As the Russia-Ukraine conflict continues, the Russian crude supply is at risk of being disrupted as Western countries roll out economic sanctions. That means oil prices will likely remain high for a longer spell, posing a considerable challenge to oil-reliant economies.
When countries are affected, people will have to bear the brunt since high oil prices will lead to a hike in fuel prices, which will impact the cost of other commodities. That means everyone around the world will feel the pinch.
Oil prices have surged past $130 a barrel on Tuesday — the highest since 2008 — after US President Joe Biden announced that the US would ban crude, gas and coal imports from Russia. The UK will phase in an import ban on Russian oil with the plan to take none by the end of 2022.
What happens next?
The International Monetary Fund (IMF) warned that the conflict, the subsequent sanctions and the unknown risks it creates will have a “severe impact” on commodity prices and the global economy.
“While the situation remains highly fluid and the outlook is subject to extraordinary uncertainty, the economic consequences are already very serious,” according to an IMF statement quoted by Bloomberg.
Sanctions — and counter-sanctions — are now the focus of the conversation. Here’s what we know so far:
What are sanctions?
In international law, “sanctions” generally refer to economic sanctions — effectively a ban or embargo — which typically involve prohibiting economic transactions with individuals or entities.
The sanctions may be: Economic, i.e. a trade embargo against a country; Diplomatic, i.e. severance of diplomatic relations; Military, i.e. the use of armed force.
Countries, multilateral or regional organisations generally use economic sanctions as part of diplomatic efforts against states or organisations to protect national security interests or promote international law and defend against threats to peace.
Targeted –– also known as “smart sanctions” –– are directed against states but can also target non-governmental entities and specific individuals.
Selective vs comprehensive sanctions
A trade sanction or embargo may be comprehensive (designed to halt all inward and outward-bound trade except for humanitarian items) — or selective (for example, an embargo only on trade in goods having military uses or non-oil products).
In recent years, the United Nations Security Council has imposed trade sanctions on several countries.
Do sanctions work?
In general, trade and diplomatic sanctions are slow to work. More often, it’s the ordinary civilians — least able to influence the government’s behaviour — who bear the burden of economic sanctions.
However, they can influence political leaders toward the desired course of action (or moderation) if the sanctions have time to bite.
US sanctions vs Russia
Recent US sanctions against Russia can be traced to 2014 following the annexation of Crimea. The US imposed sanctions on 735 entities and individuals.
When Russia recognised the independence of the separatist republics of Donetsk and Luhansk in eastern Ukraine, the US slapped more sanctions on February 22, 2022.
As of September 2021, Statista listed 1,034 individuals and entities subject to US sanctions against Russia. In addition, the US sanctioned 170 entities/individuals for “malicious cyber activities”.
Russia has also imposed counter-sanctions, including travel bans, against a blacklist of 89 EU politicians and military leaders in 2014. Russia also blocked imports of selected categories of agro-food products from the EU, US, Australia, Japan, and other countries that had imposed economic sanctions on Russia. In 2015, Russia cracked down on food from the European Union. Russia’s EU food ban was extended to Ukraine, and the bans were renewed each year.
Before February, 2,754 Russian individuals and entities were named in sanctions by Western countries (vs 3,616 for Iran). When more sanctions were announced, Russia became the world’s most sanctioned nation, with penalties targeting individuals, companies, aircraft and yachts. Post-February 22, 2022, there were 2,778 more entities/individuals added to the sanctions list, or a total of 5,532.
Impact on food and oil prices
In recent days, food and energy prices have risen sharply, and supply chains have weakened, adding to the inflationary pressures that policymakers were already grappling with.
Oil briefly hit $132/barrel on March 8, 2022, before it slid to $124/barrel on Wednesday.
JPMorgan Chase & Co economists lowered their global growth forecast by nearly a percentage point this year while raising their inflation forecast by a similar amount.
