Energy Implications of Russian Invasion of Ukraine
Financial implications take a backseat to humanitarian concerns when it comes to analyzing the implications of the Russian invasion of Ukraine. However, as we can see in the crude oil and natural gas markets, consumers are re-evaluating security of supplies. This is likely true for other commodities, such as potash and various metals. Ukraine is a large producer of steel and a significant agricultural producer (e.g. wheat), so depending on the severity and duration of Russian hostilities, this could lead to further inflation in many end-products.
Crude oil: Crude oil prices were already rising on anticipated supply-demand imbalances later this year and into 2023. OPEC+ was sticking to their previously communicated monthly increases of 400,000 b/d as of the most recent meeting in early February. We note that actual production increases have been shy of the quota increases, as some nations within OPEC+ were unable to increase production to match their quotas. Progress has been made on a deal that would remove nuclear development related sanctions on Iran and allow them to sell more oil on the market. But it is unclear how much crude oil would actually be brought on the market, as some believe Iran has been selling oil through other channels to evade sanctions. Production from North America, which is outside of OPEC, will likely grow, but at a restrained rate, as producers focus on returning capital to shareholders via share buybacks and dividends. Production from shale in areas like the Permian is facing cost inflation as the cost of inputs, both goods and services, increases, and so higher spending is not translating into an equivalent increase in production.
Natural Gas: Nord Stream 2 is a pipeline which was built to transport natural gas from Russia to Germany, bypassing the traditional route through Ukraine. Construction of the pipeline was completed in September 2021, but the pipeline had yet to receive necessary European regulatory approval to flow gas. After Russia formally recognized two breakaway regions in Eastern Ukraine (believed at the time to be a pretext for sending Russian troops there), Germany halted its approval of the project. This move will likely increase reliance on alternative sources of natural gas, such as LNG (liquified natural gas), but also may force a further acceleration of investment in other energy sources, such as renewable. Still, especially in the short term, suggestive of higher natural gas prices in Europe.
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