Horizon | June 2022

HORIZONS

The Big Ban

Global commodities in a post-Ukraine-war world

June 2022

Massimo Di Odoardo, Vice President, Gas and LNG Research Natalie Biggs, Global Head of Thermal Coal Markets Alan Gelder, Vice President, Refining, Chemicals & Oil Markets Ann-Louise Hittle, Vice President, Oils Research Peter Martin, Director, Macroeconomics

Irreconcilable differences: what happens if Russia’s ties to the West are severed?

The war in Ukraine is transforming energy and commodity markets. Oil prices are constantly above US$100/bbl and diesel has been at record premiums to crude, while global gas/LNG and coal prices are trading at all-time highs of up to four times their previous 10-year average. Commodity price volatility to-date since Russia’s invasion of Ukraine, however, has been the result of self-imposed sanctioning and fears of supply loss. The imposition of total bans on Russian imports will only amplify this.

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Conclusion: Rapid response required

Russia’s war on Ukraine has reshaped the commodities world and catapulted energy security to the top of the global political agenda. Energy trade flows are being transformed, investment in new LNG supply looks more compelling and the pace and cost of the energy transition is changing. Governments, companies and investors must respond. Governments - Countries with domestic hydrocarbon and critical mineral resources will need a twin-track approach: maximising production of their resources in the short term while stepping up investment in low-carbon energy supply to meet future demand in the long term. The huge challenges facing global supply chains can only be resolved by governments supporting strategic investments to overcome bottlenecks. Investors - Investment opportunities are widening. Energy transition investments will be more expensive, but higher commodity and power prices mean they remain competitive. European wind and solar looks a solid bet. Energy security priorities will ensure returns remain attractive for hydrocarbons and, increasingly, critical infrastructure. US LNG looks the most attractive option, capable of being delivered to market quickly and with limited capital exposure. However, the era of mega oil and gas projects is not coming back. Companies - Hydrocarbons will be tremendous money spinners for some time to come. We continue to see attractive opportunities for low-cost, low-carbon supply of oil and gas from the national oil companies (NOCs). But large-scale investment by IOCs in traditional oil and gas projects, as well as international miners in coal projects, will be increasingly displaced by growing investment in low-carbon energy projects. High and volatile prices will require a renewed focus on trading capabilities and fungible assets. Metals could be the next growth areas for cash-rich IOCs.

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Global commodities in a post-Ukraine-war world

August 2021

Implications for hydrocarbon investments

LNG could be the one truly compelling hydrocarbon investment option. The industry is champing at the bit to fill the European supply gap, and none more so than US developers. We now expect more than 50 mmtpa of new US LNG capacity will take final investment decisions over the next 24 months – could be twice that if Europe bans Russian imports by 2024 and US contracting momentum continues. But for other fossil fuels investors and stakeholders have legitimate concerns about the future trajectory of demand. They will want to understand whether OPEC’s spare oil capacity holders (Saudi Arabia, Kuwait and the UAE) will increase liquids production from their low-cost reserve base, despite recently showing political support for Russia – and to what extent China and India are prepared to increase domestic coal production to compensate for lower seaborne availability. Even the LNG opportunity may ultimately prove ephemeral, particularly if the EU and other countries get serious about net zero goals. Consequently, despite the hyperbole around high prices, many will stick to a familiar path: capital discipline and a focus on low-carbon, short-cycle, high-return opportunities.

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Massimo Di Odoardo

Vice President Gas and LNG Research

Massimo brings extensive knowledge of the entire gas industry value chain to his current position as Vice President of Gas and LNG Research. Massimo joined Wood Mackenzie in 2007 as a consultant, where he advised NOCs, IOCs and European utilities on global gas and pricing dynamics. He later transitioned to the research division, where he soon became the content lead for European gas, responsible for articulating our view on market fundamentals, pricing dynamics and corporate developments. Before joining Wood Mackenzie, Massimo worked in the strategy department at Eni SpA, where he was responsible for developing European and global gas scenario analyses to support strategic investments. Massimo is a regular speaker at conferences and remains deeply engaged with the industry. Travelling to see and discuss market dynamics with customers is at the heart of his job, enabling him to constantly challenge and evolve his own view of the global gas market.

