All the effects of the war in Ukraine on oil, gas and grain
What will happen to oil, gas, wheat and more with the war in Ukraine. The analysis by Sonal Desai, chief investment officer of Franklin Templeton Fixed Income
The invasion of Ukraine by Russia has already had tragic repercussions for the population. It also inflicts another disruptive shock on a global economy that was already facing persistent problems in supply chains and rapidly rising inflation. The clearest and most immediate impact of the conflict will materialize in heavier and more lasting inflationary pressures, driven by a negative shock on energy supplies and some agricultural commodities, as described below.
While this inflationary shock is severe, it should not stifle the robust momentum of the ongoing recovery of the global economy following the closures imposed by the pandemic, fueled by highly expansionary fiscal and monetary policies. In the US, the impact on growth is expected to be modest, but negative repercussions on business confidence are likely. In Europe, the effects will be heavier, given the continent's considerable dependence on energy imports from Russia. A delay in the plans of the European Central Bank (ECB) to cancel monetary stimulus therefore seems likely, while Federal Reserve Chairman Jerome Powell has signaled that the US central bank will go ahead with a first rate hike later this month.
The inflationary shock appears destined to be prolonged, as discussed below with reference to the various sectors. Over a longer period, the impact on growth will depend on the evolution of the conflict and on the possibility of an expansion of economic sanctions that would weigh more heavily on Russia's energy sector. As long as strong uncertainty persists, our working assumptions at this stage take into account higher inflation for a longer period, but with only a moderate negative impact on growth in the United States.
Below, our sector specialists take a closer look at price changes for certain commodities and delve into the longer-term implications for inflation and growth.
PETROLEUM
Russia ranks third in world oil production, after the United States and Saudi Arabia. As of January 2022, Russia was producing more than 11 million barrels per day (mmbbl / d) .1 In addition, Russia ranks second in exports of oil and refined products, after Saudi Arabia. As of December 2021, Russia was exporting around 5 mmbbl / d of oil and almost 3 mmbbl / d of refined products. About 60% of Russian exports were destined for Europe and about 20% for China, in both cases by pipeline and by sea.
Western governments have not yet implemented direct sanctions on Russian oil and gas, but there have already been major impacts on trade flows of oil from Russia. In recent days, for example, the press reported that a Trading House was offering a cargo of the Ural oil mix, the best in Russia, at a never-before-heard discount of more than USD 18 / barrel compared to Brent, but without success. to find buyers. Indeed, it is currently widely reported that traditional buyers, including European refineries, are unwilling to buy Russian oil, either for reputational reasons or because of the uncertainty surrounding final sanctions. Certain Asian buyers, including China and India, are also currently abstaining from buying oil from Russia, according to reports. In addition, shipments of oil by sea from the Black Sea could be curtailed as long as the conflict is ongoing. Some market observers have estimated the losses of oil exports from Russia to be between 2 and 4 mmbbl / d (or more), at least temporarily.
In the case of a block for a certain period of time of some quantities of crude oil from Russia, there are possible sources of incremental oil supplies; however, the size of Russia's exports to the global market could make it difficult to offset the reduction in supplies. First, on March 1, the member countries of the International Energy Agency (IEA) agreed to release 60 million barrels of oil from strategic reserves, a volume equal to about 60% of global daily demand. It is a short-term one-off measure, but it could still fill a modest deficit for a limited period of time. A commitment by IEA members to release other reserves could help calm markets. A source of incremental supplies over a longer period could be a possible lifting of the sanctions imposed on Iran by the United States, releasing 1 mmbbl / d of incremental supplies; in addition to a possible short-term incremental increase in Iranian oil in storage. Finally, the most important OPEC countries, mainly Saudi Arabia and the United Arab Emirates, have an unused incremental production capacity.
