Since Russia launched a military invasion of Ukraine, the whole European security order seems to have been thrown into question.
Along with the first round of US, UK and European sanctions – which include restrictions on Russian financial institutions and a suspension of the Nord Stream 2 gas pipeline – broader and tougher sanctions will be announced. These measures are bound to have global political and economic consequences. As Russia retaliates against sanctions and war in Ukraine could damage gas pipelines, a severe energy shortage is possible, leading to a global economic slowdown, but more serious in Europe, amid a surge world oil and gas prices.
But increased production and new sources will offset the impact in a few months. Russia’s modest contribution to global GDP – just 1.7% – means that the global economic pain will pass even if the fallout from the invasion will define geopolitics for years.
Pouring oil on troubled waters
Wanting to avoid plunging American allies into an energy and economic crisis, the additional sanctions can avoid banning Russian deliveries of gas (representing 40% of European imports) and crude oil (more than a third of European imports) – or at least avoid a complete ban.
Any disruption in energy supply will occur in a context of already volatile gas prices in Europe, which a measurement increased elevenfold last year to $212 per megawatt hour. Russia could respond to the sanctions by further reducing deliveries to spot markets. He could try to divide Europe by sparing Germany while cutting off supplies to countries like Poland and Lithuania, which have been more active in supporting Ukraine.
The good news? Europe is already diversifying its energy sources. So far in 2022, European gas prices have fallen back to around $85 thanks to liquefied natural gas (LNG) imported from Asia. Over the past month, US LNG deliveries to Europe exceeded pipeline deliveries from Russia for the first time. Moscow, for its part, should not shut down its supplies altogether lest it seriously damage its reliability as a long-term energy source.
Meanwhile, high gas prices have prompted a partial switch to oil, bolstering a rebound in demand following an easing of COVID-19 restrictions. After the invasion, crude oil prices jumped above $100 a barrel. Additionally, JP Morgan predicts that oil prices could rise to $150 a barrel if Russia halves its energy deliveries to Europe in response to sanctions. Yet even in the worst-case scenario, the likely impact will be less severe than the 1973 OPEC oil embargo which led to a fourfold increase in oil prices and a significant tightening of US monetary policy (which was followed by a recession).
Rising oil prices will also encourage increased production. Saudi Arabia and United Arab Emirates can produce extra 3.5 million barrels per day. The United States can also produce more, having become world’s largest producer of oil and gas in 2021. the International Energy Agency (IEA) estimates that global oil supply will increase by 6.2 million barrels per day on average in 2022, compared to an increase of 1.5 million barrels per day in 2021. This is why the world oil market is expected to return to surplus later this year, which will slow rising price pressures.
Precious raw materials
In addition to affecting energy, Russia’s invasion could also disrupt the supply of other important commodities, including titanium (used in aircraft), palladium (used to make catalytic converters), neon (from Ukraine, used to make semiconductors) and wheat (Russia is the biggest exporter). This would drive up their prices.
Indeed, rising energy and commodity prices will keep inflation rates higher for longer and growth slower amid heightened uncertainty. This will pose a dilemma for many central banks. In January, the The International Monetary Fund cuts its growth estimates for 2022 for the world by 0.5 percentage point (ppt) to 4.4%. The organization cut the expected US growth rate by 1.2 points to 4%, while raising the consumer inflation estimate for advanced economies by 1.6 points to 3.9%.
Post-invasion energy price spikes could lead to further downward revision of growth estimates while raising inflation expectations. Continued high inflation rates will put additional pressure on the US Federal Reserve – already perceived to be behind in taking timely action in response to rising prices – to tighten monetary policies soon. However, the task of central banks was made more complicated and difficult as stock markets around the world crashed on news of the invasion, adding to the slowdown in economic activity.
The long game
To be sure, the West’s renewed concern for Russia and Ukraine could give China more leeway to take aggressive actions in the Indo-Pacific that could worsen already strained relations with the United States. Hybrid warfare, especially cyberattacks, can be expected to escalate by China and Russia, threatening critical functions and facilities in Western countries and interfering in their elections.
Europe will have to suffer an increase in oil and gas prices due to the Russian invasion of Ukraine and the resulting Western sanctions. But eventually, higher prices will induce more production to relieve upward price pressures. If Europe takes advantage of this moment to truly diversify its energy sources, it could insulate itself from future shocks planned by the Kremlin.
This could be wise since the current crisis risks crystallizing the standoff between the West and a Russian-Chinese axis into a new cold war – with a hot war in Ukraine that could threaten to spread to neighboring countries members of the NATO. This is a perilous time for the world.
Hung Tran is a Nonresident Senior Fellow at the Atlantic Council GeoEconomics Center and former Executive Director General of the International Institute of Finance and former Deputy Director of the International Monetary Fund.
Wed 23 Feb 2022
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