Why the price of a ban on Russian oil and gas would likely be a recession

The Ukrainian president, Volodymyr Zelenskyy, made his position clear on Monday morning in his latest message to the world: the West must stop buying oil and gas from Russia.

Such an embargo would be one of the last remaining trade weapons that the US and its allies could deploy against Vladimir Putin’s regime.

The prospect of such a ban sent the price of Brent crude to as high as $139.13 per barrel at one point overnight, the highest since July 2008, while the price of natural gas at one point today hit 800p per therm – which, to put it in context, is four times the level it was prior to Mr Putin’s invasion of Ukraine.

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The surges raise a number of questions.

The first of these is whether the west can afford to ban oil and gas imports from Russia.

The answer to that is yes, but probably not without avoiding a recession.

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Russia is the world’s third largest oil producer after the United States and the second largest exporter of crude, after the Saudis, to global markets.

In December 2021, according to the International Energy Agency (IEA), Russia exported 7.8 million barrels per day, of which five million barrels were crude and condensate, with the remainder being refined products such as gasoil (diesel), kerosene, naptha and petrol. To put that into context, the IEA had forecast global oil consumption in 2022 would be 100.61 million barrels per day, with global production slightly higher at 101.39 million barrels per day.

Key developments:
• Kremlin spokesman Dmitry Peskov says Russian military action will stop ‘in a moment’ if Ukraine meets its conditions
• Boris Johnson meets foreign leaders to build united front against Vladimir Putin
• Adviser to the Ukrainian president says the next round of talks with Russia will begin at 4pm local time (2pm GMT)
• Foreign Office minister defends UK’s support for refugees as only ‘around 50’ visas granted so far
• Former Ukrainian president Petro Poroshenko asks for military aircraft to help fight the Russians

In other words, the global market was expected to be broadly in balance this year, with production very slightly exceeding consumption. So the loss of that Russian output will hurt. The pain would be felt most intensely in countries in continental Europe, which buys some 60% of Russian oil exports, notably Germany, Italy, Austria, Poland and Greece.

It is for that reason that the EU has not yet been able to come up with a unified line on a possible ban on Russian oil and gas.

As Germany’s foreign minister, Annalena Baerbock, told the broadcaster ARD: “We must be able to hold [the sanctions] over time. It is useless if in three weeks we discover that we only have a few days of electricity left in Germany and that we must therefore reverse these sanctions.”

Germany, whose economy is more reliant on energy-intensive industrial users, would have more to fear from a ban than a country like the US, which has been more open to such a move, probably because it imports only relatively small amounts from Russia. Canada, which has the world’s third largest oil reserves and which imports little or no Russian crude, has already introduced its own ban.

But even the US would not be able to avoid the pain because of the way oil and gas prices are set globally. The US national average price of a gallon of petrol (one gallon is equal to 4.55 litres) hit just over $4 at the weekend – a level not seen since July 2008.

Developed Asian economies would also take a hit. Japan, which has indicated that it would be supportive of a ban, relies on Russia for 4.1% of its crude and 7.2% of its natural gas – so would face a big increase in costs. So, too, would South Korea, for whom Russia is the fourth-largest energy supplier after the US, Saudi Arabia and Kuwait.

So how might the west make up that shortfall in supply? The answer is that, in the short term, it would not.

Helima Croft of RBC Capital, one of the sector’s most respected analysts, told clients: “The scramble for additional barrels to fill what could balloon to a 3-4 million barrels per day Russian export deficit will undoubtedly move into warp speed this week.

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“This could prove to be a tall order as immediate Opec spare capacity currently rests with Saudi Arabia, UAE, Kuwait and Iraq, and we estimate that these four countries could only bring on between 2-2.5 million barrels per day in the next 30 to 60 days.”

Even a breakthrough in talks with Iran over the latter’s nuclear development, hopes of which have faded over the weekend, would probably not make good any shortfall created from a ban on Russian oil and gas. At best, analysts believe, it would only add around one million barrels per day to supplies.

Such is the need to shore up supplies from elsewhere, officials from the US and Venezuela have reportedly held talks over the weekend about the possibility of lifting sanctions on the latter’s crude, although Russia’s ongoing support to the regime in Caracas makes that complicated.

Nor can the world’s major oil and gas producers – the likes of ExxonMobil, Shell and BP – be expected to ride to the rescue. All of them ratcheted down on investment after the collapse in crude prices early in the pandemic pushed them into the red and, for the last 24 months or so, have been focussing on getting as much as they can out of existing reserves rather than discovering and exploiting new ones.

Moreover, with the likes of BP and Shell coming under pressure from investors and governments to transition away from fossil fuels to renewables, the majors are in some cases abandoning exploration projects that would in the past have been considered viable. BP, for example, announced nearly two years ago it would be leaving some oil in the ground that it would previously have extracted.

All of this will have big consequences.

The 1973-74 oil crisis, sparked by Opec’s embargo on the west for its support of Israel in the Yom Kippur war, resulted in recessions in the US, the UK, West Germany, France, Japan and elsewhere. Crude prices trebled in the three months after the introduction of the move in October 1973. Oil prices have now doubled since the beginning of December and many analysts believe they have further to go.

Ethan Harris, head of global economics research at Bank of America Securities, warned clients on Monday that a ban on Russian oil would push the price to as high as $200 per barrel. That would represent an increase comparable to the 1973-74 oil shock and would certainly tip the world into a recession.

Yet some will argue, especially in the wake of Mr Putin’s brutal shelling of civilians, the west cannot afford not to stop importing his oil and gas.

For the surge in oil and gas prices will also have been of benefit to the Kremlin – one reason why, for example, Russia is doing its best to stymie an Iran nuclear deal.

There is, though, plenty of evidence that the market is already shunning Russian crude. Urals, the main Russian benchmark, was trading on Friday at a discount of $28.45 (around 25% on the prevailing price) to Brent crude.

There is also no guarantee that, even with a ban on Russian oil and gas exports, the Kremlin could not continue to make money. China, which accounts for 15.4% of Russia’s crude exports, would continue buying. So, in all likelihood, would India. With Russia having more oil and gas to sell such countries, they in turn might buy less crude from other suppliers, potentially freeing up more Saudi crude for the west.

But it would be unwise to assume that would do too much to alleviate the pain that a ban on Russian exports will cause.

As things stand, the west may decide a recession a price worth paying to defeat Putin.

It will certainly be a lower price, arguably, than the one being paid by Ukrainians right now.

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