We are entering a world where renewables will make up an increasing share of our electricity supply –the electricity sector was the leading sector for energy investment in 2018, the third year in a row that this has occurred.
This trend is set to continue. In WEO 2018’s New Policies Scenario, 21% of global electricity production is projected to come from variable renewables by 2040, up from 7% in 2018, supported by about $5.3 trillion of investment. The EU share is even higher at around 39%. In our more ambitious Sustainable Development Scenario, which aims to get energy system emissions down to levels consistent with the Paris goals, variable renewables are projected to supply 38% of global electricity in 2040 (44% in the EU), a level that would require nearly $8.5 trillion of generation investment.
Regardless of scenario, this rapid expansion of renewables will inevitably lead to particular challenges to operating power systems. This is best highlighted by the so-called duck curve, made famous by the California ISO.
The curve was developed to show the impact of increasing distributed solar PV capacity on the demand for grid electricity. As solar PV capacity grows, the demand for grid electricity falls during the day with the greatest decrease in the middle of the day when PV production is highest – the belly of the duck. In the afternoon as PV production declines towards sunset, the demand for grid electricity can grow quite quickly – the neck of the duck.
The duck is growing faster than anticipated. Five years ago, the California ISO had expected California midday demand to drop over 40% on a sunny spring day by 2020 thanks to the growth of small solar PV systems. In fact, by 2018, the spring mid-day demand on the high voltage system had already decreased by two thirds. The consequent increase in supply required in the late afternoon as solar production recedes, was already close to 15 GW, significantly greater than the 2020 anticipated level of 13 GW.
The result is that some excess supply needs to be curtailed to balance the system. While the percentages of solar and wind production that have to be curtailed in California are rather small, in other jurisdictions the share is more significant.
In China, for example, the national average for wind curtailment was around 7% in 2018, with much higher levels in certain provinces. In the Canadian province of Ontario about one quarter of variable renewable generation in 2017 had to be curtailed, along with cuts in nuclear and hydropower output. This was in a jurisdiction where wholesale market prices were zero or negative almost one-third of that year.
The challenges are clear – a world with higher shares of variable renewable energy (VRE) – i.e., wind and solar PV – will face challenges with integration. This is a priority area of work for the IEA, and we are focused on providing insights on the issues and technologies that can be employed to deal with higher shares of variable renewables.
One of these insights is that renewables integration can be divided into a set of six phases dependent partly on the share of variable renewables in the system, but also on other system-dependent factors such as the share of storage hydro and interconnections.
Two countries have already reached Phase 4. Denmark, which has been a leader, has the significant advantage of strong interconnections to handle both surpluses and shortfalls. Ireland has much weaker interconnections and additional measures have been needed to ensure short-term system stability.
No country is yet in Phase 5 (where production can exceed demand) or in Phase 6, where seasonal storage solutions would be needed to match supply and demand.
Strong renewables policies are expected to continue to favour wind and solar power for the foreseeable future. This will mean that by 2030, we expect more countries, particularly in Europe, to evolve to these higher phases.
Too much of a good thing?
As more countries move to higher shares of VRE, it appears that there could be “too much of a good thing” – excess generation that may have to be curtailed and appears as wasteful.
The tendency is to treat this primarily as a technology problem for the power system to solve. Indeed part of the solution will lie in improvements in technology. We will need some form of energy storage to convert the excess at one time of day into necessary power system supply at another. Smart grids, especially smarter distribution systems, will be better able to manage increasing shares of renewables as well – and they too will likely have more energy storage. And finally, the growth of EVs (currently driving global battery demand) represents a huge potential source of storage and demand-side flexibility as well.
But treating this only as a technical problem is missing the economic perspective. Trillions of dollars of investment in renewables is expected in the coming years, and so there is a risk that billions of dollars of renewable electricity – zero marginal cost, zero carbon – could be wasted.
Economists have their own tools for solving these type of problems. Many would see not a problem but an opportunity – offering surplus electricity available at a zero (or low) price to customers during periods of surplus is a means to manage this surplus efficiently.
Dynamic pricing of wholesale electricity is often proposed as a mechanism to efficiently manage peak demand of electricity – to charge more when electricity is scarce. Not surprisingly, passing on high wholesale prices as high retail prices has been met with customer resistance, and the uptake of dynamic pricing has been rather limited.
However, if low wholesale prices were passed on as low retail prices, we would expect customers to be more accepting. While most small customers might not be expected to respond on their own, low dynamic prices create opportunities for innovators to develop technologies and processes that would make it easy and profitable for the customer to respond. Many of these will involve using the electricity to replace, at least in part, an energy service provided by fossil fuels. In this way, it can help hasten the decarbonisation goal of the clean energy transition.
