The main impact of this conflict on global supply chains has been via disruptions to commodity markets, in particular energy commodities. So, rather than a rethink of global production chains strictly speaking, the conflict will likely impose some serious reflections on energy supply and resilience, most notably in Europe. While there aren’t easy nor cheap short-term fixes for gas shortfalls, the pandemic and the conflict in Ukraine have underscored the need for Europe to achieve energetic independence and security, with more investments in renewable sources offering the most promising solutions in the longer-term.
Escalating sanctions, counter measures and capital controls are leading to a rapid de-coupling of Russia from the global trade and financial system. It will take time for Russia’s trade partners to find substitutes for exports and import destinations, resulting in some disruptions to global supply chains and a drag on global growth. However, the energy channel will be key for the global economy. While Russia is relatively small on the global stage (~2% of global GDP), it plays a prominent role in the energy commodity space: it accounts for ~12% of the global oil production and ~17% of the global natural gas production as of 2020. Russia is also an important producer of metals and agricultural commodities. Overall, 85% of Russian total exports are in commodities, and about 50% of Russian exports are in fuels/energy commodities.
So far sanctions have mainly targeted Russian banks and financial institutions, while the energy sector has been spared. Nonetheless, energy prices have increased significantly, reflecting expectations of physical disruptions to oil and gas provisions from Russia. Indeed, sanctions are likely to be escalated further to include a ban on imports of Russian oil – some oil traders have already started to avoid Russian barrels, due to pre-emptive compliance with potential future sanctions and/or political pressures).
The agricultural sector is also likely to be disrupted globally throughout this year and beyond. Wheat, corn, and sunflower are all at risk in Russia and Ukraine. Beyond that, the surge in natural gas prices is making it cost-prohibitive to produce ammonia while potash exports from Russia and Belarus (together accounting for one-third of global traded product) are at risk. Both are essential ingredients to fertilizers.
The implications for Europe are particularly significant. The EU depends on Russia for about 40% of its gas and the conflict has exposed the need for the bloc to rethink its energy policies to achieve energetic resilience and independence. Russia could withhold some gas supplies to Europe as retaliation for sanctions, potentially leading to sector rationing (according to the Eurasia Group contingency planning between Brussels and member states is already taking place to plan for this worst-case scenario). In the short-term it will be tricky for Europe to replace Russian gas – possible sources of diversification include gas from Algeria and LNG tanks from the US (and possibly Nigeria, Egypt), although the latter would come at a higher cost. Longer-term, the energy implications of the pandemic and the conflict in Ukraine have underscored the need for Europe to invest more heavily on renewable sources to achieve energetic resilience.