Power Shortages Loom Over Europe

1. Can There Be a UK Oil Renaissance?

- The new UK government of Liz Truss might become one of the most pro-oil ones globally as she announced the opening up of some 130 license blocks in the North Sea as well as the controversial lifting of the ban on hydraulic fracturing in the country.

- The previous government of Boris Johnson suspended licensing activities in 2020 as the UK took on ambitious climate goals, whilst the ban on fracking was introduced in 2019 amid opposition from environmentalists.

- UK North Sea oil output has been declining for years and is currently at some 900,000 b/d (equivalent to 82% of its needs), in contrast to rising production in Norway’s offshore zone.

- Attesting to the weak drilling activity, there were only 5 exploration wells drilled in the UK in 2021, a record low, with a similar number expected this year, according to OEUK data.

2. Margin Calls Becoming the Bogeyman of Europe

- The pains of European trading companies have started to come to the surface with the past couple of days seeing a string of additional credit lines and bridge funding.

- What started off with a $10 billion credit line to Uniper, saw its continuation with a $4.1 billion extended credit line to the Swiss Axpo and another $2.3 billion to the Finnish utility company Fortum.

- According to Citigroup estimates, utility companies across the continent were forced to put up more than $100 billion of additional collateral to cover margin calls, seeing their liquidity shrink.

- Equinor and other Scandinavian companies have warned of a “Lehman-like moment” for Europe if the current trend continues, estimating that at least $1.5 trillion is being locked into margin calls.

3. Even If Gas Demand Is Curbed, Power Shortages Loom Large for the EU

- Even after EU members have pledged to reduce their gas demand by 15% compared to their average consumption between August 2022 and March 2023, the prospects of winter power shortages remain real.

- Rystad Energy calculations show that the power deficit is expected to reach a maximum of 13.5 TWh in January, inevitably leading to power rationing and blackouts, primarily impacting European industry.

- In 2022 so far, hydropower has been the main laggard, declining by a whopping 25% year-on-year amid heatwaves and prolonged droughts, whilst gas-powered generation has in fact gone up by 6% to 39.1 TWh in July.

- Substantial rebounds in hydro generation are unlikely given that maximum generation usually takes place in the summer and reservoirs are unlikely to recover amidst such dry weather, just as nuclear travails in France are unlikely to see a swift resolution.

4. Despite the Need for Oil, Licensing Continues to Falter

- The number of oil and gas licensing rounds is set to drop to near all-time lows as the oil industry remains underinvested amidst ongoing ramifications of the Covid-19 pandemic.

- According to Rystad Energy, licensing acreage awarded this year so far fell to a 20-year low of 320,000 km2, of which roughly a third is taking place onshore.

- Global lease rounds are expected to total 44 this year, 1 less than in 2021, with Brazil leading the world in terms of blocks awarded (59 auctioned in its Third Permanent Offer Round).

- Asia has been leading the way in terms of new allocations, whilst the United States, Australia, and Russia have been the main laggards – the cancellation of Lease Sales 259 and 261 in the US being driven by political rather than economic reasons.

5. Europe’s Aluminium Capacity Crippled by Power Prices

- Europe’s aluminum industry is set for the biggest meltdown in decades as ballooning power prices are rendering production economically unviable amidst falling market prices.

- Aluminium is produced by heating alumina until it dissolves and then running an electric current through the pot, making it by far the most energy-intensive metal to produce.

- Europe has already lost approximately 1 million tons in production capacity, of which some 25% was shut down permanently and another 500,000mt is “highly vulnerable” to closure, according to Wood Mackenzie.

- The average cost of producing a ton of aluminum in Europe stands at roughly $4,200, in stark contrast to actual market prices as the LME futures price is trending around $2,300/mt.

6. Chinese Air Travel Will Take Years to Recover

- Whilst Chinese oil demand has been a disappointment for most of this year, perhaps nothing else embodies the faltering promise than jet fuel demand, crippled by the country’s ongoing flight isolation.

- Before the COVID-19 pandemic and the introduction of a zero-COVID policy, international flights out of China have been hovering around 3,000 voyages a day – this year they have been around 100 a day.

- This is a substantial decline even when compared to the COVID-ridden year of 2021, bringing the country’s jet fuel production some 50% lower year-on-year, at some 1.6-1.7 million tons per month.

- Domestic prices were also not immune to the global surge in product prices, with China’s airlines introducing new fuel surcharges of up to $25-30 per passenger.

7. Global Scramble for LNG Lifts Freight Costs

- As Europe has been scrambling to replenish its gas inventories ahead of the winter season with whatever LNG it can buy, the shipping market is increasingly facing a shortage of tankers.

- Chartering costs of LNG tankers have already soared to the highest level this year, at some $105,000 per day, and given the LNG price discrepancy the same voyage might touch $400,000 per day at the peak of winter.

- Europe remains a premium market for LNG suppliers as the Asian benchmark JKM still trades at a $20 per MMBtu discount to European spot TTF prices, effectively diverting supplies from Asia.

- The global order book on LNG carriers has more than 280 tankers slated for future delivery, built mostly by Korean shipyards, but the tanker shortage in 2022 is unlikely to be mitigated.