“Price shocks will have an impact worldwide, especially on poor households for whom food and fuel are a higher proportion of expenses,” the IMF said. “Should the conflict escalate, the economic damage would be all the more devastating. The sanctions on Russia will also have a substantial impact on the global economy and financial markets, with significant spillovers to other countries.”
The Fund said central banks will need to “carefully monitor the pass-through of rising international prices to domestic inflation, to calibrate appropriate responses.”
Governments will need to find ways to support the most vulnerable households and help offset rising living costs.
“This crisis will create complex policy tradeoffs, further complicating the policy landscape as the world economy recovers from the pandemic crisis,” the IMF said.
Impact on other commodities
Prices of raw materials such as wheat, aluminium and nickel have soared to multi-year highs since Russia began the conflict in Ukraine on February 24.
The war in Ukraine has effectively shut off more than a quarter of the world’s supply of wheat — a food staple used in everything from bread to cookies and noodles. Ukraine and Russia are also major suppliers of corn, barley and sunflower oil.
Wheat futures have been more expensive than US cash markets as some local grain buyers baulk at high prices. Traders worldwide are struggling to gain clarity on how the disruption might alter the world food economy.
Dependence on Russian oil
“The more you go east, the more you see greater dependence on Russia’s energy exports — UK can afford to take the US line because they are shielded from Russian exports, unlike Germany,” said Carol Nakhle, founder and CEO of Crystol Energy, in an interview with Gulf Intelligence. “Prices heading up can be quite frightening, but today’s oil importers in the global economy are not the same as they were in the 1970s.”
“Although the impact on US supply may be limited, prices are soaring because the ban makes it more of a challenge to trade in Russian oil and more likely that other countries may follow suit,” said Bjornar Tonhaugen, Head of Oil Markets at Rystad Energy.
Russia usually exports 4.8 million barrels a day of crude oil to the market. Another 1.4 million bpd (barrels per day) is shipped via Russia, produced in other former Soviet Union countries, notably Kazakhstan. The US only imported 200,000 bpd of crude from Russia last year, and the UK less than half of that.
With the conflict showing no signs of ending soon, brokerages and consultancies expect prices to exceed $180 a barrel. Analysts do not expect oil-producing countries to pump out over 4 million bpd of crude oil into the market immediately.
“Oil prices could hit $240 per barrel this summer in the worst-case scenario if Western countries roll out sanctions on Russia’s oil exports en masse,” said Tonhaugen. “Market volatility is at an all-time high, with prices surging on the expectation that supply will further tighten due to restrictive sanctions on Russian energy from the West.”
The OPEC+, which includes Russia, holds about 4 million bpd in spare crude capacity, but there are few signs that the Middle East producers are opening the taps. Last week, the group held a conference and agreed to raise their production limit by 400,000 barrels a day, sticking to a schedule they set last year. The decision, which was widely expected, had little impact on oil prices.
Strategic oil reserves
Meanwhile, oil-consuming countries have tried to use strategic reserves to take some of the heat out of the market.
IEA member countries unanimously agreed on March 1 to an initial emergency response plan to alleviate the increasing pressure on oil markets resulting from the Russia-Ukraine conflict. The countries also agreed to make 60 million barrels of their emergency oil stocks available to the market.
“The decision taken to release emergency stocks – for only the 4th time in the IEA’s history – has sent a strong message that IEA Members are unified in support of Ukraine and will do all they can to provide stability to the market during these difficult days,” said IEA Executive Director Fatih Birol. “We continue to monitor the situation closely. If necessary, we are ready to recommend additional steps to build on this initial release.”
India is the big loser
India, which meets about 85 per cent of its oil requirement through imports, will be among the biggest losers in the current crisis. The country’s crude oil import bill is set to exceed $100 billion in the current financial year, almost double last year’s spending.
Petroleum prices could see a Rs15-Rs28 hike in India soon, according to industry sources. They will pile further pressure on the economy as it recovers from a two-year pandemic.