The actual volume of OPEC spare capacity is a hot topic, with the US Energy Information Agency aiming for more than 4 mmbbl / d of current spare capacity, while other market observers estimate that the current spare capacity of OPEC OPEC could be less than 2mmbl / d. The monthly meeting of OPEC + members was held on March 2. It was an incredibly short meeting (reportedly lasting less than 15 minutes) with the group's press release unexpectedly emphasizing a well-balanced market outlook, while also stating that current volatility was associated with developments. geopolitical, and not to changes in market fundamentals. We anticipate that the next meeting, scheduled for March 31st, could be much more interesting.
The other element that has made a big difference in production in recent years has been US shale. Expectations of incremental oil production in the United States in 2022 compared to 2021 generally range from 0.6 to 1 mmbbl / d. Independent public exploration and production companies have generally shifted to a low-growth capital allocation structure aimed at generating free cash flow intended to repay debt and return capital to shareholders in the current pricing environment. The discipline of production growth could be tested if oil prices continue to rise, and in recent days we have also heard hints in public comments from large US producers that the Russian invasion could lead to some change in mentality. However, even shale, with a short cycle, could take at least two or three quarters to reach an increase in production, given the planning cycles and general supply chain problems. Indeed, in light of the limited availability of manpower as well as certain materials and services, it remains to be seen when US shale production could realistically increase.
Lacking a certain share of traditional Russian exports, even with increases in supplies offered by the aforementioned sources, over time the market in 2022 could find itself in a situation where the overall spare capacity still available would be very small. A scenario like this can generally lead to rising and volatile oil prices. If supply is insufficient to satisfy demand, oil prices could switch to being driven by a price that destroys demand. It is difficult to imagine at what point the price could actually destroy the demand, however 125 or 150 dollars / barrel is not unrealistic. If oil prices were to hit that band, a certain level of demand destruction coupled with an increase in OPEC and US shale production could possibly be the cause of a sharp drop in prices over the medium term.
On the other hand, even if the war were to end quickly, it is conceivable that Western oil and gas companies could avoid Russian oil for an extended period, possibly resulting in a more limited supply-demand relationship than we would have seen. otherwise, and all accompanied by a return to the fore of energy security for many governments. Indeed, many of the major oil companies, which in recent years have been quite focused on questions related to environmental, social and investor governance factors, were quick to announce after the invasion that they would block investments and abandon projects in Russia. .
EUROPEAN NATURAL GAS
The conflict between Russia and Ukraine has led to new increases in gas and energy prices in Europe, both of which have risen by more than 120% since mid-February. Russia supplies 30% -40% of the continent's gas, and natural gas accounts for 20% of Europe's total energy needs.5 Russia is Europe's largest gas supplier, and Europe is Europe's largest gas supplier. volta is the largest customer of Russian gas.
While this suggests that Russia has an advantage, given its ability to control gas flows to Europe and ultimately put pressure on European economic growth, European Union (EU) gas imports are crucial. for the Russian government, in terms of revenues, and the possibility for Russia to shift flows from the EU to other destinations is very limited. As a result, we believe that the costs for Russia of supply cuts to Europe are high, and not our main scenario.
With the ongoing rise in geopolitical risk, expectations tend to accelerate Europe's energy transition, reducing its dependence on Russian gas, better diversifying gas supplies and expanding renewable energy capacity. However, this will not happen overnight, and it will take time for these changes to be substantial. In the short term, the security of energy supply is of the utmost importance, and countries that are heavily dependent on Russian gas, such as Germany, Italy and the Netherlands, must make decisions to quickly eliminate concerns about energy supplies. The role of nuclear energy in the mix could be reexamined; the German government demonstrated this by considering keeping the plants running to reduce energy insecurity.
Rising gas and energy prices will pass on to end users unless governments decide to take action. The EU is enabling Member States to reduce impacts on consumers, as seen in many European countries, such as France and Spain. Political interference is unlikely to subside in the near term, putting further pressure on the utilities sector.
