The geopolitical crisis between Ukraine and Russia has global commodity markets on the edge. Crude oil prices are inching closer to $100 a barrel. If this alone was not enough, a potential war threatens to derail production and exports of a wide range of other products. All this is expected to hit global economies hard and fuel inflation, which is already accelerating in many countries like the United States and UK.
On Tuesday, brent crude oil prices briefly touched $99.50 a barrel. This is the highest level oil has touched since September 2014. Eventually, oil prices closed below $97 a barrel, but worries remain it could top $100 if the Ukraine-Russia conflict escalates. Already, the US and Europe have moved to announce wide-ranging sanctions on Russia after Moscow recognised the independence of two separatist regions in Ukraine.
Russia is the second largest producer and exporter of crude oil in the world. The country exports 5 million barrels of crude oil per day, more than half of which goes to Europe and 42 per cent to Asia. India’s imports of Russian crude, though, are less than one per cent, as most Indian refineries can’t process the heavy crudes that it exports, according to analysts.
Yet, supply disruptions in the world’s second largest crude exporter will have a big impact on the oil market.
“Russia accounts for 11 per cent of global crude-oil exports. If sanctions take about 60 per cent of this off global markets (with China, Belarus and a few other customers possibly defying the sanctions), world crude oil supply would decline by 3 million barrels per day and the brent crude price would likely shoot above $110 per barrel,” said Prasenjit Basu, chief economist at ICICI Securities.
While a possible revival of the Iran nuclear deal could restore and make up for half of this supply shortfall, brent crude is likely to remain above $100 a barrel for much of 2022, he said.
It’s not just crude oil market that will get disrupted. Russia also has the world’s largest reserves of natural gas. Russia’s natural gas production in 2021 is estimated to have been around 26.92 trillion cubic feet (Tcf), second behind the US, which is estimated to have produced around 34 Tcf.
Russia supplies around 35 per cent of Europe’s natural gas. A lot of this export is through pipelines running through Ukraine, which earns transit fees. This is expected to reduce due to the Nord Stream pipelines that go under the Baltic Sea. While Nord Stream 1 is operational, the second one is not fully operationalised yet. Germany on Tuesday halted approvals for the Nord Stream 2 gas pipeline.
Any supply disruptions in these oil as well as natural gas shipments will lead to a massive shortage and spike in prices in Europe.
It doesn’t stop at oil and gas. Russia is the world’s biggest wheat grower and Ukraine is also among the top five, according to Madan Sabnavis, chief economist at Bank of Baroda.
It is also estimated that 23 per cent of ammonia, 17 per cent potash, 14 per cent of urea and 10 per cent of phosphates are shipped from Russia.
“At a time when China has already reserved much of its output of urea and phosphates for domestic use, losing the Russian products would lead to further shortages and rising prices,” said Sabnavis.
A potential conflict also threatens to derail global manufacturing supply chains as Russia is a large exporter of nickel, palladium, aluminium, platinum, steel and copper. Any disruption will drive prices up sharply.
India could step up its exports in certain areas like steel and engineering goods to the European Union, which is already among the largest market for India’s exports, said analysts.
Developed market’s central banks like the Federal Reserve in the US have already started tightening liquidity and are getting ready to raise interest rates as inflation has hit multi-decade highs.
The Reserve Bank of India, however, has remained accommodative and also left the benchmark Repo rate on hold in the latest bi-monthly monetary policy meeting on February 10. The central bank expects retail inflation in the country to peak in the current quarter and then moderate. It has projected retail inflation at 5.7 per cent in the January-March quarter and at 4.5 per cent in 2022-23.
CPI (consumer price index) inflation in January touched 6.01 per cent in January, a seven month high. Rising crude oil prices could well play a spoil sport going ahead, given that India imports more than 80 per cent of it.
“Higher crude oil prices will keep CPI inflation higher for longer, obliging the RBI to raise rates more than the two hikes we expected in August-December 2022 – unless the government sharply cuts excise duties on petrol and diesel to contain fuel inflation,” said Basu of ICICI Securities.
There are expectations that petrol and diesel prices will rise sharply in March post the ongoing assembly elections in various states. If oil prices remain higher for longer, which will in turn maintain an upward pressure on inflation, how long the RBI will continue to remain accommodative will have to be watched out for.
Crude oil prices apart, there are concerns that this conflict between Ukraine and Russia could have huge impact on the supplies as well as prices of edible oils. India is also a larger importer of edible oils. Ukraine is India’s biggest supplier of sunflower oil. Russia and Ukraine account for over three-fourths of the global sunflower oil exports.
Bilateral trade between India and Russia was close to around $8.1 billion in 2020-21; India’s exports amounting to $2.6 billion and imports at $5.48 billion. India’s total global exports last year had amounted to $291.8 billion. Thus, given Russia is not a very big trade partner, sanctions may not have a huge impact on India’s global trade. But, there will be reverberation on other fronts.
“We will not be insulated from the repercussions in terms of prices of crude oil, fertilizers, metals as well as the upheaval that can result in forex markets which translates to the bond markets,” said Sabnavis.
