Russia’s invasion of Ukraine is the immediate cause of the global energy crisis, but the seeds were sown by years of weak investment in fossil fuels, partly reflecting concerns over climate change.

Before the war, Russia was the supplier of about 8% of the world’s oil trade, 25% of gas exports, 18% of thermal coal exports and 9% of metallurgical coal.

Russia is still supplying oil, gas and coal to global markets, but estimates by a Finnish think tank ^[1] show that the volume of fossil fuel exports is down by 22% since its peak in March, and pipeline sales of gas are down by 50%.

Eight years of falling investment levels means the lost Russian volume can’t readily be replaced. In the oil industry, investment fell 45% between 2014 and 2016, as a result of weak prices, while the Covid-19 pandemic brought a further 30% drop.

According to the International Energy Agency ^[2], investment in global fuel supply reached US$1.3 trillion in 2014, but had almost halved to US$680 billion by 2020. While investment rose last year, it remains well below pre-pandemic levels.

The oil price has come down from the peak of US$120 a barrel reached in June to around US$105, reflecting improved supply from the North Sea and Canada, the release of oil from IEA reserves and the slowing Chinese economy. The IEA warns that further oil price rises remain possible.

Gas is the most critical shortage. Spot liquefied natural gas prices in Asia had been as low as US$2 per million British thermal units (MMBtu—a measure of energy volume) in mid-2020 but have risen 20-fold to more than US$40/MMBtu.

Prices were soaring ahead of the Russian invasion as LNG supplies struggled to meet rapid growth in Chinese demand and had briefly risen above US$35/MMBtu in December last year.

European authorities are racing to fill storage reserves so there’s sufficient gas to meet household heating and industrial needs over the northern winter if Russia totally cuts its supplies. Russia is already curbing supplies to Europe with the apparent intent of leaving it with insufficient gas in storage for the winter.

Coal has been the alternative to gas. The German government has approved bringing 27 idled coal-fired generators back into production; however, the European Union’s ban on the provision of financial services to ships carrying Russian coal, which came into effect this month, has halted Russian seaborne exports altogether. That has pushed the thermal coal price to the astronomic level of US$480 a tonne, up from less than US$50 a tonne two years ago.

The EU and the UK have similar plans to ban financial services to tankers carrying Russian oil by the end of this year. Few shipowners would sail without insurance, and most ports demand it. The US is concerned that the financial services ban could push the global oil price to unbearable levels.

It has proposed allowing insurance for ships loading Russian oil at a steep discount, but few analysts believe that would work without the backing of China and India. As things stand, Russia is selling much greater quantities of discounted crude oil to refineries in Egypt, the United Arab Emirates and Turkey. Much of it is turned into oil products that are then shipped back to Europe or the US, while the crude oil from the Middle East that used to supply these refineries is directed instead to refineries in Asia.

Sanction regimes inevitably leak—Iran was still able to sell oil, albeit at reduced volumes, throughout former US president Donald Trump’s ‘maximum pressure’ campaign.

Australia’s experience at the hands of Chinese economic coercion highlights the flexibility of commodity markets. Although China was by far Australia’s largest market for coal and Australia was the largest seaborne supplier to China, Australia’s coal miners quickly adjusted to the Chinese ban and found new markets in countries formerly supplied by the miners that were now supplying China. The same was true of China’s embargoes on Australian copper and cotton.

Russia has had to accept discounts of 25% to 30% on its oil sales since shortly after the invasion. Although its energy exports were not sanctioned at that stage, the financial sanctions on Russian banks made buyers wary.

The IEA estimates that energy suppliers have won a US$2 trillion windfall from the soaring prices this year, doubling their income. Although this is likely to encourage some lift in investment spending, it is unlikely to deliver an appreciable increase in supplies.

The IEA’s energy report cites the example of Australia. There was traditionally a close relationship between coal prices and investment in Australia: for every US$10 increase in the coal price, investment would rise by about US$1.5 billion.

‘If this relationship were to be applied to the situation in 2022, we would expect capital investment in Australia of around US$13.5 billion, a level last seen in 2012. However, estimated spending in Australia in 2022, at US$7.5 billion, is around half of this level,’ it says. Australian thermal coal miners can no longer obtain bank finance for expansion and must rely on their cash flow or equity sales, while hoping for government approval.

The IEA sees little prospect of increased coal investment outside China and India because of climate change concerns. It notes that large companies like BHP and Anglo American are selling coal assets to smaller businesses less subject to shareholder scrutiny, but also less able to raise capital for expansion.

However, investment in the coal sector is rising in China and India. China’s domestic coal production rose by a phenomenal 350 million tonnes in the latter half of 2021 according to the IEA (for comparison, Australia’s total production last year was 370 million tonnes).

The IEA expects some increase in investment spending in oil and gas production this year, but says that will be entirely the result of inflation. Allowing for inflation, spending this year will be unchanged from 2021 and below 2020 levels.

Soaring energy prices are a political problem for governments around the world. Responses include cutting energy taxes and providing subsidies to energy consumers.

But many emerging nations don’t have that latitude. Many have long subsidised energy costs and the budget burden is now soaring unsustainably. Argentina is facing pressure to abandon its subsidy scheme, which doubled in cost to US$13.5 billion in the year to June. Sri Lanka’s electricity board was forced to raise prices by 260% earlier this month. Others will follow.

Europe’s desperate attempts to secure LNG supplies to replace Russian gas are leaving poorer countries in the cold. Pakistan has been attempting to buy LNG, but its last four tenders have all failed to attract a single bid, with suppliers preferring the premium markets of Europe and China.