Impacts of Oil and Gas due to Russia-Ukraine crisis

Tensions over Ukraine are ratcheting up, with the prospect of sanctions on Russia threatening to further raise prices of commodities key to the global economy

After continued warnings from the U.S. and its allies that Vladimir Putin could be planning to invade Ukraine -- something he has repeatedly denied -- the Russian president officially recognized two self-proclaimed republics in eastern Ukraine and ordered what he called “peacekeeping forces” to go into the areas.

Western leaders condemned the moves, with the U.S. and U.K. planning to announce new sanctions as soon as Tuesday, while the European Union will start the process of agreeing penalties.

Markets have been on edge for weeks, and an actual conflict -- or sanctions -- could drive energy and food prices even higher, and push Europe into a major supply crisis.

Crude oil is approaching $100 a barrel and European natural gas surged on Tuesday. Other commodities have also gained, with aluminium nearing a record and wheat climbing to a one-month high. Gold, a time-honoured haven, is near the highest since June.

 “Rising geopolitical tensions are further amplifying the case for commodities, given Russia’s far-reaching impact on global commodity markets,”

JPMorgan Chase & Co. said in a report.

Sanctions could lead to shortages of food and energy, causing prices of both to soar, Bloomberg Intelligence said recently. Capital Economics said the biggest impact is likely to come through commodity prices, and a worst-case scenario could see oil reach $120 to $140 and gas jump higher, adding about 2 percentage points to headline inflation in advanced economies this year.

 Agreeing on the scope of sanctions won’t be easy since Russia’s moves fall short of a clear military attack, while penalties could threaten to further raise prices of key goods at a time when household budgets are already strained. The first steps could be penalizing individuals involved in the recognition of the two breakaway regions in eastern Ukraine, a more limited move that could happen relatively quickly.

Why Donetsk and Luhansk Matter to Putin and Global Security:

With traders and policymakers scrutinizing every move and comment in the standoff, here’s a look at the potential consequences for key raw materials.

Gas Hit

One of the biggest impacts so far has been on Europe’s gas markets. Geopolitical tensions have been amplified by already limited supplies from Russia and below-average stockpiles, with prices in the region jumping nearly fourfold in the past year.

A full-blown conflict could disrupt the massive volumes that Russia sends to Europe, about a third of which typically comes through Ukraine. Sanctions could hit trade and keep a new pipeline, Nord Stream 2, from bringing Russian gas to Europe. That could all have a big impact on refilling inventories in the summer, making next winter difficult as well. Prices could surge even higher, and send Europe’s economy reeling. Russia would also lose huge amounts of revenue.

 Still, many think it’s unlikely gas supplies would stop, or even be cut significantly. Russia plans to continue uninterrupted supplies of gas to global markets, Energy Minister Nikolai Shulginov said in Qatar, where he’s attending a gas forum.

Food and Fertilizer at Risk

A major casualty could be even higher food prices. Ukraine and Russia together are heavyweights in global wheat, corn and sunflower oil trade, leaving buyers from Asia to Africa and the Middle East vulnerable to more expensive bread and meat if supplies are disrupted. That would add to food-commodity costs that are already the highest in a decade.

 Grain Heft

Ukraine and Russia account for a quarter of global exports

When Russia annexed Crimea in 2014 wheat prices jumped even though shipments weren’t substantially affected. Russia and

Ukraine’s share of world exports has increased since, with nations like Egypt and Turkey reliant on the Black Sea breadbasket.

So far, cargoes are still flowing freely and there’s no indication of significant disruptions. But should that happen, global markets already grappling with shrinking grain stockpiles could see further shortfalls.

Tension Over Ukraine Poses a Risk for the Price of Bread

Russia is also one of the world’s biggest exporters of all three major groups of fertilizers. Any cuts in supply may result in a surge in already high nutrient prices, affecting crop yields and cause further food inflation.

Metals Crunch

Traders are also weighing the risk of disruption to Russian exports of metals including aluminium, nickel, palladium and steel, even as analysts stress that targeting Russian producers directly with sanctions would be a major own-goal for the West. U.S. sanctions against United Co. Rusal International PJSC sparked turmoil in the aluminium market in 2018, and policymakers may not want to risk a repeat. Rusal’s shares have plunged in Hong Kong in recent days.

 But should Russia get cut off from the Swift international payment system as part of any sanctions, it would slow down the flow of funds and hit exports. Any disruptions to gas flows could also exacerbate problems for metal producers in Europe who’ve been cutting output in response to high energy prices.

 Even short-lived disruptions could have an outsized impact at a time when manufacturers are already facing critical shortages of metals from aluminium to zinc. The fallout could be particularly dramatic in the palladium market, where Russia accounts for about 40% of global supply.

The country is less dominant in base metals, but remains one of the world’s leading suppliers, with JPMorgan estimating that it accounts for about 4%-6% of global refined production of copper, aluminium and nickel.

Oil Spike

Any disruptions to oil flows from Russia, with low spare production capacity in other countries, could easily send prices rallying.

JPMorgan’s analysts have even tested the possibility of a spike to $150. Prices in London are approaching $100 a barrel. Additional sanctions on top of those already affecting Russia’s oil industry could take oil higher much more quickly.

At that price, the impact on the global economy could be debilitating. It’s a reason many don’t expect sanctions to be so severe that oil flows are significantly affected. Besides, Saudi Arabia and some others in the Middle East could potentially fill the gap.

Still, traders remain edgy. Around half of Russia’s oil and condensate exports are directed to Europe. Disruptions could wreak havoc, and force trade routes to change.

