The Economics of War

With the invasion of Ukraine by Russia now a reality, the global markets face a period of uncertainty. Conflict brings about a certain reaction from the world's economic elites and share prices provide an interesting insight into the economics of war.

Following the annexation of Crimea in 2014, Brent crude and WTI oil prices rose to over $100 per barrel. As one of the biggest exporters of oil in the world, particularly in Europe, Russia’s actions against the Ukraine have serious implications on global markets. Now, oil prices soar to the same astronomical levels, hitting an all-time record of $105 per barrel.

Ukraine sits in between Russia and Europe, holding a significant role in the historic Russian-Western relations. In fact, the region of Ukraine has spent the vast majority of its existence under Russian dominion, it wasn’t until 1990 that the former Soviet Union relinquished control.

The following factors highlight how the tensions between Russia and Europe can be seen in market prices and the effects this will have:

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Brent Crude Oil & WTI prices increase

Brent Crude Oil is one of the marker grades of oil and dictates the movement of most of the world’s oil prices, it is extracted off the north sea and is used primarily for fuel.

WTI, or Western Texas Intermediate, is another (less commonly used) benchmark for oil, based in the US and traded on NYMEX.

WTI is often compared to Brent crude to assess market fundamentals and it is therefore an important indicator of global economic conditions

Europe receives 1/3 of its oil and 40% of its gas from Russia

The increase in oil prices is directly correlated to the relationship between Europe and its dependence on Russian oil. The Nord Stream (2011) and Nord Stream 2 pipelines (2021) run from Vyborg and Ust-Luga respectively (in Russia) and directly into Germany.

Despite licensing preventing NS2 from operating, the old pipe is still responsible a significant portion of European oil.

Hostile Russian action in Europe has forced a series of ‘sanctions’ imposed by the west, and therefore, the likelihood of a response is high.

The current fear is that this pipeline will be severed leading to supply side disruptions and an energy crisis. Already, the RAC and AA have said “average petrol prices hit a record high of nearly 149.5p in Wednesday, with Diesel at 152.83p” (Espiner, 2022)

With the cost of living crisis incoming, the damage that this retaliation could have is not to be underestimated with already high prices continuing to rise.

Moreover, due to the fear around the potential supply shortages of oil and gas, shares in oil companies have fallen.

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Global stock market instability

As of writing this article, the S&P, Nasdaq, Dow Jones Industrial Average, Stoxx Europe 600 and MSCI World Index have all fallen by a significant margin.

These markets, have all taken a serious downturn, no doubt following the escalating tensions in Ukraine which have led up to the full-scale invasion which took place as of today.

Gold is often used as a hedge against economic turmoil; people tend to like putting their money into material assets with stable values when things look uncertain.

An influx in the price of gold is symptomatic of the state of the global economic climate and with a 3% jump taking gold to a one year high, it is safe to say that the impact of invasion is affecting the behaviour of investors who seek to sure up funds against the global stock market dip.

With sanctions being imposed left, right and centre, the Moscow Stock Exchange temporarily went offline, returning later that day with a 33% decrease in the value of the index.

Furthermore, the rouble sank to a record low against the dollar.

These are serious issues that face the Russian economic climate, perhaps demonstrating the value which it places on Ukrainian soil.

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Food Inflation

The price of food has rocketed since the start of 2020 and this has only been exacerbated by the actions of Russia in Ukraine.

According to Bill Adams, chief economist for Comerica Bank “The bigger the conflict gets, the larger the impact to global energy supply will be, the larger the drag on the European economy, and the larger the potential drag on U.S. exports and consumption spending will be” (Lee & Bissel-Linsk, 2022)

Ukraine is a major grain exporter and sanctions on Russia could isolate their commodity market.

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Overall, Russia is focused on the capture of Ukraine irrespective of the economic effects felt across the globe. This invasion does not just impact Russia, Ukraine and a few specific securities; the instability destabilises the entire international economy.

It was Russia that spent most of the 20th century playing antagonist to America and while the modern state is not so powerful as the former USSR, it still plays a vital role in the shaping of geopolitical economies, markets and the livelihoods of citizens around the globe

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Notes:

Espiner, T. (2022, February 24). Oil tops $100 and shares sink as Russia invades Ukraine. BBC News. Retrieved from https://www.bbc.co.uk/news/business-60502451

Lee, I. & Bissel-Linsk, J. (2022, February 23). Equities Decline, Oil Surges on Russia Assault: Markets Wrap. Bloomberg. Retrieved from https://www.bloomberg.com/news/articles/2022-02-23/stock-slide-may-deepen-as-ukraine-tensions-worsen-markets-wrap?srnd=premium-europe

Nord Stream 2: How does the pipeline fit into the Ukraine-Russia crisis? (2022, February 22). BBC News. Retrieved from https://www.bbc.co.uk/news/world-europe-60131520