So, you want to hit Russia really hard?

You don’t need me to tell you that there is currently an all-you-can eat buffet of commentary on Russia’s invasion of Ukraine in the mainstream, financial and social media.

Some of that commentary is informed. Some of it is uninformed. One thread that runs through almost all of the commentary is the idea that Russia has a strong negotiating position because it is a major – if not the main – supplier of oil and gas to much of Europe.

Europe does indeed use gas for about 25% of its electricity, of which 40% comes from Russia. This is clearly a lot.

Moreover, 60% of Russia’s exports are fossil fuels. As Rob West, founding analyst of Thunder Said Energy, tweeted, Russia exports annually “$225bn of oil, $55bn of gas, $50bn of metals, $20bn of coal, $30bn basic materials and $25bn of agricultural products. 55% of the total goes to Europe.”

In fact, it’s estimated that giant Russian energy company Gazprom makes over $200 million per day from selling gas to Europe, if not more given the recent firmness in prices.

The problems (for Russia) that no one is talking about

However, there are three aspects which are often overlooked in the discussion. Each of these aspects highlights the weakness, and not the strength, of Russia’s position at present.

First, successive governments of the Soviet Union (up to the end of 1991) and Russia have seen the supply of raw materials to the rest of the world (and Europe in particular) as a crucial economic activity. This was true in World War II up to Operation Barbarossa – Nazi Germany’s invasion of the Soviet Union in June 1941. It was true during the entire Cold War – even through episodes of high tension such as the Cuban Missile Crisis of October-November 1962. It was true during Russia’s annexation of Crimea in February-March 2014. Regardless of what is happening in geopolitics, Russia never shuts off the supply of oil and gas: it just cannot afford to do so.

Second, Russia’s economic performance over the last seven years or so has been very patchy. A key problem was the slump in oil prices through late 2014 and early 2015. Real GDP growth in the aftermath was around 1-2% per annum. Real GDP contracted in 2020 by nearly 5.5% because of the Covid pandemic. Previously, high/rising energy prices had boosted growth in many of the years after President Vladimir Putin first came to power at the beginning of 2000.  Russia is a price taker in global markets for the raw materials that it exports, and this has contributed to economic stagnation – a real challenge for Putin.

Third, the energy that Russia exports is not clean energy. It consists of fossil fuels. Sustainable development in general and decarbonisation in particular are much more important themes globally than they were in earlier episodes of geopolitical tension.

The conclusion that very few people have drawn so far

Now, there has been a lot of talk and some action about sanctions by EU (and other Western countries) against Russia.

However, very few people have identified the three weaknesses noted above and drawn the obvious conclusion. One person who has, though, is Rachel Kyte. Until recently, she was the Special Representative of the Secretary-General of the United Nations for Sustainable Energy for All).

She had this to say:

“Weaning ourselves off these [fossil fuels from Russia] as quickly as possible is one route available to the West. In fact, Putin’s understanding of what decarbonisation would mean for Russian energy exports in the medium and long term may be a factor in the timing of Putin’s attack on Ukraine now.”

Kyte’s comments on timing are interesting. It may be that Putin does see the bigger picture. Interestingly, though, the all-out invasion of Ukraine has begun at the very end of winter. The West in general and Europe in particular now has eight months before the onset of the winter of 2022/23 to prepare and do whatever is needed to reduce usage of Russian oil and gas. Putin’s negotiating position would have been stronger if the invasion had taken place, say, in early October last year.

The solution that is obvious

And while it’s understandable that world leaders will push the Green Energy Transition to the back of their minds in the midst of this rare and serious geopolitical crisis, it’s possible that the Green Energy Transition provides some of the answers that they seek.

Renewables are clearly the long-term solution. But it is entirely reasonable for Western governments to plug the gap with alternative supplies of gas, in the short term.

You can’t finance, permit, and build an operational solar or wind farm in six months. Getting enough gas into storage this summer (from the United States, the Middle East, and the expanded use of liquified natural gas (LNG)) will be crucial in giving us the time that is needed – 18 months perhaps – to ramp up the renewables capacity in Europe.

As Rob West of Thunder Said Energy, points out, spiking gas prices don’t do the energy transition any favours. It worsens people’s lives, and pushes countries towards coal, which is more than twice as carbon intensive per MWh. He wouldn’t be surprised to see European delegations begging the United States to ramp up its LNG shipments within the next six months.

Back in 2014, when Russia invaded Crimea, green energy alternatives were rare and expensive. They were not competitive with fossil fuels.

But now, the picture is completely different.

Solar, wind, and battery storage costs have fallen 90%, 50%, and 80% respectively in the last decade. They undercut coal- and gas-fired power almost everywhere in the world.

We have storage to solve the intermittency problem, and grid management systems are much more adept than we could have hoped for in integrating them reliably into national grids.

Many grids in Europe already have 40% (like the UK) or more renewables as a share of national electricity, and it is still uncertainty over the supply of fossil fuels that is causing the volatility and unpredictability.

And in fact, renewables are now so cheap that they are unlocking decarbonisation across every sector of the global economy. And they are much more reliable and predictable than they were. They are also probably more reliable and predictable than supplies of oil and gas from Russia.

So, there is a silver lining in the ghastly cloud of Russia’s invasion of Ukraine.

In the short term, there is the potential for European countries to import gas from suppliers other than Russia.

In the long term, the invasion should encourage the Green Energy Transition and the rising use of solar power, wind power and batteries…

… or turbocharge it.

Suppose that, by 2027, the Green Energy Transition meant that Europe was hardly importing any oil or gas from Russia at all. That means no fossil fuels through Nord Stream 2, Nord Stream 1 or any of the other pipelines that start in Russia.

What would that mean for Russia?

Until next time,

Kit Winder
Co-editor, Exponential Investor