediately could condemn many developing nations, particularly in Africa, to a future of poverty with no obvious means with which to develop their economies.Unfortunately, high fuel prices are here to stay as it will take years to increase oil and gas supply and renewables capacity, and we can’t blame Putin for that.

Ashley Kelty is Director, Research Analyst, Oil & Gas at Panmure Gordon

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