Trade Finance, Macro And markets
Ukraine on the brink
3 March 2022
With tensions between Russia and Ukraine having exploded into full-blown war, what are the repercussions for Russian oil and gas exports that escaped the EU and G7 sanctions deep freeze, and the wider risks to neighbouring economies? flow’s Clarissa Dann shares the insights from Deutsche Bank Research
Over the weekend of 26–27 February 2022, Western governments placed an unprecedented level of sanctions on Russia that include barring Russian banks from the SWIFT messaging service and a freeze on Russian Central Bank reserves.
“In retaliation,” notes Deutsche Bank Research Strategist Jim Reid, Russian President Putin has “ordered his strategic nuclear forces to be put on high alert, while Belarus passed a constitutional referendum that paved the way for Russian nuclear weapons to be deployed there”. As he adds: “It is fair to say that the stakes are enormously high.”1
This article takes a closer look at the economic stakes – the key risks identified by the Deutsche Bank Research team to the European economy and the potential impact on commodity prices, trade flows and energy security.
While the sanctions excluded Russian energy exports, the dependence of the EU on the continued flow of Russian oil and gas sits uncomfortably alongside its decision to freeze Russia out of the financial system. A separate article entitled How sanctions against Russia affect payments and FX examines the impact on FX flows and international payments of the SWIFT restrictions.
OECD crude oil and oil products inventory, as well as European gas markets, had low inventories before the October start of the winter heating season, but Europe’s dependency on Russian oil and gas creates, according to Deutsche Bank Research, “the most significant risk channel”, given that exposure to Russia has not declined in the period since its annexation of the Crimea in 2014.2
“The one and major channel of transmission of this crisis to the global economy remains the energy market…ultimately the relevant question is ‘does Russia constrain supply or does the West curtain its ability to purchase energy?’” ask Deutsche Bank Research’s George Saravelos, Oliver Harvey and Peter Sidorov in their FX Blog of 27 February.
In an earlier report, Russia/Ukraine: Assessing the risks to the European economy (15 February 2022) the team notes that the EU has become increasingly dependent on imports for energy – In 1990 they constituted 50% of all fuel consumed, and by 2019 this figure had risen to 61% (see Figure 1).
Figure 1: The EU imports more than 60% of all fuel and more than 90% of oil and gas
Source: Deutsche Bank, European Commission
Furthermore, the report continues, within the EU’s energy imports, Russia accounts for 40% of natural gas imports and 20% of oil imports. Although Russia’s share in EU oil imports had declined in recent years – reflecting a shift by Russian oil exporters to Asian markets, the EU and the UK still account for more than half of them.
In the event of potential future disruption of Russian gas supplies it is evident, states the report that “Northern and Eastern European economies, which on average are already showing lower storage, are most directly exposed”. While Russia provides around 40% of EU gas, this figure is closer to 100% in some CEE countries and around two-thirds of Germany’s supply. “By contrast, countries on the Iberian Peninsula, which is a hub for liquefied natural gas import terminals, have much lower direct exposure to Russian gas.” However, even those countries would feel the pain of any price spike should this disruption occur.
“A prompt, well-managed transition to renewables is the only pathway to energy security”
As pointed out by UN Secretary General Antonio Guterres in a press conference on 28 February, the conflict in Ukraine underlines how the continued reliance on fossil fuels “makes the global economy and energy security vulnerable to geopolitical shocks and crises”. He added, “A prompt, well-managed transition to renewables is the only pathway to energy security.”3
What is the demand and supply gap?
At this early stage of the tougher sanctions policy, it is difficult for the team to predict whether Russian energy exports could eventually be curtailed. However, reflects Deutsche Bank’s Research Analyst Michael Hsueh, “a partial curtailment (around 10%) with a plausible disguise of operational maintenance, cyberattack or sabotage seems the option we should be most concerned about”. Given the low inventory levels, even a partial curtailment could, he explains, “result in a disproportionately large increase to market prices”. Hsueh adds, “It will be difficult to backfill even a partial disruption in Russian oil and gas exports by coordinated actions with other energy suppliers, and absolutely impossible to balance a complete disruption without significant demand-side management”.
The issue is the sheer scale of Gazprom pipeline exports into European countries – 175 billion cubic meters (m3) in 2020 – a consumption of 479 million m3 a day. As Hseuh notes: “Demand-side management typically is seen first among industrial users on interruptible contracts, although certainly an emergency situation could see service interruption in household and business heating, while the power generation sector is likely to be a last resort owing to grid stability concerts (to avoid a complete shutdown of electricity distribution networks).”
“It will be difficult to backfill even a partial disruption to Russian oil and gas exports”
Best efforts to replace Russian gas, such as Europe’s largest source the Dutch swing field Groningen (currently being decommissioned) or liquified natural gas (LNG) imports with major producers such as Qatar, Australia and the US would, says Hsueh, make up less than half of the supply gap.
