Impact of the Ukraine Crisis on the Energy Sector

In the early hours of the morning of the 24 February 2022, Russia launched a full-scale invasion of Ukraine. This conflict will have widespread consequences that will be felt across the world, including the UK. This is an extreme humanitarian crisis first and foremost, and this article does not intend to distract from that, but attempts to unpack one area of specific concern - the energy sector.

Oil supply

Russia being the second-largest oil producer in the world and Europe being one of its biggest customers, one major consequence of Russia's conflict with Ukraine is a spike in oil prices, something that has led to the oil price hitting nearly $140/bbl. for the first time in over a decade.This comes at a time when government figures already show a record high for petrol and diesel costs (as of the week commencing 21/02/2022). The average price of petrol is currently 149.22p per litre, but the chair of the Foreign Affairs Committee has been quoted as saying that this could rise to 170p per litre.The UK government has announced a continued freeze on fuel duty and is urging fuel suppliers not to take advantage of increased demand to put up prices sooner than necessary. It has also emphasised that the UK holds oil reserves significantly above the 90 days required by the International Energy Agency, which should provide some resilience. 

Will there be a gas shortage? 

The question of the effects upon the supply of gas to the UK and the price of that gas are somewhat more complex. To start with, Russia is the largest gas supplier to Europe (providing around 35% of gas supplies) and the UK is extremely reliant upon gas, with 86.3% of British homes having gas central heating and 35.7% of our electricity coming from gas-fired power stations in 2020.However, in 2021 the UK imported only around 4% of its gas from Russia (via Liquified Natural Gas (LNG) rather than pipelines) and the country also benefits from highly diverse sources of supply, the largest being extraction in the North Sea and the majority of imports coming from reliable sources (e.g., Norway).The UK also boasts interconnectors with the continent and three LNG terminals, providing Britain with one of the largest LNG import infrastructures in Europe and allowing the UK to accept gas supplies (in the form of LNG) from around the globe.All of this means the government is optimistic that UK gas supplies will not be significantly disrupted.However, the impact on gas prices may be more marked. The UK market is closely connected to gas markets in Europe, meaning that any price rises in (e.g.,) Germany or The Netherlands, will be felt by British suppliers too. The EU is heavily dependent on gas imports and Russian gas flows into Europe via a complex network of pipelines, many of which run through Ukraine - a key transit hub. If the war in Ukraine were to damage the pipelines or otherwise choke off those supply lines, it could cause severe market volatility. Germany has already halted the Nord Stream 2 pipeline project. This was designed to double the flow of Russian gas supply direct to Germany. This extensive project finished construction in September 2021 and was pending approval to commence the flow of gas, a process which has been halted in the context of the current crisis. This decisive move highlights how severely Russia's actions in Ukraine are being viewed, and it remains to be seen how Russia will retaliate, which could include reducing or halting existing gas flows into Europe.Any reduction in gas supplies to Europe will not easily, or quickly, be replaced, particularly during the winter season when gas demands across the northern hemisphere are higher; Norwegian production fields and LNG terminals are already operating at or near maximum capacity.Following the start of Russia's military action in Ukraine, wholesale energy prices across European trading hubs started to climb, with similar gains seen in the UK. Day-ahead gas and power prices rose by 30% day-on-day, while 2022 seasonal gas contracts increased by an average of 55%, with power reaching a near equivalent. Analysts from Investec said they believe the price surge could force Ofgem to take the household bills price cap soaring above £3,000.

Electricity prices

The impacts of any gas shortages and price rises are undoubtedly going to impact electricity pricing, based on our history of burning gas to generate our electricity. These impacts would be reflected in the increase of household bills price cap.Electricity prices have been rising for months, due to surging global demand following the end of pandemic restrictions. However, Investec said prices had risen even higher following Russia's invasion of Ukraine and would remain elevated for months. The overall increase in electricity prices has (since late summer 2021) led to almost thirty, mostly smaller, energy firms going bust due to suppliers being unable to deliver prices promised.This underscores the importance of renewable energy in the UK's energy mix. The more cheap, clean renewable energy produced at home, the less exposed the UK will be to the international gas market and price volatility.

 Impact on UK households

The inevitable impact of gas supply constraints and upward price trajectories is that customer bills in the UK will continue to rise for the foreseeable future. The government has promised to help households with the rising cost of energy, offering £200 loans to be paid back at a rate of £40 per year over 5 years from 2023, in the hope that markets will return to normal within that timeframe. However, if the Ukraine conflict is prolonged, prices could remain higher for longer, meaning bills may remain high when the loans fall due. The government is also promising a non-repayable reduction of Council Tax bills from April 2022 for properties in bands A to D. 

Supply chains Supply chain disruption is another potential consequence of the current conflict. In particular, imports of components for batteries, microchips, auto parts, and petrochemical production may be at risk. Russia is the world's third largest producer of aluminium and nickel, which are key elements in the production of electric vehicle and other lithium-ion batteries. Ukraine is a major producer of rare gasses such as neon, argon, krypton, and xenon which are essential in microchip production. Disruptions in these markets could further exacerbate the 'chip crisis', which is already biting as a result of the coronavirus pandemic. Disruption to imports and supply chains inevitably drives up demand and prices, and could impact production. It seems possible that the Ukraine Crisis may develop into the biggest test of resilience of global supply chains yet. Some executives across Europe are taking the follow steps to mitigate the impacts:

• visibility of the entire value chain across primary, secondary and even tertiary players. This includes looking at alternative sources and suppliers' inventory statuses, and discussing business continuity plans with key suppliers;
• anticipating the continued rise in oil and natural gas prices and securing supplies;
• recognising the continued increase in transport/shipping costs. Mitigating this by ensuring loads run full;
• building inventories of products most susceptible to shortages. Qualify and prepare to switch to alternative sources for essential goods/supplies/inputs; and
• diversifying sources and supply routes where possible and preparing risk response plans for the most vulnerable supply chains.

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If you would like any further information on anything covered in this article, please do not hesitate to contact Liam O'Flynn or our Energy team.