How did the “Bad Neighborhood” of Russia-Ukraine Affect Oil Price?

The tension in the Ukraine border has escalated quickly to full invasion by Russia. Hundreds of people have died so far, and it may worsen in the coming days. More than 352 civilians have been killed since President Vladimir Putin announced that Russia would conduct a ‘special military operation’ on the Ukraine border. 

The Russian emphasized that the operation was not for occupying Ukraine, except for the Ukraine troops to withdraw. It may not be accurate as Russia has nearly encircled the Ukraine territory with its forces and offensive military equipment.

Though the westerns have advised Russia to refrain from further military and political provocations, the neighbor decided to heighten the tension into broader regional crises. Russia’s invasion has jeopardized Ukraine’s sovereignty and violated the Minsk Agreement to support peace in the region. It was undoubtedly a hasty move from Russia, which affected European stability. Not only in the political and security context but also economic issues.

For example, the Russian stock is deeply wounded, with a nearly 18.17 percent decline in the market sector. The Moscow Stock Exchange has suspended its stock index, and they have not announced when it will open again. As a further effect, other Russian trading stocks are facing the same path since they face a severe decline. The current situation shows how terrible the impact of war is on economic issues.

The uncertainty of geopolitics then leads to market and oil price changes. The oil prices have climbed and hit a new high price to USD100.25 a barrel. The price is expected to become much higher as the invasion has just started. The price above USD100 was the highest price since 2014, and the Russian-Ukraine conflict has a role in it. Thus, how do geopolitical tension relations affect the oil price?

The geopolitics aspect in the ‘Oil diplomacy.’

Oil has been an essential commodity for most countries, and the need for petroleum sometimes faces uneven distribution.  As many countries do not own oil for their needs, they secure the needs through trade, diplomacy, and even armed conquest. The oil supply and its price have an essential role in geopolitics matters. 

The European nations who have been dependent on their oil needs since the Second World War to the Soviet Union need to keep their demand fulfilled. Therefore, an oil-producing nation may have more bargaining power in international politics, as they may lessen or even cut the supply of oil if there is geopolitical tension. An oil-importing country may lose access to foreign supplies. The geopolitical uncertainty is risking their fuel shortage, energy prices, and disruption to the domestic economy.

In addition, there is also a connection between oil prices and the average price of the transportation index in the existence of geopolitical risk (Khalid Khan., 2021). The geopolitical risk becomes the dominant element in affecting the oil price, and it may also lead to a change in the index of the shipping industry.

The attack implies the energy market and fear of the economic sanction may lead to disruption in the supply chain. The supply chain of energy and logistics in the world has been worsening since the pandemic, and the Russian invasion put more pressure on the global supply chain.  

The global consumption of oil is at 100 million barrels, and Russia is the second-largest oil exporter after Saudi Arabia. The crude oil exporter from Russia in 2020 is estimated at $72.6 billion or 11% for global consumption. For that reason, the European countries depend on nearly 40 percent of their gas consumption and 25 percent of gas from Russia. 

Noting this interdependence, the Western government exempted the energy transaction of Russia from sanction. Even the US, for now, will not support the embargo of the energy supplies, as it might suppress the US consumer and industry needs. The US imported most of its gas supplies from Russia, which accounted for 21 percent of the US’ needs. 

The needs for natural oil and gas from Russia make the Western government reluctant to sanction the Russian government. It can be said that, for now, the Westerns need Russian oil and gas more than the Russians need their money.

Germany, but the Italian, Austrian, and French are also large consumers of Russian natural gas and oil. At the same time, the Russian also relies 30 percent of their income on energy exports. Following the Russian decision to invade Ukraine, the price of Brent crude oil surged 2.4% to USD100.25 a barrel. It was the highest price since 2014. 

The correlation of oil prices and the economy

The use of oil is essential for domestic and industrial needs. Not only for producing electricity, but also heating buildings, etc.  Oil price is related to the economy, so how does oil price affect the Russian economy?  When there was a decline in oil prices, just like in 2014, the Russian economy collapsed severely. It led to severe inflation and made banks raise the interest rates. For instance, consumers and businesses need to spend more money to fulfill their needs, leading to a slow economy. 

With this current pandemic era, the economy has widely slowed down, and the chance of economic recovery may also have slowed down. On the other hand, when there is an increase in oil price, the Russian will be more than glad to accept it, but for the rest of the consumers. However, if the oil prices are too high, it slows the economy due to lower oil demand.

Like the principle of economy, oil prices are driven by supply and demand. When the shipping industry is disrupted by attack or military response, like what is happening right now in Ukraine, the normal flow of crude oil on a global scale is at risk.

Noting there is an economic sanction from the West and the US for Russia, investors are walking on eggshells, worrying they might face the consequences. Due to these fears, they are avoiding buying Russian oil. 

Shell has announced that they plan to exit Russian operations and joint ventures. More Russian oil buyers also face obstacles on payment as there are Western sanctions on banks and other payment methods.

The West will put more pressure on all sectors, such as economic sanctions, political isolation, and even military support to Russia. Even with the help of China, which is most likely backing the Russian economy, further sanctions will indeed affect Russia. 

All stakeholders need to return to diplomacy and negotiation efforts. The world needs economic recovery from these events, and the longer the war is, the more severe its effect on all sectors. The government and banks need to collaborate to formulate financial and market settings.