As diplomatic talks continue, without any apparent resolution in sight, the Russia-Ukraine crisis appears to be escalating.

Reports this week of US troops on standby for deployment to central and Eastern Europe is a further signal of a hardening of the US position. Political tensions have the potential to significantly tighten commodity markets.

If Russia engages in military action against the Ukraine, it will certainly be met with a full-on economic offensive co-ordinated by the US and EU.

The combination of conflict and economic sanctions has the potential to significantly tighten commodity markets, with consequences for both economies and society.

The impact of tough sanctions could result in tightening in agri commodities, energy and metals.

Russia is a commodity powerhouse, with almost 50% of GDP now derived from international trade. It is a leading exporter of energy commodities, metals and agri commodities.

Global consequences

While economic sanctions on Russia’s main industries would significantly hamper economic activity, they would also have global consequences.

Striking the balance will be a key consideration.

Even if sanctions are not imposed on particular industries, such as agriculture, imposition of financial sanctions would likely hamper trade as international payments would be disrupted.

Energy-related sanctions would have a disproportionate impact on Europe, which is already in the grip of an energy crisis.

Between 2008 and 2018 Russia was the leading supplier of main primary energy commodities to the EU including hard coal, crude oil and natural gas.

In 2018, the EU was 58% dependent on energy imports, with Russia the leading supplier of energy commodities. In 2018, Russia accounted for 42% of EU coal imports, 30% of crude oil imports and 40% of natural gas imports.

In an interesting turn of events, the Financial Times reported last week that the US was in talks with Qatar and other leading gas exporters regarding gas supplies in Europe in the event of Russia invading Ukraine.

According to Gasprom, Russia’s majority state-owned gas company, gas balances in Europe are already tight, with underground gas storage (UGS) facilities lagging behind last year’s level by a quarter.

A third of the gas injected during the summer period has already been withdrawn from the facilities. Similarly, inventories in Ukraine’s UGS facilities are now almost 40% below the level of last year.

In the event of war materialising and economic sanctions following, there is the potential for significant supply disruption and price volatility.

There is also the risk to Russia’s gas flows through the Ukraine in the event of war. Any reduction in Russian gas flows to Europe by way of cutting off pipe flows or through sanctions would leave Europe very vulnerable given the current energy crisis.

Similarly, any sanctions that affect Russian oil production would disproportionately affect Europe. China, which is a leading importer of Russian oil, would unlikely be significantly impacted by western sanctions.

Russia is the largest global exporter of wheat, accounting for almost 19% of world wheat exports in 20/21. It is also the largest exporter of fertiliser, exporting approximately $7bn of product annually.

Russia recently announced a wheat export quota of 8.0 million tons from mid-February until the end of June, which is expected to constrain its exports. The move comes as the government seeks to curb food price inflation.

It also introduced export quotas on nitrogen fertiliser, primarily ammonium nitrate, for a period of six months from 1 December 2021. This followed the introduction of price caps on ammonium nitrate to curb price increases in the domestic market.

Any retaliatory sanctions imposed on Russia could further limit exports of both grain and fertiliser, potentially hardening prices in the global market.

While it is understood that there are no plans to include agriculture in the proposed sanctions package, sanctions against financial institutions could hamper trade.

Should Russia invade Ukraine, any conflict may affect either or both grain production and exports. Ukraine accounted for 8% of global wheat exports and 13% of corn exports in the 2020/2021 season. Analysts suggest that while the peak in Ukraine’s wheat exports has passed, corn exports are still under way.

Where this would have a direct impact for Irish farmers is through fertiliser costs. Any further constraints to European gas supply would serve to limit fertiliser production and would likely affect prices just as international prices are showing signs of softening. Any further restrictions on fertiliser exports from Russia would be felt in an already tightened global market.

The significant escalation in tension between Russia and the Ukraine brings Europe’s vulnerability, arising from trade dependencies, into sharp focus.

The degree to which the threat of severe economic pain can soften or deter Russian advances is yet unknown. So too is the degree to which the combination of conflict and economic sanctions will affect commodities.

However, it is reasonable to assume that at a minimum it would support current price dynamics if not push both fertiliser and grain prices higher. This is reflected in the International Monetary Fund’s move to revise 2022 inflation forecast upwards on Tuesday.