Barriers to efficient pricing
Unfortunately for now, there are a range of barriers in our current policies that prevent electricity customers from seeing these prices: the level of electricity taxes, the design of electricity tariffs and more broadly our approach to the electricity demand side. This means there is a need to change outdated policies.
Much of our electricity policy dates from a period where wasteful consumption led to an increasing number of power plants – particularly fossil and nuclear plants. Indeed, electricity was considered to be a particularly inefficient means of achieving a level of energy service.
This has affected the way and level at which electricity is taxed, the way regulated prices are designed, and perhaps most challenging of all, how we address demand side policies and particularly electricity efficiency.
But now we are entering a different era, an era where most of the incremental electricity generation will come from wind and solar power. How should it change our taxation, rate setting and electricity efficiency policies?
Economics should guide us so that:
- Taxes are fixed in an efficient way, in order to distort as least as possible consumers and producers decisions
- Consumption is efficient, both through taxes and regulated tariffs
- Ensuring end-use energy consumption is carbon-efficient
Electricity taxes that exist in many countries today were set as a result of either a deliberate policy to reduce electricity consumption in energy importing countries (Europe) and/or environmentally conscious jurisdictions (Europe, California). They have also provided an easily enforceable tax base for municipalities and subnational jurisdictions. These taxes can be quite substantial, amounting to over half the cost of power for households in some European countries.
Yet many of the reasons for taxing electricity heavily are no longer valid. The emissions argument in particular makes little sense in highly decarbonised power sectors such as Sweden, France, or Switzerland.
In addition to taxation, pricing systems tend to discourage consumption regardless of how clean the production is. There are countries where, paradoxically, a high level of renewable penetration discourages the consumption of renewable energy.
Germany is probably the best known example. Although prices in the wholesale market can fall to zero when wind and solar power are particularly prolific, the end user cannot buy electricity at the real time price, but even if that were possible, it would mean paying the EEG payment (which is intended to recover the cost of renewables) which is currently 6.405 euro cents per kWh. This means that the end user incentive to use that renewable energy to substitute for fossil fuels in their own consumption is blunted.
What needs to be done instead is to encourage customer response based on the real-time price for power. Most other costs should no longer be recovered on a per kWh basis.
Getting prices right for the end consumer means also addressing regulated prices such as for networks where these are separately specified. Networks remain largely fixed cost entities in developed economies where demand has not been growing. For electricity customers, the value of the electricity network is as the provider of reliable electricity service – a value that is not directly related to the quantity of power delivered. Increasingly, as more and more customers generate their own electricity, the value of the network is evolving to become a platform to sell some of that power or other electricity services.
Moving towards a fixed charge would recognize the value of the network service for customers. It would also alleviate concerns that customers choosing to self-generate are not contributing sufficiently to the costs of using a network they still require.
Finally, demand-side policies should be designed in a way that minimizes both costs to consumers and their carbon footprint.
As renewables continue to grow and increasingly face curtailment, the optimal policy may no longer to be to encourage electricity conservation. Instead, demand side policies that encourage carbon conservation might be more efficient.
The figure above shows how the prices charged for consuming an additional kWh of electricity in each US jurisdiction is compared to the social marginal cost of producing that electricity. Red means the social cost of production exceeds the marginal cost, suggesting that marginal prices are too low and interventions such as conservation programs could be efficient. Conversely, in the deep blue regions, electricity prices are too high, suggesting that conservation and net metering programs need to be reconsidered.
Ultimately, when marginal prices for clean electricity consumption are adjusted downwards the viability of electrification increases – which can replace other end-uses of fossil fuels.
In fact, these changing circumstances are beginning to be recognized. The California energy regulator, the California Public Utilities Commission, has recently ruled that utility energy efficiency programs can include those that encourage customers to substitute electricity for fossil fuels.
More of a good thing
The good news is that the direction for electricity investments is positive, with the share of renewables likely to grow rapidly spurred by government policies and falling costs. Yet the resultant growth of wind and solar power will lead to new integration challenges for today’s power systems and these challenges will become greater over time.
Yet solving those challenges will also lead to economic opportunities in the energy system – opportunities to reduce costs, waste and emissions by making electricity available in substitution of fossil fuels.
Policies are central to realising these opportunities, by reforming electricity taxation, getting regulated prices right, and emphasizing carbon conservation above electricity conservation. The right price signals will encourage the innovation needed to advance the clean energy transition. And in the end, customers will have more of a “good thing”: greater access to cheaper, clean power.
