It is more than three months since Russia invaded Ukraine. The invasion has resulted in significant global economic fragmentation, such as disruption in production, trade, and supply patterns. One of the major economic upsets resulting from these disruptions is the inflated energy costs. Since Putin started dropping bombs on Ukraine, global oil prices have soared.
The surge in oil prices is no surprise. The war has altered the demand and supply of oil products worldwide. Besides, the US and Europe’s ban on Russian petroleum products has only worsened the crisis. With the oil and other commodity prices rising, high inflation has hit every corner of the earth, drawing significant economic implications. Let’s take a closer look at how surging oil prices are affecting the energy, food, and government sectors.
I. Energy sector
The Russia-Ukraine conflict has caused the oil prices to hit a new world record. At one point, oil prices shockingly rose to $139 per barrel! Since February this year, oil prices have been rising sharply, as shown in the graph below.
Besides, analysts have warned that the market turmoil will continue and that people should expect a further increase in energy costs. Several factors are contributing to this phenomena.
The global shortage of oil and petroleum supplies is one of the key contributing factors. The reduction in global oil stocks has been mainly caused by war interference in production and supply chains. For example, at the onset of the Ukraine attack, Russia removed about 3 million barrels per day from world supplies. Russia is one of the biggest world exporters of petroleum and natural gas; hence, removing these barrels drains Europe, China, and Africa large oil stocks. Also, as the Russia-Ukraine conflict intensifies, more shippers, traders, and financiers have avoided dealing with Russian crude products generating further oil shocks. Less trade has also been compounded by the latest US and Europe sanctions on Russian oil products. Despite these cumulating factors, the demand for oil products is still high, pushing their prices much higher.
Covid 19 has also played a vital role in the present crisis. Oil production during Covid 19 period shrunk as oil refiners tried to adjust to the economic slump. The pandemic brought a lot of uncertainty among oil refiners, who responded by lowering production. However, the economic rebound post-Covid-19 pandemic has been accompanied by rising demand for petroleum and oil products. Despite the heightened demand, oil refiners are yet to produce sufficient energy supplies to cover the scaling world demand. Consequently, the scarcity has pushed oil and petroleum prices high.
Effect of rising oil prices
The rising energy prices have made nations take several measures to curb the crises. The US and many Western nations have opted to release their oil reserves to curb the shortage. OPEC has also promised to release millions of barrels to ease the situation. Even though such moves may reduce shortage and curb prices, it is only short-lived. Hence, the need to explore other energy supplies such as renewable energies.
A shift to renewable energies such as wind and electricity may accelerate the adoption of green energies. Germany and UK are considering such an energy transition. Investment in renewable energies phases out non-renewable energies such as oil, coal, and natural gas. However, such a transition would take some years to implement successfully.
II. Food Sector
The persistent rise in energy supplies has exerted inflationary pressures on food and fertilizers markets. The food prices have risen mainly due to the increase in the cost of fertilizers which have soared with the leap in natural gas prices. As they rise, so does the price of fertilizers since large quantities of natural gas are needed to produce ammonia, a key ingredient in fertilizers. Therefore, a rise in natural gas prices (the majority which comes from Russia) increases the price of fertilizers and production costs, subsequently driving food prices high.
The cost of transporting raw materials and farm produce also plays a key role in the surge in food prices. With the current oil crisis, delivery costs involved in food production are high, meaning high costs for farmers. Consequently, the farmers must raise their prices to offset the extra costs incurred.
Effect of rising food prices
Sky-rocketing food prices are likely to cause increased suffering among low-income countries that largely depend on imports for food supplies. According to WTO’s Director-General Ngozi Okonjo-Iweala of WTO, “Smaller supplies and higher prices for food mean that worlds poor could be forced to do without.” Rising food prices pose a food security risk in Sub-Saharan Africa, Latin America, parts of Africa, and the Middle East. Besides, the upward pressure on food production stalls efforts to reduce hunger and poverty in these regions.
III. Government Sector
The rising energy costs have prompted governments to protect their people against surging energy prices. Both local and international policies are being employed to control the already dire situation. Much of the proposed policies involve subsidizing energy prices through additional spending on welfare programs, tax cuts, and fee reductions.
In Belgium, the Federal government has extended the VAT reduction on electricity. Besides, oil-heated households will receive € 200 to cushion them against soaring energy prices. The total cost is estimated to be € 1.3 billion. Through a tax cut, Germany’s ruling coalition has agreed to reduce gasoline by 30 cents and diesel by 14 cents. The whole initiative is estimated to be worth €15 billion. On the other hand, Spain and Italy propose a collective action whereby EU countries procure natural gas together. These are just a few instances. Other countries are also adopting fiscal measures. But what are the effects of these fiscal policies?
Effect of fiscal policies
Reduced duties, tax cuts, and protective schemes are good news to people already facing a high cost of living due to extreme inflation. Nevertheless, these initiatives come at a high cost.
Many European governments and developing nations will have to forego huge revenue collected through taxes and duties levied on oil and petroleum products. For example, a tax suspension on a few petroleum products in the Philippines would lead to a revenue loss of approximately P100 billion. Such a substantial revenue loss may significantly affect future expenditure and budget plans. Similarly, additional spending that costs billions may create huge budget deficits as governments borrow to accommodate additional spending. As a result, many countries may suffer from rising public debt, which slows economic growth.
Conclusion
The war between Russia and Ukraine has generated large economic shocks. Inflation in the commodities market has hit high, with oil and food prices reaching sky-high. With the disruption of production and trade patterns, Oil sanctions against Russia, and Covid 19 effects, the present crises seem a long way from ending. However, there is little hope of economic recovery as many countries subsidize energy production and supply to control the price hikes. Only time will tell if these measures are effective or not.
