EKIP– Expert Club for Economics and Politics A Different Opinion
Russia’s invasion of Ukraine has shocked the world not only politically but also economically. The sanctions imposed in response to the war are almost unprecedented in their scale and scope and could lead to an economic division deeper than that of the Cold War. The war and the sanctions will have dire consequences not only for Russia and Ukraine, but for the entire world. Global commodity markets have been in absolute shock over the past few days and there is a real risk that consumer inflation levels, which were already breaking records, will escalate even further and turn into an avalanche-like economic shock that could trigger a new global recession.
Food prices
Let's start with the most basic thing - food. Russia produces 11.6% of the world's wheat, Ukraine produces 3.5%. In total, about 15% of world production. In terms of exports (there is a difference between exports and production), Russia and Ukraine are responsible for 26% of the world's wheat exports. These wheat exports may be completely or at least partially unavailable, especially to the Western world (of which we are a part) due to the escalating economic sanctions imposed on Russia. At this stage, it is difficult to say to what extent Russian wheat exports may be hindered by sanctions, at least because we have no idea how much more they may escalate.
One thing is certain, however – wheat will be scarcer on global markets this year, not least because of the military actions in Ukraine itself, which are hampering agriculture. But beyond wheat, the situation looks even worse. For example, Russia and Ukraine together are responsible for 69% of global exports of sunflower seeds – from which oil is made. The European Union is heavily dependent on Ukraine in this regard – 88% of the Union’s sunflower oil imports depend on it.
Източник: OEC
Ukraine alone accounts for 7% of world wheat exports, 11.4% of world barley exports, 13% of world corn exports and 46% of world (sunflower) oil exports. So even if there were no sanctions on food exports from Russia, military action in Ukraine itself would hinder a huge share of exports of many grains. This means direct inflationary pressure on all foods made from these crops. Bread and oil are the most obvious – very soon we may be nostalgically remembering the time when bread was “only” 2 leva.
In addition to the direct effect on all types of grain-based foods, the disruption of the above exports will also hit meat prices. Livestock needs to be fed something, and feed is usually made from these grains. In short, the prices of all major food products could be pushed up significantly as a result of the war in Ukraine. And that is just the direct effect. Global food price inflation is already being felt extremely hard – at the end of February, the Food and Agriculture Organization of the United Nations index, which measures the prices of a basket of food commodities on global markets, reached a new historical record. It is still to rise.
Chart 1: UN Food Commodity Price Index
It should be noted that Bulgaria is one of the world's largest exporters of such raw materials - 3.18% of sunflower oil exports, 1.34% of corn exports, 2.14% of wheat exports. The government is already reacting to the expected shortage of goods such as wheat on global markets and is therefore taking measures to purchase it on a large scale from Bulgarian producers. However, price controls should not be imposed on the market in any case - this will only hinder its flexibility at a time when it should be able to function as smoothly as possible, in order to avoid sharp shocks in supply and, accordingly, prices.
Energy prices
When talking about Russian exports, everyone usually thinks of gas and oil. As of 2019, Russia was the second largest exporter of crude oil in the world, with a share of 12.5% of world exports. At the same time, it is also the second largest exporter of natural gas (in gaseous form) with a share of 16.4% of world exports. In terms of liquefied natural gas, Russia's share is 5.7% of world exports.
These are very significant values for the global market, but what is more important is what the picture looks like for the European Union and specifically for Bulgaria. According to data from the European Commission from 2019, 41.1% of natural gas imports and 26.9% of oil imports in the EU come from Russia. For Bulgaria, the dependence is even greater. As of 2019, Russia is the second largest source of imports (in general, not just energy) with a share of 8.6%. Bulgaria's largest import is precisely crude oil (7.9% of all our imports), which guess where it comes from – 55.7% from Russia.