Oil and gas geopolitics and its end
Let us see how oil barrel prices have really fluctuated in recent weeks: in April, in fact, the European and Asian Brent benchmark, in parallel with the US West Texas Intermediate (WTI), decreased by about 1 U.S. dollar per barrel a day.
The WTI, however, is a mixture of different light and sweet American crude oil and is refined especially in the Midwest and on the Gulf Coast.
The benchmark known as Brent, instead, is oil extracted in the North Sea and it has greater and faster access to large markets. It is therefore used as a common benchmark for the broader oil market, while the WTI is now used above all as a reference for the American market.
It should be noted, however, that in the previous month of March, the two benchmarks had fallen by 26.5 U.S. dollars per barrel and 24 U.S. dollars per barrel respectively.
In short, the imbalance in the oil market fully affected the March futures prices in particular, while the April fluctuations were mainly due to the OPEC plus agreement reached on April 2, setting the price at 26.03 U.S. dollars per barrel.
The breakdown in negotiations between Saudi Arabia and Russia led to a Saudi super-production – at first of 10 million barrels a day and then immediately of 12 million barrels a day – with a subsequent choice by OPEC to agree on a “fall” in the oil barrel price at 60 U.S. dollars, given the Covid-19 pandemic crisis.
A mistake, but probably a too classically macroeconomic forecast that does not consider strategic and internal competition assessments within OPEC, which are often essential to set prices.
Later the oil barrel price increased immediately to 34.44 U.S. dollars per barrel on April 9, then to 16.04 U.S. dollars per barrel on April 22 and finally closed at 25.04 U.S. dollars per barrel.
In mid-April the WTI opened at 20.48 U.S. dollars per barrel, then reached 28.26 U.S. dollars and finally closed at 19.29 U.S. dollars, after having also reached the negative and paradoxical price of -37.63 U.S. dollars per barrel on April 20, 2020.
Moreover, on April 14, the International Monetary Fund published a forecast from which it could be inferred that the world GDP would decrease by 3% in the remaining period of 2020, while on April 15 the International Energy Agency published its own analysis which estimated a reduction ofthe oil demand by 9,300,000 barrels per day by the end of 2020.
Hence the WTI futures for May delivery, immediately collapsed to -37.63 U.S. dollars per barrel. Here, however, the real problem is storage.
Short-term contracts do not envisage it at all.
In fact, as many industry analysts maintain, this caused the fall in prices.
It is no coincidence, in fact, that U.S. commercial oil stocks have risen significantly, from 469,193,000 barrels on March 27 to 527,631,000 barrels on May 24. Hence, in all likelihood, the U.S. ETF Oil Fund – which plunged by 15% in the April 27 session alone, after the announcement of major changes in the composition of its portfolio – has fallen due to unexpected overstocking.
In other words, the U.S. Fund has stated it plans to remove all WTI contracts expiring in June from its portfolio and replace them with longer-term contracts, with obvious immediate losses.
Therefore,the US Oil Fund will be broken down as follows: 30% of the portfolio will be WTI contracts expiring in July; 15% of the portfolio will be WTI contracts expiring in August; then contracts expiring in the following month up to the remaining 10% expiring in June 2021.
The losses of the U.S. Fund are now -87% since the beginning of this year.
The U.S. Fund has an estimated value of 3 billion U.S. dollars. A financial phenomenon that has made it similar to other funds specializing in oil futures.
It is clear that this behaviour has contributed to the bearish trend of recent months and this has certainly not favoured Donald J. Trump’s election campaign.
Furthermore, the WTI decline can also be explained by the structural logistical shortcomings that characterize the oil transport system within the United States.
Nevertheless, based on the ideas of the current Algerian Chairman-in-office, OPEC predicts that the oil barrel price will be equal to 40 U.S. dollars at the beginning of the third quarter of 2020 and that, in any case, the oil market will return to balance before the end of this year. A very unlikely hope.
The new OPEC plus plus agreement, however, entered into force on May 1, 2020.
The first phase of the agreement signed on April 12, 2020envisaged that all OPEC members plus the others would reduce production by 9,700,000 barrels a day until June 30, 2020.
At the beginning of May, the Russian Federation and Saudi Arabia brought their production to 8,750,000 barrels a day (with a decrease of 2 million barrels per day), with the further intention of bringing their output to the limit of 8,500,000 barrels a day.
The first phase of the bilateral agreement signed on April 12 also envisaged that the producers nor belonging directly to OPEC would “voluntarily” cut production by at least 5,000,000 barrels a day over the same period of time.
