US President Joe Biden on Tuesday announced ban on import of Russian oil into US. The decision has been taken in light of Russia’s invasion of Ukraine. Biden personally announced the decision in front of the media. Oil prices were already surging as reports of such a ban were doing rounds in the run-up to the announcement. What will the world economy have to bear as result of USA’s decision. Here is a brief look.
Record rise in oil prices
JP Morgan has predicted that oil could hit a record $185 a barrel by the end of 2022 if disruption to Russian exports lasts that long, although along with most analysts polled by Reuters the bank expects a yearly average price below $100.
Other Western governments have not imposed direct sanctions on Russia’s energy sector but some buyers are already shunning Russian oil in order to avoid legal troubles later.
“A prolonged war which causes widespread disruption to commodity supplies could see Brent moving above the $150 a barrel mark,” Giovanni Staunovo, commodity analyst at UBS, said. He was quoted by Reuters.
With natural gas prices hitting all-time highs, soaring energy costs are expected to push inflation above 7% on both sides of the Atlantic in the coming months and eat deep into households’ purchasing power.
As a rule of thumb, every 10% rise in the oil price in euro terms increases euro zone inflation by 0.1 to 0.2 percentage point. Since Jan 1, Brent crude is up around 80% in euros. In the U.S., every $10 per barrel rise in oil prices increases inflation by 0.2 percentage point.
In addition to being a major supplier of oil and gas, Russia is also the world’s largest grains and fertilisers exporter and a top producer of palladium, nickel, coal and steel. The bid to exclude its economy from the trading system will hit a wide range of industries and add to global food security fears.
Recovery to be hit?
As the global economy is still in nascent stages of recovery after the pandemic, a ban on Russian oil is likely to slow it further.
Preliminary calculations by the European Central Bank (ECB) suggest that war could cut euro zone growth by 0.3 to 0.4 percentage points this year in a baseline scenario and 1 percentage point in case of a severe shock.
In the coming months, there is a high risk of stagflation, or little to minimal growth coupled with high inflation. However, further, euro zone growth is likely to remain robust, even if commodity prices prove a drag.
In the US, the Fed estimates that every $10 per barrel rise in oil prices cuts growth by 0.1 percentage point, though private forecasters see a more muted impact.
In Russia, the damage is likely to be large and immediate. JPMorgan estimates that its economy will contract by 12.5% from peak to trough.
Impact on central banks
For the US Federal Reserve, the inflationary impact has already proved too great and its Chair Jerome Powell has said that interest rates need to rise this month, piling pressure on borrowers. read more
For the ECB, the urgency of policy action is less acute as the labour market still enjoys spare capacity and there is little home-grown inflation.
“No one can seriously expect the ECB to start normalising monetary policy at such a moment of high uncertainty,” ING economist Carsten Brzeski said.
What are the substitutes?
With fossil fuel demand rebounding from the pandemic but supply around the world still tight, policymakers will be under pressure to ramp up supply despite pledges to back green energy.
“There will be a dial back on green initiatives in the short term in an attempt to reverse the contraction we’ve seen in fossil fuel supplies,” Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said.
Talks to unleash Iran from international sanctions are in advanced stages and high oil prices are set to galvanize investment in U.S. shale, but supply may not be set to come online soon enough to replace Russian output.
“The potential supply impacts are so large that there isn’t a quick way to substitute in the medium term, meaning the only mitigant will be price inflation of these inputs and the products that depend on them,” said Alex Collins, senior corporate analyst at BlueBay Asset Management.
The long view
The Russian-Western impasse could invigorate Moscow’s relationship with Beijing but the energy infrastructure between the two countries is scant.
“Although Russia’s Pivot to the East has accelerated gas cooperation with China via gas infrastructure … all these developments are still in their infancy compared to the mature markets in Europe,” said Kaho Yu, principal Asia analyst at risk consultancy Verisk Maplecroft.
Renewables could get a boost in the medium- to long-run as countries seek to wean themselves off Russian energy.
“We should take the subsidies we now devote to natural gas, coal, and petroleum and put them into renewable energy generation, electric mobility and EV charging infrastructure, heat pumps, building efficiency upgrades,” said Wolfgang Ketter, professor at the Rotterdam School of Management at Erasmus University in the Netherlands.
“Anything that will lead to long term energy security by reducing fossil fuel dependency.”
(With inputs from agencies).