Russia-Ukraine conflict threatens energy supply as hawkish central banks could pivot

Russia has invaded Ukraine pushing commodity prices to new record highs as equities tumble in a risk-off move by markets. While disruptions to oil and gas supply are looming, markets are anticipating a softening of major central bank policies.

  • Energy disruptions are looming with gas supplies the most affected
  • Power of sanctions doubtful due to strong European dependence on Russian exports
  • New Iran oil deal could be contemplated by US and European leaders
  • Central banks could be induced to postpone rate hikes

Already in the run-up to the crisis, commodities were pricing in a geopolitical risk premium which received another bump by Russia’s decision to invade. The Bloomberg Commodity Index (BCOM) is up 20% year-to-date, WTI oil is up 8% today and Brent is trading above 100 USD, the highest level since 2014. Gas shortages in Europe have been exacerbated as Germany already blocked the opening of the Nordstream 2 gas pipeline on Monday, which makes further issues in highly needed gas deliveries likely. As a result, gas traded in the Netherlands has rallied by 50% since Monday.

However, the crisis reverberates beyond energy supply with inventories of all major commodities already dropping to their lowest levels in 20 years. Ukraine is responsible for 12% and 16% of global wheat and corn exports respectively, and it remains to be seen to what extent Ukrainian ports and shipping infrastructure will be damaged by the military conflict. In addition, Ukraine and Russia are one of the biggest fertilizer exporters which introduces risks around global food security.

Meanwhile, all US grains are already trading at their maximum daily gains of 6% triggering major trading disruptions, and French wheat is up 17% today. The picture in metals markets marked by Russian dominance is similar with aluminium up 4%, nickel up 5%, and palladium up 7% based on intraday data.

Sanctions will introduce further premiums across all these markets. However, given Europe’s dependence on Russian gas, industrial metals and fertilizer, sanctions might prove less viable options than hoped for. Furthermore, Russia signed a 150-billion-euro energy deal with China in a bid to reduce the country’s entanglement with the West which further undermines the power of sanctions imposed.

The full-fledged military conflict has increased the risks of oil and gas disruptions significantly, but it can be assumed that Russia will honor its long-term energy delivery contracts as they did in the past. However, it is unlikely that Russia will send any extra gas to replenish the European inventories in summer which are now 20% below their 5-year averages. This could prove to be a major issue next winter. Also, the much debated sanction of excluding Russia from the SWIFT payment system will be a tricky one. If Russia is unable to receive payments for their oil and gas deliveries, they will restrict or even stop supply. To alleviate the situation, Europe and US could resort to striking an immediate agreement on a new Iranian oil deal. Whilst such a deal would help to bring new oil barrels to the market - up to one million barrels per day in six months - it would create new geopolitical risks in the Middle East.

Central banks expected to shift towards maintaining growth

As the crisis could affect US and in particular European growth, major central banks could turn away from fighting inflation fighting to restoring growth and smooth functioning of capital markets – depending on how long the crisis lasts. In fact, markets are already revising the likelihood of the Fed’s envisaged interest rate hiking path in an anticipation of dovish moves as the long end of the US Treasury curve is exhibiting large drops in real yields.

Michel Salden February 2022


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