It should be recalled that these important non-OPEC producers include Norway, Canada, Brazil and, obviously, the United States.
Nevertheless, the non-OPEC total cuts have reached – with some difficulty – just 4,100,000 barrels a day.
Indeed, according to Standard & Poor’s calculations, the United States decreased production by as many as 11,600,000 barrels a day and only for the week which ended on May 8.
Hence a decrease of 1.5 million barrels a day, compared to the level of 13,100,000 barrels a day reached on March 13, 2020.
Therefore, for the first time since February 2019 the U.S. production has fallen below 12,000,000 barrels a day.
Moreover, on April 30, 2020, the U.S. strategic oil reserves reached 636 million oil barrels, compared to a total maximum capacity of 714 million barrels.
According to the Oxford Institute for Energy Studies, however, global oil demand will decrease by as many as 11,400,000 barrels a day throughout 2020, before slightly increasing by 10,600,000 barrels a day in 2021.
Despite all possible statistical tricks, however, the unemployment rate has currently reached 14.7% in the United States and it is rising quickly.
This leads to a fall of about 30% in U.S. oil consumption, but the Russian Federation records a 4-6% GDP drop at least until the end of 2020.
Moreover, on April 24, the Russian Central Bank cut rates by 50 basis points to 5.5%, while the Russian inflation rate is expected to rise by 4.8% until the end of this year.
According to data of April 30 last, China shows an increase in the composite index (manufacturing + services) from 53 to 53.4, while the index of services alone has grown from 52.3 to 53.2.
However, the index of Chinese purchases in the manufacturing sector alone has decreased by two points, while the CAXIN index – which measures Chinese private SMEs – points to a small recession.
Chinese oil imports in April, in fact – driven only by public enterprises – increased by 4.5% year over year.
Chinese imports from Saudi Arabia, however, decreased by 90,000 barrels a day while, despite U.S. sanctions, Chinese purchases of Iranian oil rose by 11.3% as against the previous year.
Therefore, we are faced with a new distribution of geopolitical and oil control areas.
The alternative for China is between Iran, the core of the new Silk Road, and Venezuela, although both Russia and China have agreed to give Russia a primary role in Venezuela.
Hence the global geopolitical games are postponed to the return of a robust oil demand after the Covid-19 crisis, which will end only with a vaccine or a universally accepted therapy. On a geopolitical level, however, it will probably concern a new agreement between China, the United States and the Russian Federation.
An agreement that this time could see a real role of mediator for Italy, involving both ENI and governmental and private technical structures.
There are many issues to be considered in the relations between the United States, China and Russia: Russia’s alleged penetration into the North American electoral and political machinery and apparata; the commercial negotiations between the United States and China which, coincidentally, exacerbated during the oil price crisis; finally, the infra-US conflict regarding the reduction of local oil production.
It has to be said that if there is a recovery of the oil market, demand could reach 90-95 million barrels a day, but the country recording the greatest loss of production will certainly be the United States, which has the highest cost of oil barrel production.
Meanwhile, in its anti-coronavirus aid programme of April 30 last, the Federal Reserve envisaged direct support to U.S. oil and gas companies.
As many analysts maintain, however, several companies of the shale sector, which live only on high prices, would go bankrupt by the end of 2020.
In terms of global assessments, however, world oil demand is estimated to fall by 19,000,000 barrels a day during this quarter of 2020 and by 8,600,000 barrels a day throughout 2021.
Global oil supply is expected to decrease by 12,000,000 barrels a day since May to 88,000,000 next year.
OECD stocks have increased by 68,200,000 barrels a day to a total of 2,961,000,000, well over 46,000,000 barrels a day above the average of the last five years – a quantity worth 90 days of average demand.
Non-conventional crude oil production in the U.S., however, declined by 183,000 barrels a day with a peak until March 13, before falling by approximately 12,000,000 barrels a day on May 8.
There are currently 374 drills operating in the United States, of which 292 oil and 80 gas ones, plus 2 mixed ones.
They are 228 fewer than those recorded on April 9, 2020, the minimum level since 1940.
In short, the Covid-19 pandemic is redesigning all geopolitical scenarios, through oil, above all, but not only through it. Here not only energy counts, but rather the whole economic system which, however, is still currently oil-dependent.
The G20 has already put forward international cooperation proposals to cancel the debt of some of the poorest countries and for a coordinated response against the pandemic by the most technologically advanced countries.
Hence any radical transformation of energy systems entails a paradigm shift at geopolitical level.
