Russia’s invasion of Ukraine and the sanctions imposed by the western world have caused huge disruption across financial markets. Volatility has risen dramatically, impacting global equity markets. Russia’s position as one of the largest and most diverse global commodity producers has caused unprecedented ructions across numerous commodities.
In this note, we elaborate on the potential impact of a prolonged disruption to commodities exports from Russia and Ukraine.
The scale of the impact is reminiscent of the 1973 oil embargo. Although the dependence on Russian oil and oil products pales in comparison to the reliance on OPEC at the time, the impact is being felt across a far broader range of commodity markets.
The opening week of the invasion pushed the broad S&P GSCI Commodity Index up 20% – the largest weekly move in the series’ history. The index is up 36% year-to-date, having moderated from a near 50% increase a week ago. Russia’s invasion of Ukraine has led to the rapid imposition of severe sanctions on the country. While Russia and Ukraine combined represent around 3% of global GDP, their contribution to global commodity exports is significantly higher.
Russia is the third largest global producer of oil (and second largest exporter) and the largest producer of wheat. Together with Ukraine, the two countries account for around a quarter of global wheat and barley exports and ~15% of corn exports. The cumulative total of all its agricultural exports add up to more than one tenth of all calories traded globally.
Europe procures nearly 40% of its natural gas and 25% of its oil from Russia. Despite Russia’s annexure of Crimea in 2014, Europe’s dependence on Russian natural gas has increased, providing a key source of leverage against sanctions placed on the country. Given the reliance on Russian gas, that will take years and huge investments to replace, the severity of the sanctions backed by the European Union were unexpected.
President Biden announced last week that the US would ban the import of Russian oil and other energy products. The move also bans new US investment in Russia’s energy sector and prohibits Americans from participating in any foreign investments that flow into the Russian energy sector.
The US imported more than 20 million barrels of crude and refined products a month on average from Russia last year – about 8% of its total liquid fuel imports. The expectation of the ban and subsequent announcement pushed the Brent Crude oil price above $130 per barrel, the highest level since 2008.
Europe’s current reliance on Russian gas has prevented it from following suit. The European Commission announced a plan (“RePowerEU”) to reduce Europe’s demand for Russian gas by two-thirds before the end of the year and totally phase out Russian commodities before 2030. This will be achieved by increasing liquified natural gas (LNG) imports from Qatar and the US, accelerating investment in renewable energy and improving energy efficiency. This will, however, come at a much higher cost than the natural gas pipelines currently used. Russia and Ukraine’s status as the “bread basket of the world” and the potential impact on production and exports of wheat, corn and sunflower oil to the rest of the world has pushed agricultural staples prices to record levels. Even prior to Russia’s invasion, global food prices hit record levels in February and were up 21% year-on-year according to the Food & Agriculture Organization. A key driver of the increase has been higher fuel, fertilizer and feed costs.
With the exception of gas, the sanctions imposed have led to a sharp drop in commodity exports from the country. The drop has not been a function of sanctions but rather the private sector “self-sanctioning”. JPMorgan estimates that around 70% of Russian seaborne oil was struggling to find buyers, despite record discounts offered for Russian Urals crude oil.
Switzerland is the one of the world’s major hubs for trading commodities with the Swiss government estimating that 80% of Russia’s raw material and resources are traded in Switzerland. Departing from the country’s historical stance of neutrality during conflicts, Switzerland have followed the rest of Europe in sanctioning Russia.
Commodities traders like Glencore and Trafigura utilize credit lines from banks and other financial organizations to purchase, transport and store commodities, while selling forward contracts to offload the physical product future. Insurance companies have been reluctant to cover ships entering the Black Sea and Azov Sea due to Russian occupation. With the vast majority of wheat and corn exports transported through the Black Sea ports, the insurance embargo will hamper the ability to export the products. Banks – wary from past sanctions violations (and hefty fines) – are erring on the side of caution and choosing not to fund the purchase of commodities from Russia.
Another stumbling block for western companies attempting to buy Russian commodities is the reputational risk involved, which Shell will attest to. Trafigura sold Shell a cargo of Russian crude oil at a deep discount to the Brent Crude benchmark price – mainly to ensure adequate supply to its refineries. Despite not breaching any sanctions, the public backlash led to the company announcing that it would stop buying Russian oil and earmarked the profits made on the purchase to humanitarian efforts to help the people of Ukraine.
Demonstrating the risks of interrupting the flow of physical metals, the London Metals Exchange (LME) halted the trade of nickel on Tuesday last week following a historic and disorderly price spike in the underlying metal. Nickel is predominantly used to manufacture stainless steel, and to a lesser extent, high quality (“ Grade 1”) nickel is needed for electric vehicle batteries. Russia’s Norilsk Nickel accounts for nearly one-fifth of high grade nickel supply – the grade traded on the LME.
The price of nickel jumped 66% to reach $48 000/tonne on Monday before vaulting to $100 000 in Asian trading on Tuesday. The historic price move triggered billions of dollars of losses for traders and certain producers who had shorted (bet on a decline in the price) the metal. In response to the damage that the sudden price move caused in the market, the LME took the unprecedented step of not only halting trading but cancelling all the trades that took place in Tuesday’s trading session. Bloomberg estimates that the exchange cancelled trades to the value of nearly $4 billion. LME has yet to resume trading on nickel.
The implications of the disruption:
The situation depends largely on whether the sanctions imposed will cause Putin to scale back the invasion and seek some form of negotiated settlement. Even more importantly, the west needs to provide an off-ramp for Putin incentivized by at least the partial removal of sanctions.
Russia’s invasion has incurred far more casualties than most would have assumed at this stage and the intensification of shelling of civilian buildings has drawn international condemnation. Over 330 companies including McDonalds, Apple, Amazon, Adidas and Nike have announced that they are closing operations in the country. The sanctions are undoubtedly exerting a heavy toll on the Russian economy and its people. Whether this will have any bearing on Putin’s plans in Ukraine is highly uncertain.
For the rest of the world, commodity shortages and further disruptions to global supply chains will have the most profound impact. Higher prices for non-discretionary categories like fuel, electricity/heating and food are expected to weigh on spending for discretionary goods, with the impact intensifying the longer the disruptions continue.
The year got off to a tumultuous start as inflation in developed markets proved far more enduring than central banks’ earlier expectations. This led to expectations for accelerated tightening of ultra-loose monetary policy, particularly in the US. Russia’s invasion has put the US Federal Reserve (FED) in an even tougher position.
The rapid rise in oil and agricultural staples prices are expected to keep inflation elevated in the near-term compared to a gradual easing of pricing pressure previously expected.