A feeling of insecurity?

Given developments in Ukraine and the role that Russia plays in the global oil market, supply availability is a big talking point once again. Below UX Energy Services consultant Dr Craig Lowrey looks at some of the issues that this situation could generate for the UK market.

Closer to home, the devastating weather conditions that hit parts of the UK over the last winter have also brought security of supply into renewed focus.  

 

The UK’s ability to control the fate of its heating oil price has diminished; something also seen in the wholesale natural gas market over the last decade. A decline in domestic refining capacity coupled with the decline in crude production from the UK Continental Shelf has meant increased import reliance, making the UK price for heating oil increasingly reflective of international events. As North Sea output declines further, forecasts from the UK government show that this trend is likely to continue well into the next decade for all petroleum products.

Reflecting the economics of the refining industry across Europe, the nation’s refining capacity has fallen over the past few years as the industry struggles with falling demand in the wake of recession and the resultant over-capacity.  This has been compounded by growing competition from facilities in the US, Russia and Asia, although these regions themselves have had a few mixed years.  Many sources in the industry are predicting that further European refinery closures can be expected by the latter part of the decade.

The refining sector saw the closure of the Petroplus-owned Coryton site in 2012 and in late 2013, an industrial dispute threatened to result in the closure of the INEOS site at Grangemouth.  The start of 2014 has been equally challenging; in February, Essar Energy announced that its Stanlow refinery would see production capacity reduced by a third from October, citing ongoing losses on site.

For some years Murphy Oil has been seeking a buyer  for its Murco facilities in the UK which include the Milford Haven refinery.  With the latest efforts regarding a takeover having recently broken down, the future operation of the site is now in further question; particularly given the general ill health of the European refining sector.

Increasing imports with ‘mutual interdependency and common interest’
With the UK’s reliance on imports showing no signs of abating, there is the question of the source of those imports and, in particular, the role Russia plays with respect to energy matters in the UK and Continental Europe.

Building on a long standing partnership, Russia and the EU signed an agreement in March 2013 aimed at cooperation in the energy sector through to 2050.  In recent years, Europe has sought to diversify away from Russian energy imports, a move that largely commenced in 2006 following the Russia-Ukraine gas supply dispute when Russian gas flows to the EU through Ukraine’s pipelines were compromised. A second dispute in early 2009 accelerated the move away.

The EU describes the relationship with Russia as one based upon ‘mutual interdependency and common interest’ with Russia being the largest oil, gas and coal exporter to Europe.  In the oil industry, EU-Russia cooperation has been growing over recent years with European companies active in Russian exploration and production, while Russian companies have made increasing inroads into refining, marketing and retail.

According to the latest figures from the UK government, at 40% of total imports Russia may have been the nation’s largest single source of coal and solid fuel imports in 2012 but it was third in terms of crude oil imports with the provision of 11% of the total, behind Norway at 50% and Nigeria on 12%. The Department of Energy and Climate Change did however note that Russia ‘has generally become a more important source of imports’ of crude oil in recent years.

The effect of sanctions
While the possibility of economic sanctions and a decline or loss of Russian energy flows into Europe is – at the time of writing – a number of steps away, even the possibility of such an event gives rise to continued volatility in financial and energy markets in the short term.  So far, Russia’s comments regarding a possible reduction  in energy flows have focused more upon gas than oil and oil products, a fact reflective of Ukraine’s outstanding multi-billion debt to state-owned Russian company Gazprom.

The ability of both the UK and the rest of the EU, notably Germany – the largest single importer of Russian oil and gas – to diversify away from this traditional and long standing source is limited – particularly given that the influence of sanctions will have a global effect.

Sanctions against Iran in the summer of 2012 contributed towards a 10%-15% increase in the price of crude oil that was reflected in the markets for petroleum products. As well as impacting energy prices, this in turn fed through to the cost of living through the prevailing inflation rate.

Russia’s status as the largest non-OPEC oil producer – as well as the world’s largest largest oil producers in general – means that sanctions would have a noticeable effect, although the extent of this – not to mention the likelihood and form of sanctions – remain speculation at this stage.

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