David Brown, Head of Markets and Transitions, Americas Ram Chandrasekaran, Head of Road Transport Brian Mcintosh, Title

Plastic surgery:

Reshaping the profile of the plastics industry

Prices will inevitably rise should EU enthusiasm for banning Russian gas become a reality

LNG could be the one truly compelling hydrocarbon investment option

War has catapulted energy security to the very top of the political agenda

Oil and refined products: a global reshuffle, but limited net loss Russia’s oil exports have continued to flow, though buying patterns have shifted. Even with an EU ban on most Russian crude and refined product imports by the end of the year, we expect the global market can handle this without an extreme effect on oil and refined-product supply and prices. The EU and UK imported 2.4 million barrels per day (b/d) of Russian crude in 2021, but a myriad of self-sanctions and embargoes have already prompted buyers to for alternatives. Russia has successfully enticed buyers elsewhere to import discounted cargoes. In April, its exports to India increased by 750 kb/d. Consequently, an outright ban on EU Russ ian imports merely accelerates a reshuffling of the crude and refined products trade that has already started. Perhaps the biggest risk to long term Russian oil production is the loss of access to western partners, technologies and services. Russia needs to keep its oil and gas flowing. With limited access to capital and drilling technology, our analysis suggests that by the end of this decade Russian oil production could be two million b/d lower than our pre-invasion outlook. And by this time, Russia’s refining runs could be down by 500 kb/d, reducing diesel/gas oil exports by only 165 kb/d, holding up at 85-90% of our previous estimate. Unlike crude oil, diesel exports will remain broadly stable over the decade. We have already cut our pre-invasion forecast for Russian 2022 crude production by 1 million b/d. Whether these losses in supply will heat up the global market by the end of the decade will ultimately depend on demand. Higher prices and slower economic activity are already denting demand growth expectations. Our analysis suggests 2030 global oil demand could be a full 2 million b/d lower than our pre-invasion forecast. But while lower demand will temper market tightness, prices will remain lofty: a new, less efficient, trade equilibrium means prices will stay at present levels before coming down. Further out, prices will still be higher than our pre-war view, with Brent only pulling back towards US$85-90/bbl by 2025 and European refining margins remaining higher through to 2030.

Gas: Europe goes on an LNG spending spree Despite the challenges, Europe has already dramatically reduced its dependence on Russia gas, as record gas prices trimmed demand and facilitated an unprecedented wave of LNG imports. As a result, the EU is set to import only 90 bcm of Russian pipeline gas in 2022, a stark reduction from the 140 bcm it imported in 2021. A positive scorecard so far, but additional cuts will be harder to achieve over the next few years. High prices have already forced thermostats down, maximised the use of coal and put energy-intensive industries out of business. The EU has pledged to spend hundreds of billions on renewables, low-carbon hydrogen and energy efficiency to reduce demand by another 150 bcm, but little of this will come by the end of 2024. Our Strategic Planning Outlook features a steady reduction in Russian imports in line with existing contracts (some of which extend beyond 2030), and a softening of prices. It has been precisely the risk of Russian supply disruption that has pushed traded prices north of US$30/mmbtu in recent months. Prices will inevitably rise should EU enthusiasm for banning Russian gas become a reality ahead of the next wave of new LNG supply after 2026.

Perhaps the biggest risk to long term Russian oil production is the loss of access to western partners, technologies and services

Source: Wood Mackenzie

The trillion-dollar offshore wind opportunity

Offshore wind is poised to become one of the key technologies powering the decarbonisation of the global economy. The technology is proven and investors have confidence in it. Costs fell 50% between 2015 and 2020 and are expected to fall further. In December 2021, the world’s first fully non-subsidised contract for an offshore wind project was awarded in Denmark. It’s not just about cost; it’s also about location. Offshore wind has strong public policy support as another source of large-scale, carbon-free generation in land-constrained areas or regions with less attractive solar irradiance or onshore wind resources. Consequently, sectoral growth is set to explode. We project that US$1 trillion will flow into the offshore wind industry over the next decade. By 2030, we expect 24 countries to have large-scale offshore wind farms, up from nine today. Total installed capacity is likely to reach 330 GW, up from 34 GW in 2020. By 2030, as much money will be invested in offshore wind as in onshore wind. There is further upside potential to our outlook, too, such as Europe’s accelerated push to capitalise on offshore wind and other renewable technologies to reduce its dependence on Russian gas and coal. Similarly, competitively priced offshore wind is likely to play an important role in powering electrolysers to produce hydrogen, so some of its growth will be tied to the scaling up of the green hydrogen industry. The opportunity in offshore wind has not gone unnoticed and is attracting a growing number of competitors. As bidders flock in, Wood Mackenzie has come up with a new competitive framework to assist offshore wind players in determining the capabilities and competencies they need to improve their chances of success around the world. The framework sets out which bidding parameters will be important when and where in a rapidly changing market.