Figure 2: OPAL pipeline infrastructure
Given that since mid to late 2021 a majority of Russian gas exports to Europe have been transiting Nord Stream (phase 1) into Germany’s NEL, OPAL and EUGAL networks all eyes are on these border points for signs of any reductions in intraday gas flows. See Figure 2 for OPAL’s pipeline network, which is jointly owned by Russian gas monopoly Gazprom and Germany’s Wintershall Dea. On 27 February, Hsueh notes that Russian gas exports had actually increased over the 26-27 February weekend with Nord Stream inflows to NEL and OPAL pipeline networks remaining at maximum capacity.4
However, his report also makes the point that Russia could still constrict energy exports as retaliation. “It is useful to remember that President Putin himself ordered the January 2009 halt of gas supply through Ukraine during a dispute over contract gas sales prices to Gazprom and pipeline transit fees to Ukraine.”
Lowering of EUGAL gas pipes near Brandenburg, Germany
Oil price sensitivity
If Russian crude oil and oil export products were completely curtailed, OPEC core spare capacity, says Hsueh, could plug less than half of the gap (three million barrels a day (mmb/d) out of a combined 7.6 mmb/d of Russian crude oil and oil product exports. What might this do to the oil price? History provides a clue. “The absolute scale of such an outage could be higher than that seen in the 1973 OPEC Embargo when measured as a proportion of today’ oil demand,” says Hsueh (see Figure 3).
Figure 3: Historical oil supply disruptions and effect on Brent
Source : Bloomberg Finance LP, Reuters
Non-energy trade exposure
On the trade front, the EU’s exposure to Russia remains much larger than that of the US. Deutsche Bank Research puts total trade with Russia at around 1.5% of GDP for the EU compared with 0.1% of GDP for the US. However, note Sidorov, Wall et al in the 15 February report Assessing the risks to the European economy, trade linkages with Russia have halved in the past decade (see Figure 4).
Figure 4: EU trade exposure to Russia fell during 2014-15, stabilising more recently
Source: IMF, Eurostat, Deutsche Bank
Exposure to Russia across EU members, continues the report, “differs widely”. Those countries neighbouring Russia and the CEE region are most exposed in terms of their exports. Moreover, Germany (0.7% of GDP), Netherlands (0.8%) and Belgium (0.9%) also have a relatively large exposure to Russian demand. And in terms of Ukraine itself, again its CEE neighbours face particular risk. Ukraine borders Belarus, Hungary, Moldova, Poland, Romania, Russia, and Slovakia by land and Georgia and Turkey by sea (see map at the end of this article).
Machinery and equipment comprise the largest sectoral exposure on the export side – with exports of these items to Russia accounting for 2% of total EU goods exports. As indicated above, import reliance on Russia is at its highest in the energy sector.
However, the conflict is expected to disrupt the processing and export of Ukrainian oilseed crops for at least a month, given that Ukraine is the world’s largest producer of oilseeds (US$3.75bn of total world trade of US$11bn), as the consultancy Strategie Grains said in a note report to clients referenced by Reuters on 28 February.5 In addition, Russia and Ukraine together export around a quarter of the world’s wheat, with Ukraine often referred to as “Europe’s breadbasket”. As Karabekir Akkoyunlu, a lecturer in politics of the Middle East at SOAS, University of London noted in an interview with news agency Al Jazeera,[ii] “The wheat harvest starts in about two months and this year’s yield is expected to be a healthy one, meaning abundant supply for global markets in normal conditions. But a protracted war in Ukraine can affect the harvest in that country, and therefore global supplies.”
An uncertain future
Each of the reports cited in this article agree “news is flowing very fast” and that further detail is needed about the scope and applicability of the sanctions and asset freezing measures (SWIFT has announced it is “engaging” with the relevant authorities to understand which entities will be subject to potential disconnection under the new measures7 and late on 1 March the EU named seven Russian banks, including VTB but not Sberbank or Gazprombank). However, most assume that commodity prices will rise further.
Not only could the potential disruption in oil and gas supply push energy prices even higher, but other commodities such as oilseeds and wheat could also see price rises. Not only would this drive further inflation, but the general dislocation might also accelerate de-globalisation. “The lines between financial and geopolitical security are becoming increasingly blurred,” reflect Deutsche Bank’s Saravelos, Harvey and Sidorov.
Deutsche Bank reports referenced
Early morning Reid: Macro Strategy, 28 February 2022
FX Blog: Commodity risk on stronger sanctions by Michael Hsueh, Deutsche Bank Research, 27 February
FX Blog: Historic moments – thoughts on the market open and beyond by George Saravelos, Olive Harvey and Peter Sidorov, 27 February
FX Blog: Energy markets on the edge by Michael Hsueh, Deutsche Bank Research, 24 February
Focus Europe: Russia/Ukraine: assessing the risks to the European economy by Peter Sidorov, Mark Wall, et al, 15 February
1 Early morning Reid: Macro Strategy, 28 February 2022
2 See also Higher energy prices – here to stay? at flow.db.com
3 See https://bit.ly/3HAooBg at un.org
4 FX Blog: Commodity risk on stronger sanctions by Michael Hsueh, Deutsche Bank Research, 27 February
5 See https://bit.ly/3C5tlRo at nasdaq.com
6 See https://bit.ly/3hCck7G at aljazeera.com
7 See https://bit.ly/3462Yhw at swift.com
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