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Global recession fears hurting European energy

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The outlook for Europe’s economic growth continues to deteriorate with the combination of tightening monetary policy, high interest rates, high inflation, and concerns about the supply and cost of energy.

At the same time, China’s economy is still hampered by Covid-19 restrictions and its deteriorating property sector, with GDP growth down to 0.4% during Q2 2022.

The US economy shrank for two straight quarters in 2022, putting it into a ‘technical’ recession.

All of these are affecting global energy, especially in Europe.

Global recession fears are bringing S&P500, Dow Jones and FTSE down to record lows into bear market territory, while the FTSE has reached its lower level so far this year.

In addition, major central banks are expected to remain aggressive with interest rate hikes, weakening economic activity, hastening recession, and already impacting the short-term demand outlook for crude oil.

Impact on the oil market

The tightening of US monetary policy will continue to support the US dollar, which is putting further pressure on the economies of other countries because it is making dollar-denominated commodities more expensive.

Buyers using other currencies must spend more to buy crude – hence the slowdown in demand and drop in prices.

This and the threat of recession have brought the Brent crude price down to $86/barrel.

OPEC is producing well below its targeted output – down to 29.65 mln bpd in August – but it still expects world oil demand to grow by 2.7 mln bpd in 2023, to 102.73 mln bpd – well above pre-Covid levels.

Many experts expect the price of oil to rebound during Q4 2022 and Q1 2023.

As sanctions on Russian energy tighten in response to the ongoing war in Ukraine, global supply could be further limited.

As a result, many of Wall Street’s biggest banks are predicting a rebound in prices during the fourth quarter of this year, especially if steady demand and low inventories continue.

Oil prices are expected to surge as the EU prepares to implement sanctions on Russian oil in the coming months.

While some of the EU’s Russian oil imports will be diverted to other countries, China and India taking most of its crude, but not all will.

Russian oil exports will decline, and filling the void in the oil supply could prove difficult, sending prices up.

Global oil flows are changing as Russian crude moves east, ahead of the coming embargo on Russian oil.

Meanwhile, the fuel and oil flowing from the Middle East and Asian producers and the US to Europe are increasing to cover the shortfall.

But Europe is coming out of it worse off. Russian oil going east is cheaper than oil coming to Europe, hurting Europe’s competitiveness.

The risk of a supply shock grows as China’s economy re-opens while the European embargo on Russian oil comes into effect in December.

The US will need to refill its SPR at some point because it is depleting.

US oil and gas production growth is moderate, and permitting challenges make it difficult to build the pipelines to take increasing production to the coast for export.

Supply shock

Industry executives are saying the US will not be able to bail Europe out with oil or gas shortages, making the situation bleak.

A supply shock will likely come to Europe if the US cannot help.

The EU has begun discussing a price cap on Russian oil, in addition to the embargo.

US senators are pushing for increased sanction pressure on Russian crude buyers to ensure the other price cap, agreed to by the G7, works.

If any or all of these efforts succeed, Russia will likely respond, as it said, by stopping oil sales to those implementing the price caps.

This would mean even less oil in the market, sending prices sky-high.

When the CEO of Aramco said last week that years of underinvestment had damaged the balance between supply and demand in the oil market, it should have been a wake-up call to those in decision-making positions, but that does not appear to be the case.

It seems many in positions of power are oblivious to this threat.

At congressional hearings in the US, banks were asked whether they had already devised strategies for exiting oil and gas investments.

The answer given by Jamie Dimon, ex-CEO of JP Morgan, was blunt: “That would be the road to hell for America”.

The evidence is right there in Europe.

For all its efforts to convert to the lowest emitter in the world, Europe thrived not on cheap solar and wind but cheap gas and abundant oil.

Now that these are gone, European economies are beginning to fall apart, with no clear way forward for a while yet.

The OPEC+ production shortfall is not all a result of conscious action but a lack of investment over many years, under pressure to divest oil and gas.

This means it would be almost impossible to make up for this shortfall for some time to come. Avoiding a supply shock in oil would be difficult in such circumstances.

UAE industry minister Dr Sultan bin Ahmed Al Jaber highlighted the dangers of fossil fuel underinvestment, as world spare capacity is less than 2% of demand.

He said: “If we under-invest in the energy system of today before the energy system of tomorrow is ready, we will only make matters worse.” Wise words.

Analysts expect a much higher oil price by year-end, with some expecting it to be as high as $120/barrel.

UBS forecasts this to reach $125/barrel in 1Q 2023, while Bank of America sees Brent averaging more than $100/barrel in 2023.

Dr Charles Ellinas is Senior Fellow at the Global Energy Center, Atlantic Council

Tw: @CharlesEllinas