We project that US$1 trillion will flow into the offshore wind industry over the next decade

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Missed our previous editions of Horizons?

Higher international prices are pushing China and India to double-down on domestic developments

Alan Gelder

Vice President Refining, Chemicals & Oil Markets

Alan is VP Refining, Chemicals and Oil Markets, responsible for formulating our research outlook and integrated cross-sector perspectives on the global downstream sector. Alan joined the business as part of our Downstream Consulting Team in 2005 and later went on to lead the division. He has managed consulting assignments all over the world, focusing on major transactions (projects and M&A) and their alignment with key success factors for industry players and third parties. He then transitioned into research upon his return to London from Houston in 2011. Prior to joining Wood Mackenzie, Alan spent 10 years as an industry consultant after working for ExxonMobil in a variety of project planning and technical process design roles.

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Europe’s energy dependency on Russia

Energy prices

Coal: if you’ve got it, you’ve got it With an EU ban already announced for October, ARA prices have been trading at historical highs of more than US$350/t, a 300% increase from last year. Since the invasion of Ukraine, European buyers have been steadily negotiating long-term contracts with alternative coal suppliers, reportedly paying above spot prices at times. European coal imports doubled in April as supply was redirected from other markets. Europe’s scramble to acquire long-term contracts has inadvertently shifted more of the shortage ‘pain’ to Asian markets, with local buyers struggling for spot cargos to ensure adequate stockpile levels amid the increasingly short seaborne coal market. Coal prices in the Pacific continue to rise and are now well above ARA, at over US$400/t Newcastle 6,000 Kcal. Higher international prices are pushing China and India to double-down on domestic developments. As top consumers and producers of thermal coal, each has tremendous sway over the global market. They will both seek to reduce exposure to the more volatile import market by increasing cheaper domestic production, which will ease demand pressure on the seaborne market and reduce prices. Our post-war view considers a managed reduction in Russian coal imports in Europe, with prices softening as some Russian coal is absorbed in Asia. However, full implementation of the EU ban, followed by similar action from Japan, would require an increase in alternative supply. Amid environmental, social and governance (ESG) concerns and reduced access to capital, seaborne coal supplies have become less responsive to higher prices – particularly for the high-quality coal segment. As a result, global coal markets will remain tighter for longer, keeping prices higher than our pre-war view in the near term. ARA prices are expected to end the year at around US$250/t and remain well above last year’s levels until after 2024 as the market rebalances.

Metals: the answers lie in China Kicking the Russian metals habit will be hard. Russia produces typically 3% to 6% of global metals supply and significantly more of the world’s palladium and high-quality iron-ore pellet feed. Metals prices spiked following Russia’s invasion of Ukraine, with mounting concerns about supply disruptions from sanctions and bans adding fuel to the fire. The knock-on effect of high energy prices on marginal supply costs has kept some metal prices high. Yet despite self-sanctioning, demand for Russian metals remains robust, albeit at more modest price premia. The effectiveness and implications of a future ban on Russian metals hinges on two key questions. First, will non-sanctioning countries absorb Russian supply and refined output? And, if not, can global supply chains function while alternatives are developed without an extended period of shortage? The answers are likely to come from China. The country could readily absorb Russian metals if they were banned in western markets, but Europe and others will want to ensure that ‘washed’ Russian metal – processed and used in manufactured goods by China - doesn’t simply find its way back in. Alternatively, China could secure raw-material feed from Russia for its dominant smelting and refining sector and leave western markets facing supply deficits and higher prices. If, however, Russian metal was shut out of the global system with minimal redirection to alternative markets, this would very quickly lead to even greater deficits and higher prices. Markets would remain tight for several years until new supply was developed.

