As we approach the 50th anniversary of the 1973 global oil crisis, international energy markets and the global economy are about to receive a similar jolt. Since Russia attacked Ukraine on Feb. 24, the price for crude oil has twice soared as high as $105 a barrel—a level last seen in 2014. And things could get a lot worse from here. Even if the current sanctions imposed on Russia do not explicitly target the energy trade, sanctions on banks and other entities will impede Russia’s oil, natural gas, and coal exports, wreaking havoc on global energy markets. In addition, the dangers for oil tankers traveling in the Black Sea will reduce oil reaching global markets, including seaborne supplies from non-Russian producers such as Kazakhstan. The cut in Russian oil and natural gas supplies to markets will have spillover effects and further jack up the prices of coal and liquefied natural gas (LNG), adding another burst to inflation.
The crisis underlines that it’s time for Western governments to be honest with their publics about the basic facts of energy security, restore their own energy production, and enhance the reliability of European energy imports. Even if the crisis with Russia is resolved soon—a very big if—Western governments need to make fundamental changes in their approaches to energy policy. The question of energy security was never gone, but Russia’s war has put it back at the top of the agenda.
In coming days, Russian energy exports—oil, natural gas, and coal—will be significantly curtailed, even without sanctions. Traders buying energy cargoes, banks issuing letters of credit, shippers needing to insure their cargoes, and many other participants in the global energy trade will be cautious with all transactions and thus likely pass even on nonsanctioned ones involving Russia. This was the case with the recent round of sanctions on Iran. Companies tended to overcomply to avoid U.S. retribution. In the current case, companies will be even more averse to trading with Russia or processing Russian payments for fear of reputational damage and pressure from investors.
Just like the 1973 oil crisis, the current energy crisis is taking place while energy markets are already stretched. The tight market will amplify the impact of the lost Russian supplies. And unfortunately, all the signs are pointing to higher prices—perhaps much higher prices—that will be stay us even if the war comes to a quick conclusion one way or another.
Prior to the current crisis, oil prices were high and on an upward trend. This was mainly because U.S. oil production plummeted at the start of the COVID-19 pandemic and has returned nowhere near pre-pandemic levels. All other major producers have been pumping at pre-pandemic rates, and there is very little spare capacity left in the global oil markets that could quickly come online to replace the shortfall in U.S. production or Russian exports. Global inventories of stored oil are also being rapidly drawn down, and there hasn’t been enough investment in new production. Even OPEC has fallen substantially short of its output targets, suggesting capacity is limited as existing wells decline and aren’t replaced with new discoveries.
On the demand side, global oil consumption has returned to pre-pandemic rates—and is likely to continue to rise, especially once international travel snaps back. The pandemic led to higher base demand for oil: There has been increased use of plastics (which are made from petroleum) because of the rising use of masks, disposable goods, and various consumer wares as spending shifted online; at the same time, use of public transportation is sharply down as many people switched to cars.
Meeting this new oil demand without a further jump in price requires producing additional oil, something few Western governments have been willing to openly admit. And one of the only countries that has major underutilized oil production capacity is the United States. U.S. President Joe Biden’s policies and his political base’s sentiments against fossil fuels are major factors that have prevented fresh investment in U.S. oil production. Canada is another major global producer with substantial additional capacity, but it is constrained by transport, especially since Washington has been squeamish about the pipeline projects that would bring more Canadian oil to market.
This past weekend’s new sanctions, though they were carefully constructed to exempt Russian natural gas exports to Europe, will inadvertently reduce them. Like the global oil market, the European gas market was already in crisis before Russia’s invasion of Ukraine because of the European Union’s own actions. In the hope of fostering greater use of renewable energy, the EU and individual European governments in recent years undertook policies that greatly hurt Europe’s energy security, not least by putting the brakes on efforts to diversify energy supplies. While Europe has secured some new gas supplies, for instance by building LNG terminals and the completion in 2020 of the Southern Gas Corridor, which supplies Southeastern Europe and Italy from Azerbaijan, these projects have been nowhere near enough.