According to the International Monetary Fund, no oil-producing country can make money with an oil barrel price at 40 U.S. dollars. Only Qatar barely can, but every country in the Middle East needs prices of at least 60 U.S. dollars per barrel.
However, there is more than the tax or productive breakeven point: the producing countries’ economic diversification is essential.
From this viewpoint, only Mexico, the Russian Federation and the United Arab Emirates could survive, while some others with less differentiated economies can still ask for loans or temporarily stop public spending.
Nevertheless, this depends not only on macroeconomic evaluations, but above all on political and structural issues: the presence of foreign manpower that can be easily sent away (Saudi Arabia); the possibility of using other forms of energy (Morocco) or the negative impact of some old Welfare State on the oil price (Algeria).
Other countries are, instead, particularly vulnerable: Iraq, which is currently also one of Italy’s main suppliers; Oman, Algeria, Nigeria, Ecuador, Angola, Surinam, not to mention Iran and Venezuela, where the oil issue is part of a severe international political crisis.All these countries can shortly fail or fall into an indefinite crisis, with unpaid salaries in the public sector and primary services largely reduced, as well as military crises and great political instability.
In some cases, this may lead to the expansion of “terrorism”, more exactly of the “sword jihad”, which can drive a wedge within the hotbeds of crisis and rule the States or the areas left by the old legitimate governments. It may also lead to the uncontrolled expansion of the great international crime, which can turn the failed States into bases to attack the still relatively healthy economies of some Western countries, and to connect the areas of illegality one another and hence turn the crime territories into a new great geopolitical player.
A further possibility – not to be ruled out at all – concerns the mounting of regional tensions, which could become a not entirely irrational option, at least for some producing countries.
Just think of the oil barrel price crisis triggering a final showdown between Iran and Saudi Arabia.
There will also be Asian or African countries that will benefit from the vertical fall in prices.
It should be recalled, however, that on April 20 last, the West Texas Crude contract expiring in May fell to -40.32 U.S. dollars.
The countries which will benefit – to a certain extent – from the fall in prices include Argentina -which is currently already prey to yet another default, but which will pay much less for energy imports- as well as the Philippines, India, Turkey and South Africa.
These countries will no longer be burdened by the cost of oil imports, but will also attract less investment from producing countries, whose availability of capital will collapse quickly.
Previously oil prices had fallen due to the expansion of the shale market in the United States, to lower global growth and to the slow, but stable shift to renewable energy in most consumer countries.
Then the Covid-19 pandemic broke out, which accelerated all these factors and, in fact, blocked the economy and saturated oil inventories and warehouses.
The world economy will not “recover” soon or, more exactly, will no longer be as it was before the pandemic.
Global Value Chains will become much shorter and many mature, but essential productions will go back to the countries which, in the times of rampant globalization, moved everything – except for high technology and finance – to countries with low labour costs and low taxes.
The producing countries’ adaptation to the new context will certainly be slower than needed.
The large solar energy basin planned by Mohammed Bin Salman’s Vision 2030 was stopped indefinitely last November, while the privatization of Saudi Aramco has now proved to be a failure.
Once the profitability of the Saudi oil has ended – and hence the special relationship between the United States and Saudi Arabia, as well as the U.S. penetration in the Middle East -currently a phase of great instability in the relations between Saudi Arabia and Iran is beginning, in which Iran could play other cards besides the purely military ones.
However, the Iranian oil extraction cost is higher than the Saudi one.
The Russian Federation “falls” at an oil barrel price of 40 U.S. dollars and, if it cannot control its internal areas and the border with China and the Caucasus, it is very easy to imagine what could happen.
Even the United States is not in a better situation.
Shale oil is the biggest source of employment in Michigan, Arkansas and Ohio. These are essential States for the re-election of Donald J. Trump and surely the President will do everything to support the workers-voters and these States.
The end of the oil economy is near – or probably it has already arrived – and no one can imagine what will happen to energy markets and to our economies in the near future.
The greening of China’s industrial strategy
The prominence of China’s role in the global green shift currently underway may seem a paradox. Whilst it has been despoiling its own environment and that of some other countries in pursuit of the same fossil-fuelled industrialisation strategy that made the West wealthy, China has also emerged as a renewables superpower, dwarfing other countries in its building of renewable capacity and the speed of its transition to innovations such as electric cars, trucks and buses. China is betting big on renewables and on a circular economy. Indeed, the success of its development depends on this wager succeeding. Scale is the key to understanding its strategy: China’s industrialisation is a process taking place at a scale without historical precedent.
