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Energy Reconfiguration Will Have Different Impacts

By Fernando Cruz - Dolphin Drilling
Business Director


Fernando Cruz Galván By Fernando Cruz Galván | Director Mexico - Thu, 03/24/2022 - 17:00

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Clearly, we are facing one of those moments in history in which a transcendental change begins. It is difficult to understand based on immediate information but without a doubt, as events progress, we will better understand the long-term effects and, above all, how these effects will result in a change in the current configuration of the world economy with different impacts in each region.

The demand and availability of energy are undoubtedly among the engines that move the world and, therefore, economies. While the world, especially Europe, has been making progress in the energy transition and gradually increasing the use of clean energy, dependence on oil and its derivatives continues to be a determining factor in the world economy, and above all, in conditioning the transition pace and technological innovation.

At this time, Europe's dependence on gas from Russia is one of the main risks and one of the triggering factors for immediate changes, but above all in the future, we will necessarily see a reconfiguration of the energy market aligned more with a security issue and that will also influence the speed of the energy transition. As big countries like India and China are still driven by fossil sources, we have certainly seen how the worldwide CO2 emissions have rebounded to the highest level in history at over 2 billion tons. As a result, a new reconfiguration of emission targets is logically expected, bringing a new set of policies and rules to meet in the short and long term.

Until developments allow a more accurate assessment of the impact on Europe’s economy (and then the rest of the world), the International Energy Agency (IEA) has suggested some measures to try to reduce dependence in the shorter term and, of course, some of them are focused on incentivizing an acceleration of the deployment of renewable energy and to try to replace Russian gas with alternative sources as well as reduce/stop contracts with Russian suppliers. But none of these measures can provide the kind of immediate relief that actions taken by consumers to reduce the use of gas, such as replacing gas boilers and adjusting thermostats, in combination with efforts to keep incentives to offset the price increase. So far, I believe the economic impact is clear, holding back any potential growth, which was expected to reach +/-3.9 percent for Europe this year but which could eventually turn negative or close to zero. Of course, it is too soon to say at this time because the effects are most likely to extend in the event of a longer conflict than even Russia anticipated.

Another immediate consequence is that we are seeing a significant increase in the prices of raw materials, oil, gas, and of diverse agricultural products, such as wheat and corn, as well as mineral products. This will produce changes in the economic perspective of the world, and unfortunately, these changes are not going to be similar among different regions, such as the case of Mexico where we have a significant dependence on U.S. gas producers and with significant imports of agricultural products.

Many people tend to think that a higher oil price is positive for Mexico. That assessment comes from the old idea of Mexico being an oil country, but that hasn’t been the case for years. In 2021, net oil-related importations were +/- US$11 billion higher than raw oil exportations. In all cases, there might be a positive impact on PEMEX’s revenue but in exchange, there will be a very negative impact on Mexico’s public finances. The most immediate impact for now is related to the Special Tax (IEPS) that is usually adjusted by the government to compensate for a rise in gasoline prices. At this time, that buffer is gone because given the higher prices of imported gasoline, the government is actually reducing that tax to zero and providing a subsidy instead. This will necessarily damage public finances over the rest of the year, definitively limiting the resources available to meet economic targets. It will force more budget cuts to key public services as in the case of health and education. A negative impact on the country’s credit rating is also possible.

Inflationary pressure has been and will be a constant effect that we need to deal with this year and most likely next year as well. In the case of Mexico, we will be caught in the middle of an electricity reform discussion and its potential implementation. The result will be the worst if on the one hand, Mexico has severe inflationary pressure while, on the other, there is a deterioration of public finances and then severe damage to foreign investment resulting from this reform.

The financial markets will also continue to see volatility as long as the Russia-Ukraine conflict continues. As a result of this, the US dollar will become a concern, not right now but down the road. The reason is that many countries have reserves invested in US dollars among other currencies. Given its appreciation, its exposure is also affected, resulting in a reconfiguration of reserve portfolios to allocate resources in different currencies and avoid having too much dependence on the US dollar. In this regard, the Mexican peso is a very dynamic currency that actually sees higher trade volume in the global markets compared to internal/domestic trade. As a result, there will be variations that bring ups and downs to specific sectors. Regarding energy, I’m afraid the result would be more on the negative side because we still depend on gas and gasoline imports, while PEMEX continues to suffer from its weak balance sheet and is achieving very marginal improvements in production.

Finally, it is a bit early to assess how the global energy market will be reconfigured, which, of course, will depend on the Ukraine situation and the course of the military action. But some initial conclusions are a reality so far,

  • The change in the speed of the energy transition, with adjustments of policies focused on energy security and changes in portfolio exposure.
  • Maximized inflationary pressure with differentiated impacts by regions, especially emerging markets where the transition is well behind.
  • Change in reserves portfolios for many countries, if not all.
  • China will play a leading role in the reconfiguration of the energy market and supply chain dynamics.
  • Inventories will continue exhausting minimum levels and then oil and raw materials will continue at high levels, producing shortages in many developing economies.
  • Non-compliance with environmental goals in the short term and reassessment of goals for the long term.
  • Unfortunately, CO2 emissions will continue increasing by the time the world comes up with a new set of rules and goals.
  • Many countries could end up having inconsistent environmental policies and rules and at different speeds amid the European and US rule adjustments to come.
  • Cost of money will bring more financial challenges for those countries (like Mexico) with lower competitiveness and certain dependence on external energy sources.

We will see in the coming weeks (even months) how the changes and consequent configuration of the different markets and human reality play out, including, of course, a change in the access to energy and security.

Photo by:   Fernando Cruz

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