Energy sector strongly affected by Ukraine crisis

Energy sector strongly affected by Ukraine crisis

With events rapidly unfolding, energy comes to the forefront in the East-West conflict over Ukraine. 

The past weeks in Ukraine have once again shown a close correlation between extreme political volatility and energy markets.  As an immediate consequence of the Russian intervention in the Crimea, the price of crude oil has gone up by more that $2, and natural gas futures increased by 10%. At the same time energy companies involved in the Russian energy sector saw their shares being slashed by the stock markets.

Although markets quickly stabilized, long-standing effects of the Ukrainian domestic crisis and subsequent Russian intervention are yet to be assessed. For Ukraine and its energy sector, the result might be devastating. The country’s strategy of reducing energy overdependence on Russia by developing its own resources is now under question.

In the past two years Ukraine signed Production Sharing Agreements (PSAs) worth more than $20 billion with Shell, Chevron and ENI, while the signing of a PSA with Exxon Mobile was postponed due to recent political crisis. The PSAs envisaged explorations of Ukraine’s abundant shale gas reserves in the Western Ukraine’s Lublin basin and the Dnieper-Donets basin in the Eastern part of the country, as well as Black Sea hydrocarbons off Crimean shores.

However, due to regulatory and political insecurity after the deposition of president Yanukovich, and the likeliness of Crimea remaining under Russian control, it is highly unlikely that any activity in this direction will continue until the political situation becomes more clear for investors.

In addition, Russia’s gas giant Gazprom promptly announced the hike in the previously discounted price of natural gas. Considering that 90% of Ukraine’s commercial and heating gas supplies come from Russia, the decision will be a powerful blow to the country’s already kneeling economy.

The new pro-Western government in Kiev will most certainly, should it succeed to establish and stabilize its political position, continue to pursue the diversification of energy sources even more vigorously. With the favourable investment regime and the signed PSAs, diversification will include reviving plans to establish a reversing gas flow system coming from Slovakia, and the development of an LNG terminal in the Odessa area of the Black Sea.

The prolonged crisis is equally damaging to the global energy industry. Western oil companies doing business in Russia will be the first to experience Russian retaliation over the potential sanctions imposed by the West. Russia already made clear that confiscation of assets and property of Western companies is one of the options on the table.

Gazprom has lost 13% of its market value since the beginning of the crisis. Moreover, further escalation of the crisis could pose a potential threat to its regular distribution of Russian gas to Europe. This will immediately push LNG prices upwards globally. Also, should Europe decide to toughen its stance on Russia, the company can easily become a collateral victim over the EU’s antitrust charges and the status of the South Stream pipeline.

Finally, the worsening of the situation in Ukraine might affect Gazprom’s almost signed deal with China. The agreement to export natural gas to China is due to be signed in May, but CNPC might take advantage of potential disruptions in Russian gas supplies to Europe and try to negotiate additional price reductions. On the other hand, heightened tensions on its Western borders can also give Russia incentive to increase its energy presence in Asia.

Events in Ukraine could enhance other global energy trends, primarily affecting the US decision to liberalize the exports of its abundant shale gas reserves to Europe, and thus decreasing European dependence on Russian gas. EU’s East European member countries are particularly keen to see these developments occur sooner rather than later.

US natural gas exports will not solve European energy dependency in the short-term. Even if politics allow it, a turn to LNG imports from the other side of the Atlantic would require development of an expensive infrastructure over a long-term period, which would most certainly succumb to uncertainties of LNG markets. It is reasonable to assume that US producers would rather sell their natural gas in the Asian LNG markets where the prices and demand are much higher compared to Europe.

In addition, Russia will remain an important energy player in Europe for years to come. But the Kremlin’s reaction and behaviour over Ukraine will leave a deep scar in East-West relations, and similar to 2006 and 2009 when the continent experienced first-hand Moscow’s determination to use gas as a political tool, it will make Europe more resolved to reduce its energy dependence on Russia.

About Author

Ante Batovic

Ante was previously a lecturer in International History at the University of Zadar where he specialised in Cold War and East European history. He was also a visiting fellow at the LSE IDEAS centre and the fellow of the Robert Schuman Foundation in the European Parliament. He holds a master’s degree in Global Politics from the London School of Economics and a PhD from the University of Zadar.