The answers are likely to come from China. The country could readily absorb Russian metals if they were banned in western markets

How war is transforming the energy transition

Some governments have accelerated their decarbonisation strategies in response to the war. The European Commission’s hastily published REPowerEU plan has set a goal to rapidly reduce its reliance on Russian imports by increasing its renewables target to 45% by 2030 – 15% higher than Fit-for-55 and more than double today’s capacity. Others will follow, along with increased policy support for innovation and investment in the emerging technologies needed to accelerate the energy transition. Hydrogen, carbon capture and storage (CCS) and long-duration battery storage stand to benefit. This is heaping pressure on already stretched global supply chains. Costs for solar and wind-turbine components are already being driven up by higher-than-anticipated demand, although the level of cost increase pales in comparison to what’s happened to coal and gas prices because of the conflict. We are also seeing a scramble for the metals to build out electrification, potentially compounded by reduced exports of critical metals from Russia. The pace of the energy transition might be getting bolder, but it is also getting more expensive. There is also a risk that an accelerated energy transition could prove more carbon intensive. As coal rebalances more quickly than gas, coal demand remains resilient, particularly in those markets able to leverage cheap domestic resources, such as China and India. Consequently, coal could rival gas for the role of the transition fuel in some emerging Asian economies as investment in renewables ramps up. Further, replacing Russian metal supplies could also prove more carbon intensive. Indonesian nickel, for example, is produced and refined using coal, while Russian output is powered by hydro, nuclear and gas.

Global CO2 emissions: Strategic Planning Outlook vs Russian import ban scenario

Source: Wood Mackenzie

The global economy: pragmatism rules

As discussed in our April Horizons, Russia’s rapid isolation from many of the world’s major economies is hugely disruptive. But Russia will not become a pariah - its ample natural resources preclude this. However, no economy faces a greater challenge when it comes to substituting imports and diverting exports. Asia will be key, but Russia may find avenues closed as some prefer not to swim against the current of much of the global economy. Pragmatism rules: the G7 plus remaining EU accounted for 42% and 38% of China’s and India’s exports, respectively, in 2021. China will put its own interests ahead of its ‘no limits’ friendship with Russia, while India walks the line between courtship by the west and historical ties with Russia. This isn’t the end of globalisation, but it is a structural shift as global trade becomes more regionalised and increasingly defined by politically aligned trading blocs. And while some stand to gain from import substitution, most notably Southeast Asia, Africa and South America, the net economic impact is negative. Wood Mackenzie estimates that a cumulative US$9.3 trillion could be wiped off global GDP by 2030.

Wood Mackenzie estimates that a cumulative US$9.3 trillion could be wiped off global GDP by 2030

It is scant consolation when emissions can be curbed only by restricting improvements in global prosperity and living standards

Russia’s invasion of Ukraine was a geopolitical quake that will reverberate for decades. Europe is at the centre, its relationship with Russia now seeming irrevocably broken. War has catapulted energy security to the very top of the political agenda. Europe’s highly public commitment to wean itself off Russian energy is beyond the point of no return. Every alternative is now on the table. Those with domestic hydrocarbon resources will look to fast-track production, while many will increase investment in low-carbon energy supply, even as tighter supply chains push up costs. The precise timing and implementation of future bans on Russian commodity imports are difficult to predict. But it is inconceivable that Europe and its allies will abandon their diversification strategies and return to any meaningful dependence on Russia. A rewriting of energy trade flows is now underway, with Russia inevitably looking east for alternative markets. The din of Asia’s economies has long been music to the Kremlin’s ears, but buyers can never be taken for granted. China and India will look to benefit from discounted Russian imports, but they will also want to protect their access to European and US markets. There is, therefore, a real risk of some global supply being lost. Moreover, the divide between ‘the west’ and non-aligned countries could deepen, curtailing global trade and worsening supply-chain tightness. With the world entering a new geopolitical paradigm, fresh thinking is required. In this month’s Horizons, we consider the consequences of the war for commodities and look at how governments, companies and investors must respond as the outlook for energy and metals is transformed, investment opportunities widen, and the cost of the energy transition rises.

