Years of turmoil

Gas prices will remain elevated for some time

It has now become clear that the Russian invasion of Ukraine is not a crisis that will swiftly blow over. Its consequences, not just for the geopolitical order but also for the global economy, will be felt for years to come. Perhaps the most impactful of these consequences arises from Russia’s major position in the supply chain for oil and natural gas. It is particularly influential as a crude oil and pipeline gas exporter, but it also has an effect on liquefied natural gas (LNG) as well as coal markets. Thus, the commodity and energy space has been thrown into uncertainty for some time to come. This will impact energy importers in particular. India, for example, will see pressure on the rupee, some weakness on the external front, generalised inflation, and some fiscal slippage if it does not pass on all increases to end-users.
 

The impact of the war is felt clearly in LNG contracts. It has been reported that LNG suppliers are setting considerably higher rates for long-term contracts than they were prior to the war, and this premium is likely to last for at least a decade. These price dynamics are a result of efforts to cut Russian pipeline gas out of the European supply chain by replacing it with LNG. Bloomberg has reported that 10-year contracts from large LNG suppliers starting in 2023 are priced 75 per cent higher than equivalent deals signed last year. Many gas importers in Asia have been insulated from the immediate effect of the Ukraine invasion because they have signed long-term supply agreements. However, this does not mean they will remain insulated forever, since newer long-term contracts will have this sharp escalation built in. Credit Suisse has estimated there will be an LNG deficit of 100 million tonnes a year by 2025 as a result of attempts to move away from Russian pipeline gas. Crude oil has remained around $100 a barrel although futures have been very volatile as Europe debates ending its dependence on Russian oil. Some traders have attributed the fall in prices from $130 a barrel to a liquidity crunch because speculative money left the oil market amid uncomfortable levels of volatility. Structurally, the long-term effects of the Ukraine invasion on the market are being balanced by medium-term concerns about a Covid wave in China, the fuel-guzzling manufacturing powerhouse of the world.
 

India will face some difficult choices in the future. It is not just a question of moderating medium-term inflationary effects, but of securing long-term supplies of energy at reasonable and remunerative prices. Gas pricing and distribution in India are, in particular, the product of a series of awkward compromises. Attempts have been made to ensure that there are incentives for domestic exploration, for steady supply, while also preserving access to natural gas for essential sectors like fertilisers. While politically a delicate topic, the gas-pricing formula, derived years ago and which is partially dependent upon global LNG prices, may nevertheless have to be revisited, especially if the world is entering a permanently higher price level for LNG. Market dynamics and incentives will have to be preserved in any new settlement. Gas should also be rendered more competitive than coal, given that the emission profile of the former is far more in line with India’s international climate commitments.