The economic impact of Russia’s war in Ukraine is not confined to oil. It extends as much to agricultural commodities and fertilisers. What do the soaring prices of these commodities mean for India?

 The current Russian invasion of Ukraine— unlike previous wars in Iraq and Libya or sanctions against Iran — is having an impact not just on energy prices. The effects of shipping disruptions through the Black and Azov Seas, plus Russian banks being cut off from the international payments system, are extending even to the global agri-commodities markets.

The reasons aren’t difficult to see: Russia is not only the world’s third biggest oil (after the US and Saudi Arabia) and the second biggest natural gas (after the US) producer, besides the No. 3 coal exporter (behind Australia and Indonesia). It is also the second largest exporter of wheat. The US Department of Agriculture (USDA), in its most recent report on February 9, estimated the country’s shipments for 2021-22 (July-June) at 35 million tonnes (mt), next only to the 37.5 mt of the whole of European Union.

But the story doesn’t end there. At No. 4 position in wheat exports, after EU, Russia and Australia (26 mt), is Ukraine, at 24 mt.

Ukraine, moreover, is the world’s third largest exporter of corn/maize, with a projected 33.5 mt in 2021-22, after the US (61.5 mt) and Argentina (42 mt). Ukraine and Russia are also the top two exporters of sunflower oil, at 6.65 mt and 3.8 mt, respectively in 2021-22, as per USDA. If that weren’t all, Russia and its next-door ally Belarus are the world’s No. 2 and No. 3 producers of muriate of potash (MOP) fertiliser, at 13.8 mt and 12.2 mt in 2020, respectively, behind Canada (22 mt).

It should not surprise, therefore, that Russia’s war on Ukraine hasn’t stopped at driving up Brent crude to $110-15/barrel and international coal prices to unprecedented $440/tonne levels. The shutting down of ports in the Black Sea have also sent prices of wheat and corn traded at Chicago Board of Trade futures exchange soaring to their highest since March 2008 and December 2012, respectively.

What does that mean for India?

Skyrocketing global prices have made Indian wheat exports very competitive and, in a position, to at least partially fill the void left by Russia and Ukraine. Wheat from Gujarat, Rajasthan and Uttar Pradesh is now being delivered by rail wagons or trucks at warehouses near Kandla port at Rs 2,400-2,450 per quintal, as against Rs 2,100 or so hardly 15 days ago. This is above the government’s minimum support price(MSP) of Rs 2,015/quintal for the new crop that will arrive in the markets from mid-March. High export demand for wheat – India has already shipped out 5.04 mt of the cereal in April-December 2021 – could result in lower government procurement this time, compared to the record 43.34 mt and 38.99 mt from the 2020-21 and 2019-20 crops, respectively. A lot of wheat from western and central India may end up getting exported rather than in the Food Corporation of India’s godowns and, in turn, putting pressure on public stocks: These, at 23.66 mt as on February 28, were the lowest for this date in three years.

“The government might, sooner than later, have to impose some kind of a tariff or other restrictions on exports,”

says S. Pramod Kumar, senior vice president, Roller Flour Millers Federation of India.

Whether or not required, the situation post Ukraine is a far cry from FCI’s overflowing granaries that enabled, if not forced, free distribution of this excess wheat and rice to some 81-crore people.

The free grain scheme, introduced in April 2020 following the Covid-19 induced lockdown, will end this month with the conclusion of state elections in UP.

According to Kumar, the government would hereon need to carefully manage both its own stocks and also the overall domestic availability position in wheat.

The other oil

The Ukraine crisis has also led to prices of vegetable oils and oilseeds skyrocketing. That includes not just sunflower and its immediate competitor, soyabean. Palm oil in Malaysia has hit all- time-highs, even scaling 7,000 ringgits-per-tonne levels briefly in the past few days. The benefits of it should flow to mustard growers in Rajasthan and UP, who are set to market their crop in the coming weeks. Mustard prices are ruling at Rs 6,500-plus per quintal, which is again above the MSP of Rs 5,050.

Brent at $110-115/barrel is also helping lift the prices of cotton (because of synthetic fibres becoming costlier) and agri- commodities that can be diverted for production of ethanol (sugar and corn) or bio-diesel (palm and soyabean oil). High prices (above MSP) and a good monsoon (hopefully) can act as an inducement for farmers to expand acreages under cotton, soyabean, groundnut, sesamum and sunflower in the upcoming kharif planting season.

That will serve the cause of crop diversification – especially weaning farmers away from paddy, if not sugarcane.

But there is a flip side. The ongoing Black Sea tensions are impacting fertiliser prices as well. Take MOP, a nutrient that India wholly imports. Out of the total 5.09 mt that was imported in 2020- 21, nearly a third came from Belarus (0.92 mt) and Russia (0.71 mt). With supplies from there virtually choked, more quantities would have to be procured from other origins such as Canada, Jordan and Israel.

International prices of other fertilisers (urea, di-ammonium phosphate and complexes) and their raw materials/intermediates (ammonia, phosphoric acid, sulphur and rock phosphate), too, have gone up in the past one month and more. These commodities essentially track crude and gas prices. It doesn’t help when China is also India’s largest supplier of urea (Ukraine was No. 3 in 2020-21, after Oman) and second largest of DAP (after Saudi Arabia).

In short, the challenges that Ukraine will present in the coming days are going to be vastly different from those in the aftermath of Corona. And this war and the associated sanctions are also different from those experienced vis-à-vis Iraq, Libya and Iran. The effects are not confined to oil.