As Ukraine war puts strain on energy supplies, China must ensure its slice of the fossil fuel cake is secure

Energy production constraints and increased winter demand mean it’s not just the price but the access to energy that policymakers need to consider
The move away from fossil fuels in the fight against climate change comes with costs which current circumstances are only exacerbating

Neal Kimberley

Published: 4:15pm, 9 Aug 2022

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Oil prices may have edged lower last week on market fears about slowing global economic growth but winter is coming to the northern hemisphere. Homes will need to be heated and even slowing economies do not run on fresh air. As a massive energy importer, China needs to make sure its requirements will be met even if the choices it makes don’t necessarily go down that well in Western capitals.

There is every possibility that energy production constraints amid increased winter demand will result in higher prices but it’s not just the cost of energy that policymakers need to consider, it is access to it.

It’s that access that China needs to be locking in.

Much has been made of the economic challenges facing China, not least those that are directly consequential to Beijing’s continued adherence to its zero-Covid policy, but that doesn’t negate the fact that powering the Chinese economy and, in winter, heating Chinese homes will still require vast amounts of imported energy at a time when there remain marked supply constraints.

In truth, Russia’s invasion of Ukraine – or, as Moscow puts it, Russia’s “special military operation” – and the subsequent decision of China, and indeed India, to take a neutral stance on this issue, has resulted in a situation where both Beijing, and New Delhi, have been able to purchase copious amounts of Russian oil at competitive prices in recent months.

In stark contrast, the European Union, in solidarity with Ukraine, has imposed wide sanctions on Russia that have included, at no small cost to EU member-states, overturning decades of increasing reliance on Russian energy imports.

Moscow, for its part, has responded by limiting the supply of natural gas to Western Europe.

That doesn’t mean the imported energy that the European Union needs has suddenly plummeted, far from it, but what it does mean is that the EU, having decided that it no longer feels comfortable buying Russian energy, now has to source it from somewhere else and pay up for that energy as required.

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Russia-Europe gas pipeline temporarily closed for maintenance amid EU fuel shortage

In that sense, with China and India having upped their purchases of Russian energy in recent months, the reduced dependence of both Beijing and Delhi on oil and gas from other suppliers has arguably freed up supply that can be redirected to Europe.

While acknowledging that the stance both China and India have taken towards the war in Ukraine might irk nations fully backing Kyiv, from a purely energy demand and supply perspective, if Beijing and Delhi had also forsworn Russian energy, then that would have only magnified demand for and the price of non-Russian energy.

As it is, if you imagine global energy supply as a cake, it’s still roughly the same size as it used to be, it’s just being sliced up differently.

But there’s another problem. The cake needs to be bigger but the ingredients just are not there.

The hydrocarbon energy demands of the global economy, notwithstanding worldwide efforts to address climate change and transition away from fossil fuels, continue to be huge.

China’s temperature rises ‘outpace global average in past 7 decades’

Last week the Organization of Petroleum Exporting Countries, along with allied nations that include Russia (Opec+), announced an increase in oil production of 100,000 barrels per day (bpd), effective next month, but this is a drop in the ocean.

China, the world’s biggest buyer of crude, imported 8.72 million bpd in June alone.

The problem is, as last week’s Opec statement made clear, there is “severely limited availability of excess capacity” and “that chronic underinvestment in the oil sector has reduced excess capacities along the value chain”.

Pursuing a climate change agenda has inevitably led to the effective demonisation of investment in new fossil fuel projects. When the global economy is still reliant on hydrocarbons, however laudable are the aims, that agenda comes with costs which current circumstances are only exacerbating.

Elsewhere, in an attempt to bear down on domestic gasoline prices, Washington has released in excess of 125 million barrels from its Strategic Petroleum Reserve this year, with more to come. The US Strategic Petroleum Reserve has been depleted to a level not seen since June 1985.

That is not strategically sustainable, especially when China-US relations are strained, not least over Taiwan. Washington will want to rebuild that reserve in a timely manner from non-Russian sources, a prospect that markets might well conclude is consistent with a well-supported oil price.

Short-term energy price movements aside, all countries still want a piece of the fossil fuel cake and there is only so much to go around.

Beijing must ensure that China’s own slice is secure.

Neal Kimberley is a commentator on macroeconomics and financial markets