Curbs on Russian exports raise risk of an oil shock and recession in Europe

Economy News


The spike in oil and gas prices triggered by the Ukraine conflict and western moves to punish Moscow has raised the threat of the worst stagflationary shock to hit energy importing economies since the 1970s.

Crude prices surged after Antony Blinken, US secretary of state, said at the weekend that Washington was discussing a ban on importing Russian oil. On Monday, US politicians were discussing bipartisan legislation while European officials were devising plans to reduce reliance on Russian fossil fuels.

Even without a ban on exports from Russia, the second-biggest crude producer, many experts doubted whether the global economy, and Europe’s in particular, was robust enough to escape a new oil crisis and recession.

“The post-Covid recovery will surely be significantly delayed with a clear risk that we could be heading into a period of stagflation – if not even a recession with inflation,” said Erik Nielsen, economic adviser to UniCredit.

The talk of stagflation, the combination of sluggish growth twinned with high inflation, raises memories of the two 1970s oil shocks, when prices surged after Arab states imposed an oil embargo in 1973 on countries that had supported Israel in the Yom Kippur war and in 1979 after the Iranian revolution.

The problem for western governments has been that the rise in energy prices is indirectly helping Moscow withstand the tough sanctions they have imposed in response to the Ukraine crisis.

“High oil prices lower the anticipated costs or punishments for bad behavior [by Russia] and provide partial insurance against risky behavior, ”said Cullen Hendrix, senior fellow at the Peterson Institute of International Economics.

But talk of an embargo on Russian exports sent the price of oil and gas shooting even higher. Oil prices jumped 20 per cent in morning trading to exceed $ 139 a barrel and European wholesale gas prices hit € 335 a megawatt hour, up from a price a year ago of about € 16. Sustained increases at that level would sharply raise inflation and squeeze consumer incomes.

Line chart of Russian crude oil production as a% of world total showing Russia output is vital to global oil markets

EU countries import 40 per cent of their gas from Russia supplies, while Moscow has also consistently supplied over 10 per cent of the world’s crude oil.

Some economists said prolonged high energy costs for consuming companies and households were likely to tip European economies into recession.

Rupert Harrison, portfolio manager at BlackRock and former economic adviser to UK Chancellor George Osborne, said “massive” energy subsidies would be needed because “a serious attempt to rapidly limit Russian energy imports risks causing a European recession”.

Annotated oil price chart, nominal and real prices G0426_22X

The 1970s oil shocks caused rampant inflation and recession across most advanced economies, primarily because higher oil prices redistribute global income from energy consumers to producers.

For this reason, economists expect Europe, Japan and emerging economy oil consumers to be the hardest hit again, while the US could increase domestic oil production.

American energy consumers, however, would be hit just as hard if not harder than those in Europe because fixed levels of taxation are a smaller factor in US petrol prices.

Vienna summit: oil ministers from Opec countries meet officials from western oil majors in October 1973 © George T Piercy / AP

Some African oil producers are already expecting to be beneficiaries of the Ukraine crisis. The African Energy Chamber predicted an “influx in investment” this year.

Far from all economists, however, are forecasting a recession in Europe even though stagflationary forces have hit new highs.

The underlying recovery dynamics of European economies are still strong despite the price rises. Germany posted strong retail sales and factory orders for January, highlighting how any Ukraine-related weakness will be initially offset by robust consumer demand.

Even if some countries could face quarters of contraction, many economists still think that higher energy prices will lower growth but not push the eurozone into a prolonged recession this year, especially if Monday’s prices moderate a little.

Reducing its growth forecast by 1 percentage point, Neil Shearing, chief economist of Capital Economics, said: “We do not expect the [European] post-pandemic recovery to be derailed. ” But the research group cautioned that if a complete ban on Russian energy was introduced, the eurozone economy would not be able to avoid a recession.

In its downside scenario, Oxford Economics reckons that output in the eurozone will be 3.2 per cent lower than in a “no war” scenario by next year, but even with this hit, it still forecasts growth in eurozone gross domestic product of 2.2 per cent in 2022 and 0.9 per cent in 2023.

The greater optimism is based on factors that limit the potential for damage and restrain stagflationary forces.

Line chart of Global oil intensity (barrels of oil consumed per $ 1,000 of GDP in 2015 prices) showing The efficiency of oil use has improved

First, the reliance on oil is much weaker now than in previous supply-side crises. The world is now able to produce more than twice as many goods and services for every barrel of oil as it could in 1973. Progress in advanced economies has been even stronger.

In a study of oil intensity of economies, Christof Rühl, senior research scholar at the Center on Global Energy Policy at Columbia University, New York, concluded that wars, revolutions, booms and busts have all failed to break a steady decline in the amount of oil needed to produce economic output.

“Oil has become a lot less important and humanity has become more efficient in making use of it,” he said.

Alongside the reduction in energy intensity, after adjusting for inflation, oil prices are still lower than the peak of the late 1970s.

Second, economists expect governments, supported by central banks, to offset the higher price of energy resulting from sanctions with a further batch of extraordinary fiscal support.

Producing new global economic forecasts, Jagjit Chadha, director of the UK’s National Institute of Economic and Social Research, predicted that higher energy prices would reduce the level of global GDP by only 1 per cent by the end of 2023, but with significantly larger effects in Europe.

Even then, he did not predict a recession. “We expect higher public spending to support a massive inflow of asylum seekers from Ukraine and to bolster military spending, which will limit adverse effects on European GDP,” Chadha said.

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