INSIGHT: Oil price surge amid Russia-Ukraine war poses dire global economic impact

SINGAPORE (ICIS)–Crude oil-led spikes in commodity prices if the Russia-Ukraine war is prolonged will further fuel inflation, with possible dire consequences for the global economy still recovering from the coronavirus pandemic.

Hits on global GDP will be significant at 0.6% in 2022 and 1.1% in 2023, “if the fighting in Ukraine lasts well into 2023, the west imposes further sanctions, and Russia retaliates by restricting gas supplies”, Oxford Economics chief global economist Innes McFee said in a note on 2 March.

The research firm’s ‘downside scenario’, which is not the worst case, still projects global growth to be close to 3% in 2022 and 2023, as the projected “spillovers to the Americas and Asia are mild”.

Russian GDP could contract by 3.1% this year, causing growth in the eurozone to slow to 2.2%, according to Oxford Economics.

“As in the baseline [scenario], the adverse impact of higher inflation is key. But in this scenario, it is amplified by a loss of confidence among markets and consumers,” McFee said.

Pounding of Ukraine by Russian forces has entered its second week, sending oil prices firmly above the $100/bbl levels, with Brent crude crossing the $118/bbl mark – its highest since August 2014 – as of midday in Asia.

Financial sanctions on Russia are expected to hit the energy major’s crude exports at a time of tight global supply.

Russia is the world’s second biggest crude exporter after Saudi Arabia.

The financial sanctions on Russia include removal of the major Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) – a global payments system – effectively deterring any transaction with the country.

The International Monetary Fund (IMF) and the World Bank are currently assessing the economic and financial impact of the conflict and the Russian sanctions on the world.

“Disruptions in financial markets will continue to worsen should the [Russia-Ukraine] conflict persist. The sanctions announced over the last few days will also have a significant economic impact,” the multilateral institutions said in a joint statement issued on 1 March.

In one week, Brent crude soared by nearly $16/bbl or more than 16%, pulling up petrochemical prices with it despite weakness in downstream demand.

“The war is also creating significant spillovers to other countries. Commodity prices are being driven higher and risk further fueling inflation, which hits the poor the hardest,” the IMF and WB said.

Any impact on Asia is indirect but nonetheless painful, as economies in the region fall under the developing country category and are reliant on imports for crude.

Strong crude prices tend to weaken regional currencies against the US dollar, which makes imports even more expensive for these economies.

Petrochemical producers in Asia are struggling with thinning margins which may soon force them to cut output amid continued spikes in raw material prices.

Spot prices of petrochemical feedstock naphtha in Asia surged on Thursday noon to their highest since 2008 – at above $1,100/tonne CFR (cost & freight) Japan – on concerns about tight supply.

Commodity prices were surging at unprecedented speed at a time when most economies are trying to fend off inflationary pressures created by monetary and fiscal expansionary policies implemented in response to the COVID-19 pandemic in the past two years.

High prices for a prolonged period could inhibit consumption.

It will be a tough balancing act for central banks to rein in prices and remain supportive of economic growth. The US Federal Reserve and the European Central Bank were generally expected to hike interest rates in 2022, before the Russia-Ukraine war and the consequent crude oil surge.

In its October 2021 World Economic Outlook, global financial stability watchdog – the IMF – forecasts the world economy to post a slower growth of 4.9% in 2022, from a projected 5.9% in 2021.

The forecast assumes weakening in the pace of expansion of both the US and China – the world’s two biggest economies – to 5.2% and 5.6%, respectively.

The projections now appear too optimistic as the coronavirus pandemic continues to constrain business activity for the third year, and now, high fuel prices are threatening overall consumption.

“A key uncertainty is the extent to which the war further disrupts supply chains. This is not yet fully captured in our [downside] scenario,” McFee of Oxford Economics said.

“Anecdotal evidence suggests that we may already be seeing some of these impacts,” McFee said citing suspension of production by car giants Volkswagen (VW) and Renault, among others, “as they face delays in receiving manufactured parts from Ukraine”.

The world’s industrial sector will be most vulnerable to volatility compared with the services sector due to higher international exposure, McFee said.

“It would not be a surprise to see more of these issues surface if the war is prolonged. Combined, Russia and Ukraine are important sources for a variety of goods as well as raw materials,” the economist said.

Insight article by Pearl Bantillo