Chart 2: Level of energy import dependence, EU Member States, 2000 vs. 2019
The energy dependence of the entire European Union on energy imports is enormous. According to official Eurostat data, the dependence of the entire EU was 60.5% as of 2019. You can see the approximate levels of energy import dependence by country in the graph above. For the moment, no direct sanctions have been imposed on Russia's energy exports to the EU. However, the question is - will they be imposed? The markets seem to expect such sanctions to appear, which is why the price of Russian oil collapsed and Shell made a deal for $ 28.5 per barrel, while at the same time the price of a barrel of Brent oil at the global level jumped to a new historical record - $ 129. This paradoxical situation is due to the fact that everyone seems to expect Russian energy exports to be hit directly or indirectly by sanctions. Western oil importers themselves can be said to be sanctioning themselves - they are already starting to avoid Russian supplies due to the extremely uncertain political environment and in anticipation of more severe sanctions against Russia, which will also hit its energy exports. This in itself is causing oil and natural gas prices to rise at a dizzying pace. This morning, the price of natural gas on the European market reached $3,700 per 1,000 cubic meters for the first time in history.
Uncertainty is the biggest problem right now. The key question that needs to be answered unequivocally by European leaders as soon as possible is – will Russia’s energy exports to the EU be sanctioned or not? The data suggests that in the short term, significant sanctions are absolutely impossible. The reality is that with a share of 41.1% of total natural gas imports, the EU literally cannot afford to live without Russia in the near future. Developing alternative sources would take at least several years. Germany does not even have a single LNG terminal and is 67% energy dependent on imports, most of which comes from Russia. In the short term, a return to coal-fired power plants could be considered, but this would require a serious revision of the EU’s plan for decarbonizing the European economy and a number of legislative amendments. And even then, a complete rejection of Russian imports remains impossible in the foreseeable future.
Whatever happens with the sanctions, the sharp inflation in the prices of energy raw materials is a fact. And this leads to an increase in costs that are part of any production – costs for transport and electricity/heating (natural gas is also key to replacing coal as a source of electricity in the EU). In addition to directly affecting the prices of heating, transport and energy for households, in the longer term this can further fuel inflation in almost all consumer goods.
Industrial raw material prices
In addition to food and energy, the war in Ukraine threatens to cause global shortages and inflation in a number of industrial materials and raw materials. For example, car manufacturers such as BMW and Volkswagen are already suffering from new problems with the supply of production materials from eastern Ukraine, which is why production at some factories is temporarily paused. Last year, this happened regularly due to the global shortage of semiconductors and chips.
The chip shortage is likely to get worse. About 65% of the world's neon production is concentrated in two plants - one near Odessa in Ukraine and one near Moscow in Russia. Neon gas is key to making lasers, which are key to making chips, which are everywhere these days - in your computer, in your phone, in your car. Currently, supplies from the Odessa plant are disrupted by the war, and it is unclear to what extent supplies from the one to Moscow are suffering due to sanctions. What would happen if Russia took over Odessa and controlled 2/3 of global neon production?
Chart 3: Price in US dollars per ton of aluminum
Source: TradingEconomics
If we also look at the production of key industrial metals (base and precious), we see that as of 2019, Russia was responsible for 16% of global platinum exports, 24.3% of global palladium exports, and 10% of global aluminum exports. In addition, one of the largest nickel producers in the world is the Russian company Norilsk Nickel. It alone is responsible for 6.7% of annual global nickel production. Nickel is an important component for making stainless steel, but it is also widely used in the production of electric vehicle batteries. The big question is – to what extent will the sanctions affect the supply of all these raw materials? If the market reactions are any indication – to a very significant extent. The prices of all these (and other) raw materials exploded over the past week. Nickel jumped by 18%, and aluminum by 21%. All this portends strong inflation in the prices of a wide range of non-food products with high added value.
Is a recession coming?
All this data suggests that we can expect the inflationary shock to only intensify, at least in the short term. And in the medium term, we are very likely to see an economic crisis. Extremely sharp price shocks, especially in energy commodities, usually lead to recessions. The market cannot withstand the surge in costs, and in response, demand and production collapse, leading to an economic crisis. Every time the price of oil has jumped at a pace comparable to the recent ones, a recession has followed. Will we witness the first exception? Unlikely. The question is when it will come and whether inflation will go away once the crisis arrives. Alas, at this stage we have no way of knowing, and because of the extreme supply-side shocks, I fear that the risk of stagflation is becoming increasingly serious.