The future path of European gas and energy prices will largely depend on the outcome of the conflict between Russia and Ukraine. Assuming that Russia does not end up cutting off natural gas supplies to Europe, we are convinced that prices should still remain high compared to the levels prevailing before last summer, given the need to restore gas reserves that have depleted. A reasonably mild winter (and presumably some marginal destruction of demand) helped save the continent from the worst-case scenario of running out of gas this winter. Nonetheless, by the end of winter, storage levels this year will be at their historical low since 2010, and liquefied natural gas (LNG) is in short supply around the world.
There is a gap in the upcoming growth of LNG supplies and a lot of time and capital is needed to strengthen US LNG export capacity. Europe will have to bid for more LNG cargoes than Asia if it is to make more purchases so that reserves are in better condition early next winter. Even before Russia invaded Ukraine, futures market prices were discounting much higher natural gas prices for the coming winter and the next, compared to the levels prevailing in the spring of last year. If Russia were to cut natural gas supplies to Europe, storage could be in worse shape by the time next winter than last year.
The result is that natural gas and energy prices in Europe will remain predictably high for the foreseeable future, regardless of the outcome of the conflict between Russia and Ukraine, with negative implications for inflation and growth. While consumers in certain European countries may have some protection from high energy prices, companies are predictably more exposed, however they may have some time to prepare, given the usual regulatory gaps of 12-24 months before utilities pass on cost increases. Spot natural gas prices in Europe have recently been up to 10 times higher than in the United States; should expensive natural gas in Europe become a long-term structural issue, it will be important to closely monitor the global competitiveness of certain sectors of the overall European industrial economy.
AGRICULTURAL RAW MATERIALS
The conflict between Russia and Ukraine has also caused the prices of some raw materials for nutrition to rise rapidly, with oats up 40% since the beginning of the year and wheat by 25%. This reflects the fact that in 2021-2022 the two countries were expected to contribute approximately 25% -30% of world export oat supplies and around 20% of world export grain supplies (with the vast majority of this figure represented by Ukraine), as well as significant volumes of other agricultural commodities. Port closures in Ukraine, transport problems and restrictions on funding for Russian raw materials have all played a role.
Problems for planting and harvesting seasons, compounded by labor and transportation problems caused by the conflict, can impact global markets for these agricultural commodities for the next 2-3 years, and lead to product prices for the crop. high nutrition for the foreseeable future.
The global supply of fertilizers is also likely to suffer from the impact. About 10% of nitrogen production and phosphate exports come from Russia / Ukraine, and nearly 31% of global potassium capacity is in Belarus / Russia.7 To further complicate the situation, European natural gas currently determines the marginal cost for nitrogen fertilizer, a global commodity. Part of nitrogen fertilizer production had already stopped towards the end of 2021, due to high gas prices in Europe; this contributed to a tight global market even before the war broke out. Indeed, on March 2, the management of major US nitrogen producer CF Industries publicly stated that they expect nitrogen stocks "to drop to the lowest levels of the history."
Changes in fertilizer prices since the beginning of the year have been relatively modest, pending the start of the planting season in the Northern Hemisphere, partly due to markets which are not very liquid and the latest price data points were rising. a before the invasion. That said, recent prices are significantly higher than in previous years, and for most fertilizers of virtually any quality they have doubled or more than tripled in 2021. Given potential supply issues and already tight global markets for fertilizers, this will be another key area to look at in the coming months.
Considering that oats and wheat are not only components of human food, but also of feed for cattle, poultry and pigs, and that fertilizer is a crucial input for modern agriculture, pressures on food prices are likely to be generalized, large and persistent. Again, the implications for inflation and growth are negative, leading in this case to a contraction in disposable income for consumers and possible squeezes in the margin for grocery companies and restaurant operators.
CONCLUSION
The ramifications of the conflict between Russia and Ukraine, by shifting paradigms, will predictably create certain cross currents that are difficult for economies and central banks around the world to overcome next year and perhaps beyond. Similarly, investors will need to think through complex implications and flexibly position portfolios accordingly.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/guerra-ucraina-conseguenze-petrolio-gas-grano/ on Tue, 15 Mar 2022 07:23:41 +0000.