Like all previous industrial powers, China initially depended on fossil fuels for its industrialisation. It has paid a terrible price for this – far more than earlier industrialisers, including its predecessors in East Asia. As China became the largest manufacturing power on the planet, it created a huge domestic market that provided a first port of entry to global industry for its manufacturing and service firms, on a scale that exceeded its East Asian predecessors. China was able to utilise its domestic banking system to channel flows of savings to firms as they sought to catch up with international rivals. In these ways, the strategy has followed earlier patterns of industrialisation, with emphasis on manufacturing, state guidance and state-derived finance, while exhibiting some differences in emphasis, such as the use of its own domestic market, its own finance and foreign reserves, and a combination of national and provincial state involvement and guidance.
But a feature of China’s industrialisation that is decidedly unique is its strategy for supplying the energy needed for its industrialisation efforts. Alongside China’s “black” industrialisation strategy, powered by fossil fuels, has been a “green” strategy, focused on renewables and circulated resources – again, at unprecedented scale. China has been greening its energy and resources system at a furious pace, while maintaining a dependence on fossil fuels that is steadily diminishing. The chart below reveals how China has been ramping up its green electric power system to become the largest green electricity producer on the planet. The shift in electric power generation towards water, wind and sun as sources is clear – a 15% green shift in capacity in just the past decade, an enormous change for such a huge technoeconomic system.
What is driving this green trend?
If China were to proceed with the typical industrialisation strategy – based on fossil fuels and the plunder of raw materials – then it would face insuperable problems. These would not just be problems of shortages of resources and immediate environmental problems, but most centrally problems to do with the geopolitical limits to a fossil-fuelled strategy relying on virgin materials. To put it bluntly, China would face entanglements in oil wars and resource wars if it were to pursue such a strategy at the scale of industrialisation it is managing – not to mention the burden on its balance of payments as it sought to raise its imports of these fossil fuels. It would mean a horrendous 21st century – for China and for everyone else.
As interpreted by China, a green growth strategy is not so much about a return to nature, but instead involves a clear reliance on manufacturing of energy, as well as greening of food supply through increased reliance on enclosed urban agriculture. The advantage for China of renewables technologies is that they can be manufactured domestically and enjoy economies of scale and cost reductions associated with the manufacturing learning curve.
It is not lost on China that these are all potentially the mainstream energy, transport and food production industries of the future, where the country’s state agencies clearly anticipate it will emerge as world leader, at the technological cutting edge. While the United States under President Trump battles to maintain the supremacy of its fossil fuel industries, China is forging ahead to dismantle its coal, oil and gas dependence and build strong renewables and resource recirculation industries based on its manufacturing strengths. This is what may be interpreted most accurately as China’s green growth industrialisation strategy.
When one looks at the scale involved in its industrialisation, China really has no alternative to a green strategy. And in the typical no-nonsense approach of the Chinese government, their leadership has adopted it with determination and ambition. As China adopts this green shift strategy, so it drives down costs for itself and for all – and makes such a strategy more accessible to other industrialising countries like India, Brazil or nations in Africa. And so the green shift that is initiated by China becomes a global green shift – even if it is complicated by further investments by Chinese state-owned enterprises in coal power as part of the Belt and Road Initiative. This in turn opens opportunities for companies and countries nimble enough to take advantage of them – including companies based in the US, the EU or Japan.
As China’s economy emerges from the Covid-19 pandemic, it can be expected to focus even more on this green growth strategy. After all, this is where China holds decisive competitive advantages in terms of manufactured exports and energy as well as resources security. The 14th Five Year Plan can be expected to place primary emphasis on both features of China’s industrialisation in the 2020s – the greening of its energy, transport and industrial systems, and the growing levels of resource recirculation (e.g. “urban mining” of electronics materials) as it pursues circular economy strategic initiatives.
At the time of writing, oil prices have hit a record low (even moving into negative territory) and so no doubt some tactical purchases are being made by China. But it would be a serious error to regard these purchases as deflecting China from its long-term strategy of green growth, and the energy and resource security it brings with it.
From our partner chinadialogue
The oil market crisis
The Covid-19 pandemic triggered a crisis or rather a real collapse in the oil barrel price, down from approximately sixty US dollars just before the coronavirus spread to the current twenty dollars – with downward peaks before the end of April 2020, still significantly lower than the current twenty dollar average.
The origin of the price collapse is obvious, i.e. the closure of the purchasing countries’ economies and the major crisis in the car market, in particular, with the lockdown of all public and private mobility.
