BT: The Conflict is Changing the Face of Commodities Flows
The Russian invasion of Ukraine has turned the world of commodities on its head. The conflict comes not just at a time of a shortage across a wide spread of commodities but also at a point when the world’s supply chains have never been more interconnected, where supply disruptions on one raw material can have wide reaching consequences across several products at the end other of the globe. The disruption is not just confined to the physical areas of production, the financial systems of banking but also the importance of the Black Sea in transporting commodities from one region to another. Faced with severe disruptions, energy and agricultural buyers alike are now thinking of how and where alternative capacity can be sourced, reinforcing the recent pandemic lessons of diversification of supply chains and once again changing the flows of international trade.
How does the conflict affect commodities?
Russia is a major producer of oil, gas and coal, the fossil fuels that form the base of most energy portfolios of countries. This ability to produce cheap energy has a direct effect on Russia’s significant role in producing key materials such as aluminum, steel and fertilizers, all high energy consuming materials needed in dozens of industries. Together with Ukraine, the region exports close to a third of the world’s global export of wheat to the point that it is commonly described as the breadbasket of Europe. Conflict affects the commodities markets on several layers starting at its source: mines, oil fields or plantations might be damaged during a conflict. Even if they escape damage, manpower might not be able available to operate or maintain these facilities.
Most importantly, transportation of these commodities has been severely hampered as the Black Sea, the main artery used to deliver commodities to other parts of Europe and the Middle East is now a high-risk area. Shelling of vessels in the Black Sea have resulted in closed Ukrainian ports with some shipowners and insurers refusing to operate in that area. With movement on the waters curtailed, deliveries of commodities have been hamstrung with many market participants seeking relief through force majeure declarations under their contracts.
Then there is the specter of sanctions – a powerful but blunt tool likely to trigger self-sanctioning by parties even if carve-outs have been created for oil, gas and coal. The nature of the widescale sanctions affecting Russian banks and the SWIFT banking systems, means most traders are unwilling to take a risk on any Russian counterpart. The immediate result of these concurrent dynamics is a downward spiral, where shortage produces buffering of inventories which in turn produces price spikes fueling the juggernaut of scarcity. Out of sheer need and to prevent being hostage to disruptions to key raw materials in the future, countries will once again need to reassess their supply chains.
Germany provides the best case in point when it comes to reassessing and diversifying its energy suppliers. Over 40% of its energy needs are supplied by Russia and while the commodity itself is not sanctioned, Germany is now faced with the reality of funding a regime the West is trying to stifle economically or worse still, the possibility of the Russians reducing gas supplies if it finds itself backed in a corner.
The lack of diversification from Russian pipeline gas is now coming back to haunt Germany as it does not have a ready alternative to step into its energy needs: liquified natural gas (LNG), already at sky high prices is not a ready solution that can deployed immediately. LNG requires tremendous investment in costs and time to build the import and regasification facilities needed to return the gas into a state where it can generate power.
On the other hand, there are still questions of economics and political willpower for renewables to become the baseline energy mix for any nation, particularly when assessing the likely to need to overhaul old electricity grid systems to accommodate the intermittent nature of renewable energy. The need to accelerate renewables is obvious but that doesn’t address the pressing question of what fuel is to form the baseline energy for the immediate future. Gas was the obvious compromise, but that choice is no longer that attractive if the reliability or morality of Russian gas has been thrown into question.
It is therefore no surprise that Western nations are contemplating putting coal and even nuclear power back on the table. Long demonized for its carbon polluting qualities, countries which have shunned coal are now facing the embarrassing prospect of reverting back to coal fired power at least as a temporary measure. The Australians and Indonesian coal producers, who focus on the Asian region might now find increasing requests for cargoes headed to European ports. Nuclear energy, long sidelined after the events of Fukushima in 2011 might get a second coming in a world that might say its better placed to handle the risk but in truth, is actually out of options. The scramble that some European nations find themselves in are testament to the reality that diversification is key and for many it’s a return to the drawing board when it comes to their supply chains.
While the energy sector has received the most coverage, it is the agricultural sector that is likely to see stark changes as both nations are responsible for significant supplies of grains and vegetable oils. Unlike oil and gas which can be produced and stored, agricultural produce is seasonal and its harvest perishable, meaning food security is now a legitimate concern for some nations. The grain market covering a wide range of crops like wheat, corn and oats is at significant risk of disruption. While the harvest season is some months away, there is a real concern of how much of this season’s harvest will be affected, if not by damage than at least by the lack of manpower to upkeep and harvest the crops. The role of wheat shortages in the Arab spring uprisings of 2010 is a compelling reminder of the importance of having a “Plan B” when it comes to food supplies.
The two nations are also responsible for a staggering 75% of sunflower oil export in a vegetable oil market that has already faced supply constraints from producers like Malaysia and Indonesia grappling with pandemic disruptions and market shortages. To add a spanner in the mix, agricultural produce is also highly dependent on energy through the often understated role of fertilizers. With the energy crisis gripping the world, fertilizers have been in scarce supply with several exporters like China putting in export curbs. With the supply of fertilizer ingredients affected, farmers have to think long and hard about what they plant.
Putting aside the production of these commodities, the conflict has thrown into sharp focus – the critical role performed by the Black Sea in moving these materials from Russia and Ukraine to every other direction across the sea. With operators wary of operating their vessels in the area, the historic trade routes of the Black Sea are likely to be redrawn with buyers considering alternatives in South America or India. The longer the conflict carries on, the more these changes in trade flows will be entrenched, recalibrating international trade chains.
* This article was first published in The Singapore Business Times on 9 Mar 2022.