1 April 2022

If Europe can last two years of an energy crisis, Russia will be the ultimate loser


Ukraine provided has given Europe a wake-up shock.

Until March this year, it was too easy to forget that power and energy drove industrial revolutions and propelled Europe into the modern age. Without energy security, most of us would remain subsistence peasant farmers living to the ripe old age of 36 before dying in excruciating agony from something like dirty water.

Suddenly we are having to deal with multiple energy threats. The crisis in energy costs is driving inflation, crushing consumers, and creating many negative consequences. And we still don’t have effective energy transition and security strategies in place. 

For all the hot air at COP26, the absence of transition strategies – how we move from bad coal to clean renewables – is a massive political failure. The UK government still hasn’t gotten the message. Next week, or maybe next month – who knows – they will release a mind-numbing new energy supply strategy which will be long on solar power, offshore wind farms but less keen on on-shore because the Sir Bufton Tuftons of the Tory Shires don’t want their views spoilt.

In contrast, the investment market quickly cottoned on to the decarbonisation message and set out to arbitrage it. Savvy investors realised how making lots of noise about how green they are would attract clients’ environmentally-concerned money. Big money clambered on board the ESG bandwagon and bought every solar and wind farm they could find while holding back ‘evil’ funding for gas, oil or coal.

The result has been energy supply distortion and a very sub-optimal renewable strategy. Wind and solar are massively over-invested. Why? Because they are proven, easy to understand and sell internally. They are seen to work. The glossy financial models look great at investment committee meetings. Meanwhile, other more promising and more reliable technologies, especially tide and hydro, have been dismissed because they look more ‘difficult’ and expensive. Well, maybe, but any new tech is expensive in its early phase!

Although gas is massively less polluting and cleaner than coal and has to be a critical part of any sensible, considered long-term transition strategy for decarbonisation, no ESG ‘woke aware’ investor will fund gas. It will not earn green points. 

The result is we are under-invested in the right energies. We are discovering the brutal reality that well-presented financial models of wind farm returns have dramatically over-estimated their reliability and under-estimated their off-time, the reality of maintenance, the weather and their repairability – especially at sea. Likewise, solar farms are degrading faster than expected.

An ‘Energy Shock’

The second issue has been the failure of Western governments to anticipate the ‘Energy Shock’ that economic war with Russia has delivered. Over the past few years, Germany made the critical mistakes of closing nuclear and assuming Russian gas supplies would be steady and non-political. The UK didn’t bother maintaining a strategic gas reserve making the flawed assumption perfect markets would ensure supply. It was a lesson we learnt back in 1973 with the Oil Shock. We got complacent and forgot, which is hardly unusual over the span of human history.

And whatever the West thinks about how Russia is being beaten or how much damage the economic sanctions are inflicting, the brutal reality is Putin holds a powerful hand. He has energy leverage. He is betting Europe’s economies will be forced to concede his Ukraine land grab because they won’t be able to withstand years of energy crisis and shortages wrecking their economies. 

The impact is being felt already and a European recession is now a distinct possibility. It will take two years to build the LNG terminals to distribute the gas Germany intends to import from Qatar. There is only so much the USA will be able to do to prop up European energy needs in the medium term. The 1973 crisis gave immediate power to the Gulf States and empowered OPEC to become the West’s nemesis as it set the energy price agenda. Ultimately the West had no alternative but to adapt to higher oil prices and accept OPEC. We can’t give Russia similar control. 

A second critical point is energy insecurities can be rectified given time. If Europe can last two years of an energy crisis, Russia will be the ultimate loser. You soon learn who your friends are when gas prices go through the roof. It will change how we perceive other power blocs and how globalisation evolves. When Russia loses, good luck to the Gulf and India trying to regain favour.

In contrast, climate change will prove a much slower tectonic shift moving through the global economy, but it will change the foundations of economies far more fundamentally in the long-term. Decarbonisation – even during an energy crisis – remains critical.  

There also seems to be an assumption that battery technology will somehow solve everything as a renewable solution. No. It will not. Batteries only store energy. They do not create it. Any car battery is filled with energy at least 60% generated from carbon sources.

Suppose you weigh the carbon costs and energy transformational inefficiencies of current lithium batteries and the environmental damage done by mining and eventually recycling them. In that case, the actual contribution of lithium batteries to decarbonisation is questionable. I am not a fan of Lithium EVs. This is the year the bubble will burst when the spiralling costs of lithium cause an EV cost crisis. But we do need to think about how to decarbonise transport.

Going nuclear

Ultimately, I believe the West needs to invest in relaunching nuclear power. Extending the life of current design nuclear plants, building new hybrid nuclear power alternatives like mini-nukes, and putting in a monumental collective effort to innovate fusion as the paradigm shift into long-term energy security to transform our future.  

The problem is largely driven by policy, or the lack thereof. We need a grown-up strategy on energy transition and security. Thus far, the UK government is long on statements but has consistently failed to deliver a plan. I am, however, heartened to read the UK has just appointed a senior BP executive to advise and assist on the ‘UK’s transition to a low-carbon economy, while prioritising efforts to increase the UK’s clean energy independence by increasing home-grown energy and renewables’.

The press release then goes on to blag about:

While the UK’s reliance on fossil fuels continues to fall, there will be an ongoing need for oil and gas over the coming decades while we ramp up renewable energy capacity, as recognised by the independent Climate Change Committee. The UK government is clear that we cannot have a cliff edge where North Sea oil and gas are abandoned overnight. Turning off the taps would put energy security, British jobs and new industries like hydrogen and Carbon Capture and Storage at risk – and we would be even more dependent on foreign imports.” 

However, it still feels like there is a bureaucratic fug hanging over UK policy – where easy solutions get approval, but better, more reliable, but more difficult alternative renewable energies like tidal power (predictable as clockwork) have been largely ignored. ‘Too difficult’ is an easy way to dismiss solutions. 

Many people question the wisdom of putting too much reliance on a single technology like nuclear, arguing we’d be better to diversify energy sources. I agree – so let’s have more of everything: wind, solar, tide, geothermal and nuclear.  

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Bill Blain is market strategist and head of alternative assets at Shard Capital. He writes a daily market commentary called The Morning Porridge (www.morningporridge.com).

Columns are the author's own opinion and do not necessarily reflect the views of CapX.