Moreover, for many producing countries, twenty dollars a barrel is a price well below break-even points and sometimes below the mere production cost.
Fifty-sixty US dollars a barrel is less than the cost of oil extraction in the Arctic, for example, and less than what is necessary to break even European and Brazilian biofuel production, but also US and Canadian shale oil. In Great Britain the oil barrel cost is 52.50 US dollars, while in Saudi Arabia the cost for producing an oil barrel is still 10 US dollars approximately.
Saudi Arabia, however, also needs much higher prices, at least from eighty US dollars per barrel upwards, to rebalance its public budget and seriously invest in production diversification, not to even mention the social stability of this country and, in other ways, that of the Russian Federation.
World demand has therefore plummeted, with a reduction of 29 million barrels per day from the over 100 ones a year ago.
This also means that storage capacity has reached the saturation point, with countries selling directly at sea, with a view to avoiding the high and unpredictable costs of overproduction and, by now, even at direct agreement low prices.
According to some specialized analysts, oil production will fall by at least 9.3 million barrels per year, until the time in which the coronavirus epidemic stops significantly. But this is a very optimistic forecast.
As is already seen, the most predictable effects of collapse in oil prices will most likely be the bankruptcy of small and medium-sized oil companies in the United States and Canada, where the banks had also strongly supported these companies with debt.
The economic, financial and social repercussions on these countries’ productive systems will be immediate and hard to manage.
Some extraction of US and Canadian “zombie” companies has continued, in view of cashing immediate liquidity, but, obviously, this cannot last very long.
It is hard to speak about public support for oil companies, considering their international corporate structure and, above all, because of the large mass of liquidity that would be greatly needed and would inevitably be drawn from other budget items, which are more socially necessary and with a strong psychological and hence electoral impact.
Nevertheless, the whole economy of producing and of typically consuming countries – which, for various wrong or short-term choices, have never established their own “OPEC” – will be severely affected by the vertical fall in oil prices, even though the US IAEA supported and legitimized the cut in production last April. The initial sign of an inevitable agreement between producers and consumers in the future, also at financial and investment level.
Furthermore, some producing countries have considerable financial funds to stand up to the fall in the oil barrel price, probably even until the end of the pandemic, but this is certainly not the case with other producers.
Saudi Arabia, the UAEs and Kuwait can last relatively long, albeit stopping their plans for economic expansion and diversification in the short term. Just think here of the Saudi Vision 2030 plan.
Iraq, Iran and Venezuela – with Iraq which is currently one of Italy’s largest exporters – will certainly have to withstand periods of extreme social crisis and even political legitimacy.
In Africa, Nigeria and Libya will face further political and social crises of unpredictable severity – in addition to internal wars by proxy, as in Libya.
China itself, the current largest oil buyer, has stopped as many as 10 oil shipments by sea from Saudi Arabia.
The tax break-even point reveals the complex internal dynamics and trends of manufacturers: Saudi Arabia is at 91 US dollars; Oman at 82; Abu Dhabi at 61; Qatar at 65; Bahrain at 95. Iraq is currently at 60 US dollars, but it should be noted that Iran is now at 195 US dollars, Algeria at 109 and Libya at 100- to the extent to which Libyan oil exports can work after General Haftar’s closure of oil wells- while Nigeria is at 144 US dollars and Angola has only acost + tax per barrel of 55 US dollars.
Currently Russia has a strong need for a tax per barrel of at least 42 US dollars, while Mexico 49 and Kazakhstan 58 US dollars.
In order to survive, the US, Canadian and Norwegian oil companies need an oil barrel cost of 48, 60 and only 27 US dollars, respectively, to simply break even.
Russia will probably be able to survive(“for ten years”, as it says, but probably exaggerating) a pandemic crisis, which has also hit its own population hard, by using its Strategic Fund, which is currently worth 124 billion US dollars.
Every year of crisis, however, is likely to cost Russia 40-50 billion US dollars.
Not to mention jobs, which could be reduced by over a million in Russia.
Saudi Arabia, too, is very liquid, and predicts a loss of over 45 billion US dollars at the end of the pandemic.
If Saudi Arabia makes another deal with Russia and manages to raise the oil barrel price to 40 US dollars, it is supposed to reduce losses to 40 billion US dollars annually.
Iraq, the second largest Middle Eastern exporter, covers 90% of its public spending with oil revenues.
In Iran and Iraq, the closing down of private companies has caused the almost total closure of oil production since last March.
Moreover, Iraq has no sovereign funds. Mexico has already started to implement “austerity” measures, although it has stated there will be no closures or staff cuts in the public sector.