For this edition of Horizons, we assume the following developments and bans come into play. We then use our integrated analysis to consider these consequences of the war over the next decade and compare this to our base case Strategic Planning Outlook:

A ‘war without end’. Low-intensity conflict in Ukraine drags on for years, keeping tensions high between Russia and ‘the west’. The European Union will ban Russian coal from mid-August 2022. This will be followed by the European Union’s ban on most oil and refined products by the end of the year. Banning Russian metals will increase energy transition costs, but Europe is unlikely to allow exceptions. We assume an EU ban by the end of 2023. A sudden ban on gas would usher in recession for Europe. But through its REPowerEU plan to accelerate renewables, manage demand and add LNG import infrastructure, the EU could press for an earlier ban; we assume end 2024. Asia is split. Japan and South Korea will follow Europe (and the US) and ban Russian commodities. China and India will look to benefit from discounted Russian imports, but pragmatism will rule - both will want to maintain good relations with key export markets. GDP growth will slow and, in tandem, global energy demand.

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Energy prices: Russian ban scenario vs Strategic Planning Outlook (% increase)

Source: Wood Mackenzie

These upward pressures on emissions will be offset by the consequences of slower economic growth. Even with coal holding its own in Asia, weaker overall energy demand growth should set the world onto a lower CO2 emissions trajectory. It is scant consolation when emissions can be curbed only by restricting improvements in global prosperity and living standards.

Natalie Biggs

Global Head of Thermal Coal Markets

Natalie is the global head of Wood Mackenzie’s thermal coal markets research for the Metals and Mining group. She has over 15 years of experience in the global coal and energy industry; authoring reports, forecasting markets and model development, and financial valuation of individual mining assets. Natalie joined Wood Mackenzie in 2007 and initially helped to develop short-term coal market forecasts. Her work quickly expanded to international markets and eventually led to managing our global coal markets products. She has played an integral role in the evolution of the Wood Mackenzie’s Coal Market Service products, providing product enhancements and driving integration across market sectors. Prior to joining Wood Mackenzie, Natalie worked in US-based coal research and consulting, gaining experience with linear programming models for forecasting US coal prices, supply and demand.

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Ann-Louise Hittle

Vice President Oils Research

Ann-Louise Hittle brings to Wood Mackenzie over 25 years of experience in analysing global oil markets. Her career began with Gulf Oil, where she focused on OPEC and markets in Asia. She then worked as a Middle East/Oil Markets research associate with Kissinger Associates and a Senior Oil and Gas Futures Analyst with Shearson Lehman Brothers. During her decades in the industry, Ann-Louise established an international reputation for her analyses of short- to long-term oil markets. Prior to joining Wood Mackenzie, Ann-Louise worked at Cambridge Energy Research Associates, where she was Research Head of the Upstream Oil Service with responsibility for world oil market analysis and writing long-term scenarios. After joining Wood Mackenzie in 2003, she directed the development of the Macro Oils Service, launched in April 2005, and led it until her promotion to Vice President. In addition to overseeing the oils research team, Ann-Louise is a frequent contributor to numerous industry publications and conferences, where she shares her trusted insights on the futures of oil markets. Ann-Louise's extensive experience and deep understanding of Middle East markets make her an invaluable member of the Wood Mackenzie team. With oil markets becoming more complex due to production cuts and the growth of renewables, her guidance helps our research team provide clients with timely, accurate market outlooks.

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Peter Martin

Director Macroeconomics

Peter joined Wood Mackenzie in September 2010, initially covering European energy markets before moving to the macroeconomics research team in 2011. Responsible for producing Wood Mackenzie’s macroeconomic outlook to 2050, Peter is experienced in forecasting key macroeconomic metrics such as GDP, Industrial Production, FX and inflation. Peter regularly develops macroeconomic scenarios and sensitivity analysis. Examples include Brexit, banking crises and trade wars. He has also contributed to consulting projects, assessing the economic impact of oil and gas development. An area of special interest is the fiscal stability of oil-producing economies in the Middle East and Africa. Before joining Wood Mackenzie, Peter was an energy analyst at Iberdrola for three years. In this role he was responsible for providing technical and fundamental analysis of European energy markets to the trading desk.

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Alan Gelder

Vice President Refining, Chemicals & Oil Markets

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