Implications of the Russia -Ukraine crisis on Oil and Gas
By Teresa Bosibori
The Russian – Ukraine crisis has slowly been evolving in the last few weeks and the implications for the global oil and gas prices continue to unfold. Russia is one of the leading producers of oil and gas after the US and a big importer to Europe. At the beginning of the crisis, the oil and gas market responded with an increase of Brent crude oil prices that has now surpassed the $ 100 per barrel mark. The US and its allies moved to sanction Russia though there have been apprehensions from the Western powers to specifically sanction Russian oil and gas. Imposed sanctions have relatively been designed not to impact energy trade flows and energy related payment. However, these sanctions and corresponding effects on the financial systems are already affecting the global demand, supply, and prices of oil and gas.
Immediate sanctions on Russia included cutting off the country from the international financial system. Western allies-imposed sanctions on Russia’s central bank limiting its ability to access reserves in shoring up its banks and companies locally. In addition, some Russian banks were cut off from the SWIFT financial messaging system which is an international payment system that allows the smooth and rapid transfer of money across borders. The SWIFT system is used to process payments for import and export goods and services across various Russian sectors. A similar sanction on Iran saw the country lose almost half of its oil export revenues and 30 percent of foreign trade. The EU and US ban of Russia from SWIFT targeted institutions that are not heavily involved in energy trade and exempted energy payments.
The sanctioning of these banks nevertheless had a chain reaction with specific countries and banks overseas also self-sanctioning Russian, refusing to finance Russia-related transactions. Buyers and companies are struggling to clear oil related payments or opening credits or in some instances, companies are halting procurement from Russia in favor of other markets or opting for a waiting approach. For instance, the British Petroleum Company (BP) announced it would be exiting its shareholding in Rosneft (a Russian oil company) and thus exiting the Russian market. Similarly, Shell announced its intention to exit its joint ventures with Gazprom and related entities, including its 27.5 percent stake in the Sakhalin-II liquefied natural gas facility, its 50 percent stake in the Salym Petroleum Development, and the Gydan energy venture.
The sanctions are thus having an impact on the global oil and gas prices which were in the process of recovering and stabilizing after a turbulent two years as a result of decreasing prices and effects of the pandemic are once more in array. Oil prices are set in the global market and therefore any supply disruptions anywhere affect prices in the global market and translate to local price fluctuations. There is already a disruption to oil and gas supplies from Russia which according to the International Energy Agency account for 60 per cent of oil consumption and 40 per cent of gas consumption in Europe. During the pandemic, there was a decreased demand and thus investment in oil production. As the vaccines were rolled out and the world started opening up, there were increased demand and supply shortages that are now stabilizing. The Russian crisis is destabilizing the demand revival and contributing to the increase in prices and having spillover effects on the global level. At the macro level, an increase in oil drives up inflation, leading to increased interest rates, increase in factors of production including capital and labour; which all result in the micro-level effects of increase in commodity prices and a high cost of living.
Western countries are already in talks to coordinate the release of oil stockpiles. The IEA has already moved to release 60 million barrels from its strategic petroleum reserves. This is however a temporary measure that is expected to help slow down the soaring prices and is not sustainable to meet the global demand. Further, Europe generally stocks piles gas that is used through winter when there is peak demand for gas. Tapping into reserves at a time when supplies are low could have even more impacts for not only current supply but also supply come next winter and their corresponding repercussions for the global prices. OPEC has remained unaverred to the Russian – Ukraine crisis impacts on oil and opted to maintain its current production.
With the cost of oil and gas soaring, some view it as an opportunity to speed up the transition from fossil fuels, however, the economic costs of associated commodities would soar. Imbalances between supply and demand would create prices volatility, shortages and increase the cost of living going forward. The reality is the global economy is still dependent on fossil fuels directly and indirectly. Energy transition has in fact slowed the growth of investment in fossil fuels but not a decrease in demand. Natural gas, considered a transition fuel, is also seeing soaring prices. The increase in gas prices is creating pressure for increased oil demand and this is the midst of the pressure from reduced gas further impacting the transition journey. There are speculations that European counties, which are also the biggest importers of gas from Russia may be ramping up coal plants to meet demand further impeding progress made in moving away from dirty fuels such as coal.
Locally, fuel prices have remained constant for the last three months with the Energy Petroleum regulator cushioning citizens by compensating oil marketers despite an increase in landed costs. Ongoing global increases in oil and gas prices will continue to increase landed costs in the near term and we should expect fuel prices to increase in tandem. Prices of goods and services in Kenya is already high and the any increase in petroleum and petroleum products would lead to a hike in the transport sector, electricity prices would increase and associated sectors such as manufacturing and agriculture would also increase market prices due to increase in production costs. The Kenyan shilling has also been depreciating and expected global increases in fuel prices would increase the cost of imported goods and thus imports could become even more costly in the coming days were oil prices to increase.
Kenya is however in an electioneering period, therefore, an increase in fuel and the corresponding increase in goods and services not only affects households’ pockets but may also influence voter decisions. On the economic side, increased prices will drive up inflation further impacting citizens’ purchasing power and cost of living. Neither side of the political spectrum will want this transitionary problem thus we could expect political pressures to stabilise any upward soaring of prices to a certain extent and only short term. Compensation of oil marketers is also not sustainable short to midterm though how much the government has collected, used and what is remaining its coffers to be used for compensation the OMCs remains a mystery. There is need for the policy makers to explore various mechanisms to cushion citizens including reviewing taxation on petroleum and petroleum productions and alternative energies. In the coming days, more oil and major commodities companies are expected to pull out of their Russian ventures which will keep impacting supply. Diversification of Europe’s energy supply will not be immediate and demand is expected to rise as Europe goes into winter. If the conflict prolongs, current sanctions will keep impeding supply from Russia and strategic reserves can only cushion the demand for the short term. Global infrastructure is heavily fossil fuel dependent and clean energy cannot be an immediate substitute. On the other hand, there is the possibility of Russia weaponizing its oil and gas (even at the cost of its economy which is heavily dependent on fossil fuel incomes). The effects of the current risk to oil and gas will continue to affect demand and supply up to 2023 if the crisis was to be resolved sooner. If it prolongs, the global oil and gas market will continue to deteriorate with consequential effects on commodities, other sectors, and cost of living.