The Nigerian GDP will certainly go below zero. Nigeria was the economy recording the greatest development rate in Africa, but since May it has had 50 million barrels unsold.
The unemployment rate will rise from 25% to well over 25 million people, but Nigeria has a very small Sovereign Fund that owns 2 billion US dollars.
There are very large differences among producing countries. There are countries with a financial power potentially able to further stand up to the collapse of oil prices and countries with an internal social and economic situation on the verge of collapse, as well as other economies floundering in a very severe crisis.
Just think of the Lebanon, which had already defaulted before the fall in oil prices. Obviously neither Saudi Arabia nor Iran will help it any longer.
This means that the producing countries with a more “liquid” financial situation can start buying oil assets – not at a very low cost – from their fellow OPEC competitors or even outside that OPEC protectionist framework, while the countries without long or short liquidity, will quickly be economically colonized by the strongest ones and this would make their economic autonomy irrelevant. Especially if they are, like Iraq, truly oil dependent countries.
The GDP for the current year, however, is expected to slightly decrease in Kuwait (-1%) while Algeria and Iraq are expected to immediately fall to a -5%, which could be fatal not only for their economy but also for their social stability.
Libya, just to remind us of a key country for our security, as well as for oil, will record an expected fall in GDP of almost -58%.
It is easy to understand what will happen and how much impact it will have on Italy.
The International Monetary Fund has also predicted a quick rebound in prices beyond the oil break-even point for the whole oil area between Africa and the Middle East as early as 2021, but the forecast seems to be completely unfounded, given the multi-year length of the buyers’ crisis and hence the inevitable fall in producers’ prices.
Even if the coronavirus crisis were to end in a month, which is highly unlikely, the economic outlook would not change radically even for 2021.
The fact is that, according to all the most reliable projections, the GDP of non-producing countries will fall even faster than that of oil-producing countries.
Certainly there is the temporary relief and redress of public accounts in the Middle East and North Africa (MENA) non-producing countries, which is estimated at around 3-4% of their GDP, but these are countries like Morocco and Jordan having little economic weight in their respective geo-economic regions.
There is also another factor to consider: the producing countries’ crisis adds to the much longer-standing crisis in the African countries exporting not oil, but food products.
I am here referring to Jordan, Mauritania and Morocco – which is still a leading country in the world production of citrus fruits, with companies cooperating with the United States – and to the wine-producing Tunisia.
The FAO sugar index has fallen to -14.6% – more than ever over the last 13 years.
The FAO index for vegetable oil is -5.2%. The dairy prices are currently falling by 3.6% and meat prices by 2.7%. Wheat prices, however, are expected to remain stable, although storage, and hence the future final cost, will increase from now on.
Certainly the “rich” producing countries, i.e. those with greater liquidity reserves, have already begun to inject liquidity and implement tax rebates.
Saudi Arabia has tripled VAT from 5 to 15%. It has also issued 7 billion US dollars of public debt securities that will fall due in 5, 10 and 40 years respectively, with a 5% planned restriction of public spending, and as many as 13.3 billion US dollars in support of small and medium-sized enterprises, with the nationalisation of 14,000 jobs in the most technologically advanced sectors.
Just to give an example of the most capitalized oil exporting country.
It is not even said that soon the Saudi and Emirates’ sovereign funds do not want to acquire – at selling-off prices – even the U.S. and Canadian shale oil industries undergoing an evident crisis.
Both in countries in crisis and in those with greater financial resources investment will be well diversified in the health or in the large infrastructure sectors. Investment will be made also in research and in the expansion of the oil sector, which will certainly start working again – as and probably more than before – at the end of the pandemic.
There will probably be an economic and financial rebalancing between the United States and Saudi Arabia, which have similar interests, both in the purchase of shale oil companies in crisis, obviously, but also in a closer direct financial relationship, considering that Saudi Arabia still holds 177 billion US dollars of North American public debt securities.
A record amount which could increase rapidly.
Obviously, in the darkest phase of the crisis, the objective of the financially sound OPEC countries will be diversification from oil to more technologically advanced and expanding sectors, such as health and pharmacology, particularly abroad, but again without neglecting the oil sector.
While maintaining the same – or almost the same – current investment in the oil sector, which cannot but take off again in the short to long term.
For the other less financially sound countries, it will be about implementing great political reforms, which may at least stabilize the countries floundering in severe economic crisis, or having their oil assets quickly sold by the richest Arab countries, which will thus have a much greater power of pressure vis-à-vis consumer countries when the oil recovery starts.
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