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Q&A: S&P Global’s Roger Diwan on how oil and gas prices are rebalancing global energy dynamics

18 May 2022 Kevin Adler

Refined products and natural gas prices have spiked in Europe to more than double their levels of a year ago, and all predictions are that markets will be tight at least through the end of the year. Brent crude was $60/barrel in January 2021, but it's projected by S&P Global Commodity Insights to average $105/barrel in 2022.

Volatility in the fossil fuel markets can be attributed to many factors, including strong demand coming out of the COVID-19 recession, supply recovering more slowly, and the shock of supply cutoffs related to Russia's invasion of Ukraine. In response to the invasion, a de facto embargo on oil, refined products, and natural gas from Russia by European nations is underway—accompanied by fossil fuel imports from other nations and a redoubling of investment in renewable energy.

"Energy security is rebalancing global energy and power dynamics," according to Roger Diwan, global energy to finance lead for S&P Global Commodity Insights.

Diwan says that distillate (diesel) markets will be the most affected this spring and summer, and then winter will bring tightness to natural gas markets as well. While the industry will seek to maximize production—both of refined products and natural gas—Diwan says that he expects governments to intervene on the demand side if tightness persists and prices stay high.

In this Q&A, Diwan discusses the impacts of the current fossil fuel crunch on prices, how carbon emissions are adding to the challenge, and what implications lie ahead for clean technology investments.

Net-Zero Business Daily: What is the supply-demand situation today? What markets are most stressed?

Diwan: What's happening right now, not only in Europe, but globally really, is that we are close to capacity limits for refiners and their ability to meet the seasonal surge in demand for refined products. We see this acutely for distillates. When this happens, it means that demand will not be met, and shortages will appear.

Stocks are already low, prices are already high, and some areas in the world are likely going to be short of distillate at certain times, or not able to afford it. In general, when this happens, those with difficulty accessing markets, as well as those that cannot pay for it, will curtail their demand. For Europe this is a novelty, not so much in emerging markets.

Net-Zero Business Daily: Which areas are vulnerable?

Diwan: Eastern Europe is vulnerable, Africa is vulnerable, Southwest Asia and India are also likely to see demand destruction. With trade flows disrupted due to the Ukrainian crisis, this has increased the dislocations in global markets for refined products.

Russia is a key player, and the self-embargo by important buyers is redrawing flows and prices. Europe as a whole can afford to buy distillate from other places if it is available, but redrawing supply routes takes time. US distillate will increasingly find its way from US Gulf Coast refiners to Western Europe to replace Russian imports, instead of going to Latin America, for example. Sending Russian distillate away from Europe will occur, and maybe will reach Latin America and Africa, but probably the overall volumes will be lower. We expect this to become a more globalized phenomenon this summer and see real shortages.

Net-Zero Business Daily: What can be done?

Diwan: There's no easy solution to rapidly change the trajectory of supply, so demand will take the brunt of the adjustment.

I think European governments are aware of it, and they will do something as it happens, depending on where and how much it happens. That could mean demand management, but in what form? Does it mean a form of managed rationing, does it mean voluntary measures, does it mean [imposing] alternate driving days or restricting speed limits? Or will it be left to the market to sort it out?

High prices could bring down demand, but also mean economic dislocation. At the end of the day, we will have to manage our way through it.

For supply, there is not much that can be done in a short time. In the US and Europe, we've been rationalizing the refining portfolio, shutting down refineries in the last three years. That capacity is lost. Those marginal refineries [with high costs, high emissions, and low profitability] can't come back online. Marginal refining capacity is effectively in China, but the government is not allowing exports of distillates. This is part of a longstanding policy to constrain their own marginal refineries, and to manage down the carbon emissions from the refining sector.

You will probably have localized shortages of diesel in the US too, with inventories at 30-year lows. There are reports of truck stops not having supply or being re-supplied infrequently. The diesel market between the US and Europe will have to arbitrage the supply that's available. You have to manage the flow between different areas.

Net-Zero Business Daily: What about natural gas?

Diwan: This started last summer in Europe, when inventories were not rebuilt [to historic norms]. Russia didn't refill its capacity in Western Europe; the storage that Germany has now nationalized. Last summer was a time of high demand for power and low output from wind, so natural gas use was high. If Russia cuts off part of its gas exports to Europe, as it already announced for Poland and Bulgaria, and now part of Germany, then the question is who will get rationed, and how much? Each country will [behave] slightly differently, but we will have these types of outcomes all over Europe this year. This is why gas prices are staying very high despite a good refill of stocks right now.

Net-Zero Business Daily: How can the natural gas tightness be solved?

Diwan: The US is moving as much LNG as it can to Europe to replace Russian supplies. If the winter is mild, that would help. But if Russia doesn't supply all the gas it normally does, which is our assumption, you could be looking at shortages. Governments will have to step in and decide who gets cut in Europe, [and] they will probably focus on industrial demand. I think it's very likely that governments will intervene to manage prices as we see shortages.

Net-Zero Business Daily: In addition to demand response, we've seen European governments say that they will accelerate clean energy investments. What impact will this have?

Diwan: High oil prices and a renewed commitment to the energy transition as the ultimate path to energy security will decelerate gas demand in the medium and long term in Europe. They will also stoke the fires for electric vehicle penetration and accelerate R&D and market development for alternatives such as sustainable aviation fuel where available. I don't see this happening overnight, but we are seeing the emergence of strong headwinds that could shift European oil and gas demand lower by 2030.

Net-Zero Business Daily: Do you see private investors pushing harder in cleantech under the current circumstances, or will they be looking at the shorter-term opportunities in fossil fuels?

Diwan: Opportunities in cleantech, renewables, and hydrogen are growing. And opportunities in fossil fuels too. This is an environment that will be favorable for energy investors as high prices and disruptions have revealed the need for more energy investments, and to match the decarbonization agenda to the energy security agenda.

Posted 18 May 2022 by Kevin Adler, Chief Editor



This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.

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