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Russia, Ukraine & Oil Prices | 3rd March 2014

Why Crimea will be an economic flashpoint | Will the Crimean crisis have an enduring effect on oil prices? Europe teeters on the brink of a crisis that could, at best re-draw the post-Cold War borders between a Russian aligned Crimea and eastern Ukraine and a European aligned western Ukraine and, at worst, re-open the East-West fault-lines of the Cold War. Underlying the global geo-political tensions that are a consequence of the current stand-off is an equally pervasive and persistent tension between Russia and the Ukraine around oil and gas supply. Since 2006 Russia has interrupted its supply of oil and gas into the Ukraine in response to political and economic disputes (specifically non-payment by the Ukraine of its bills for gas supply). In January 2009 this caused a complete shut-down of oil and gas supplies by Russia to the Ukraine for thirteen days. Memories still linger and there will undoubtedly be nervousness in markets now as European energy security threatens to coincide with broader political instability.

It is easy to see why Russia is keen to retain its influence. Despite the fact that the country’s economy is bankrupt, it is the largest ex-Soviet destination of Russian oil and gas exports. Over 50% of its imports of oil and gas are from Russia and are worth over USD 6.7bn to Russia. Assuming other things are equal and that conflict is abated, growth rates in natural gas alone, are forecast to be higher than 16% in 2014 on their 2013 value.

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Figure 1 | Russian exports of Natural Gas to former Soviet States and forecast growth

Source DeltaMetrics 2014

Yet Ukraine supplies oil and gas in its own right, recently entering into agreements for shale gas exploration and production. Similarly, European countries, concerned about the impact of the 2009 crisis and their dependency on Russian supply through the Ukraine, have sought energy supplies directly from the Ukraine or from elsewhere. This reduces Russia’s influence on the Ukraine, even Europe, through gas supply in particular and it is arguably for this reason that Vladimir Putin will be keen to keep Ukraine within his control.

The effect on oil prices of all this is ambiguous and this is shown in Figure 2 which shows Ukrainian exports and imports of oil and gas against the oil spot price. Exports of oil and gas from the Ukraine track the oil price closely – price rises mean increases in exports and vice versa.

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Figure 2 | Ukraine’s Oil and Gas trade against the Oil Spot Last Price Monthly, June 2006-January 2014

Source DeltaMetrics 2014

 

Two things are clear from this chart.

First, there is a sharp increase in Ukrainian exports following the shutdown of Russia’s gas supplies in January 2009 that starts in May 2009. The increase is sharper than it was for Russia and continued until the beginning of the second quarter of 2011. Since then, Ukrainian exports have fallen: trade growth generally across all sectors has slowed following rapid catch up in 2010 from the financial crisis and oil and gas from these two countries were no exception. But equally, this drop for the Ukraine corresponds with the run up to and opening of the Nord Stream gas pipeline taking natural gas from Russia directly to Europe.

But second, since that point, trade has been relatively flat, indeed on a downward trend in both countries. Ukrainian exports have also been more volatile but until Q3 2012 moved in the same direction as oil prices. In other words, more was supplied as prices rose. Since then, oil prices and Ukrainian exports have periodically been inversely correlated with each other: that is, increases in price have been accompanied by lower exports from the Ukraine.

There is more to this than simply the breakdown of a relationship between two things in the wake of the financial crisis. Figure 3 shows Russian oil and gas exports to the Ukraine only from 2001 to 2014 against the NYSE Oil Spot Last Price Monthly over the same period.

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Figure 3 | Russian exports of Oil and Gas to the Ukraine versus NYSE Arca Oil Spot, Last Price Monthly, June 2001-January 2014

Source | DeltaMetrics 2014

The turning point is even clearer in Figure 3. From September 2011, Russian exports to the Ukraine appear to have moved inversely to the oil price as both Russia and the Ukraine began to use different supply routes and corridors to export their oil and gas. At the launch of the Nord Stream pipeline, around Ukraine, Vladimir Putin was clear about what this meant: “Any transit country has always the temptation to take advantage of its transit status,” he said. “That exclusivity is now disappearing.”

What does this suggest the outcome of the current crisis is likely to do to oil prices?

Much will depend on whether or not Russia gets its way and increases its influence in the Crimea and into the Ukraine quickly. If it does, then we can expect the risks to oil supply from the Ukraine itself and into the Ukraine from Russia to be short-lived meaning that oil prices will not be affected. However, Russia is unlikely to extend its influence into Western Ukraine without deepening instability and while it does not, we can expect Russia to restrict its supplies of oil and gas accordingly. This will put upwards pressure during 2014 on oil prices, not just because of the clear inverse relationship that appears to have developed but also because of the threat to energy security that it poses.

And in the very short term, March 2014 in particular, there is almost an inevitability about increased oil prices as markets absorb the likely effects of geo-political insecurity on energy prices and, hence, the prospects for economic recovery. How long this upward pressure persists depends on how quickly and effectively the crisis can be resolved.