What Does The Russian Invasion of Ukraine Mean for Energy Markets?

March 18, 2022

The fact that Russia has invaded Ukraine has rattled the global energy market, under-scoring how the continuing crisis could prolong Europe’s energy woes as the West rolls out sanctions on Moscow.

The Kremlin’s recent decision to deploy forces in eastern Ukraine, has halted global markets and hit commodity prices. In the last week of February, crude oil prices spiked to their highest levels since 2014, approaching +$100 per barrel, sending shock waves through the different energy markets, as was the case with prices of coal and electricity, which also increased.

The announcement by the Biden administration about the sanctions imposed on Nord Stream 2, a controversial Russian gas pipeline project in Europe of just over 1,200 km (equivalent to the distance between Monterrey and Oaxaca by road) that would transport +150 million cubic meters of gas daily between Ust-Luga in Russia to Greifswald in Germany, and which was expected to start operations this year, further straining the energy markets on that continent. A recent note in the Wall Street Journal pointed out that more economic retaliation is likely if the crisis deepens.

Russia in the energy market

Russia is the world’s third-largest oil producer and second-largest natural gas producer, ranking among the top energy providers for the United States and China, the world’s two largest economies.

In 2020, Russia provided 7% of United States oil and crude oil imports, making it the third largest supplier to that country alongside Saudi Arabia. This is one of the probable reasons why the United States has indicated that the sanctions against Russia would not be aimed at the energy sector of said country, except for the one referring to Nord Stream 2. It should be recognized that imposing a financial cost on Russia for its actions in the Ukraine presents a dilemma for Western powers, since they could cause inflationary damage to their own economies.

Even sanctions not specifically targeting the energy market could indirectly reduce oil and natural gas exports or prompt Moscow to retaliate by limiting the supply earmarked for exports.

The global community and the invasion

New Western sanctions aimed at bringing Russia’s economy to its knees could significantly curb those exports to most other countries, or convince Moscow to stop exports on its own, depending on the severity of the sanctions and the Kremlin’s response.

On February 24, a couple of days after the start of the armed conflict, the group of the seven most industrialized countries in the world (G7) strongly condemned the Russian invasion and said that it would present severe and coordinated economic and financial sanctions against Moscow, arguing that “this crisis is a serious threat to the rules-based international order, with ramifications that go far beyond Europe”, and that the Russian president had reintroduced war on the continent. They adding to their statements, that they would “support the consistent and constructive commitment and coordination among major energy producers and consumers to achieve a stable global energy supply, and that they are ready to act and deal with potential disruptions.”

Some experts believe that the commodity markets have not considered the severity of the crisis. In other words, prices have not yet reflected the immediate impact of war, but they probably will, especially if financial sanctions force Russia to withhold supplies.

The rippling effects of the sanctions on energy

Russia’s move has also impacted stocks, bonds, and commodity markets around the world. The first day of war saw US stocks stumble and the S&P 500 index fall 1% in what Wall Street calls a correction: a decline of at least 10% from its most recent peak. This growing conflict has changed the value of mutual funds and exchange-traded funds in millions of pension accounts.

Other financial pundits have pointed out that Moscow could decide to change the calculus in the West, using commodities as a form of hybrid warfare, essentially cutting exports, making sure Ukraine cannot export, to provoke an inflationary spiral.

The effects on energy in Europe

Europe depends on natural gas from its eastern neighbor, with Russia accounting for around 30 -40% of its supply, as well as nearly 25% of the oil consumed on that continent. US and Eastern European leaders have repeatedly warned that the Kremlin will not be afraid to wield its gas supplies as geopolitical leverage, if it decides to launch a counteroffensive in the form of a spiraling economic war. In the past, Russia has used its supplies to Ukraine as an economic weapon by cutting off the flow of its exports.
Before the crisis erupted, the President of the United States had refrained from expanding the Nord Stream 2 sanctions, despite immense pressure from the U.S. Congress, and it was not until Wednesday the 16th that he finally announced new sanctions against Nord Stream AG, which even though it is a Swiss-registered company, is actually a subsidiary of Russian state-owned gas giant Gazprom. This announcement came a day after the German chancellery announced that it would be freezing the certification of the pipeline, dealing a financial blow to Russia.

The announcement of the sanctions imposed by the US had an aggressive impact, since the company is now blocked by US commercial and financial institutions.

Considering that the gas pipeline was awaiting German certification and was not yet in the operational phase, some analysts assure that the decision would not affect the supply of natural gas existing in Europe, however, this statement has not been sufficiently accepted, and has many traders and investors on edge in an already volatile market.

The USA in the Conflict

In recent months, US federal officials have been exploring plans to alleviate Europe’s natural gas supply problem, including options to ship liquefied natural gas (LNG) from the United States and seeking to push Qatar, one of the main gas exporters to divert more supplies to Europe. However, those efforts may not be enough to make up the difference in Russian imports if Moscow decides to turn off the tap to Europe.

In that sense, the Qatari government stated that it would be “almost impossible” for any country to completely substitute Russian gas to Europe, because most of the LNG production is already committed to pre-existing contracts with other countries. Qatar could divert only 10 to 15 percent of its capacity to Europe.
As this reliance on Russian gas continues and the conflict intensifies, some experts have warned that Europe will be the region hardest hit by the supply crisis, even more so, when other global commodities are affected.

Oil prices rose above $100 a barrel for the first time since July 2014, just after the Russian president ordered a full-scale military assault on Ukraine, drawing copious international condemnation from countries allied to the United States. Brent crude registered an increase of close to 7.3% to settle in the range of $104-$106 dollars per barrel, just in the first hours of the Russian military assault.

Escalating energy prices

Some analysts said that if the US supply or the talks in Vienna do not go as planned, it could result in further appreciation pressures to push the Brent price into the $150-$170 dollars a barrel range.

Just last January, a group of economists predicted that a rise to $150 a barrel could cut global economic growth by more than three-quarters, to less than 1% in the first half of the year.

We must not forget that energy prices had already skyrocketed in recent months due to a confluence of factors, including the pandemic, limited supply and, obviously, the growing tensions between Russia and Ukraine.

In the United States, which is dealing with its highest inflation since the early 1980s, the average price of gasoline across the country is $3.52 a gallon, nearly 90 cents higher than last year.

The US President’s plan released on February 24, 2022, states that the country will be working with major consumer nations to coordinate a collective release of strategic oil reserves, while continuing to avoid sanctions on Russian supplies.

That same day, once the news was released that it is possible to release more barrels of oil from strategic reserves in coordination with other nations with which it would seek to add 400,000 barrels per day of crude to the market each month, the futures in New York closed at $92.99 dollars a barrel and those of Brent at $95.48 dollars, after they had risen to $100 and $106 dollars respectively during the first days of the conflict and their exists the possibility that prices could rise in the medium term.

The future of the energy market

This is a fluid situation, and the news will continue to flow as the conflict progresses. Therefore, the markets will reflect those changes, and we could be entering a time of great volatility in fuel prices. At Acclaim Energy, we will continue to closely monitor the evolution of this situation and impact on prices and consumers, when it comes to thermal and electrical energy in Mexico. If you need help in understanding what these shifts mean and their impact on your energy costs, don’t hesitate to give us a call, as risk mitigation is one of our core services.