How Russia’s control of oil and gas can put Australia’s economy at risk

There is one thing that even the United States or Europe cannot challenge Russia on – which leaves Australia at the mercy of Vladimir Putin.

One could be forgiven for thinking Australia has been suddenly thrust back into the 1970s. As markets panic over inflation, a resurgence of OPEC and oil shortages, Russia now looks poised to invade Ukraine.

How will this affect the Australian economy? Is this also a throwback to the boom and bust cycles of the 1970s?

It should first be noted that at this moment it is difficult to say. We don’t know if Russian President Vladimir Putin has in mind to take back Russian border lands to build a buffer against a NATO that has extended to its borders. Or, if he has in mind the restoration of Russian imperial glory. Or a mixture of both.

What we can say is that there are a few points of economic connectivity between Russia and the world that are under pressure and the tension will increase in direct correlation to the intensity of the conflict.

We can go further and observe that these connection points happen to be areas that are already causing central banks to panic about inflation, so the Russian adventure is likely to make things worse for markets in that sense. .

What am I talking about ? In a word: energy.

Russia is a very large supplier of energy to the world and in particular to Europe. It exports around 10% of world oil, 20% of world gas and 20% of thermal coal.

Describing it as hardware doesn’t quite say it. This is why no other country, not even the United States or Europe, has applied energy sanctions against Russia in response to the crisis. They can not. It’s just too big of a supplier.

So what if the situation in Ukraine deteriorates. Let’s use a few scenarios to understand the impact on Australia.

Likely outcome if Russia slowly invades

If Russia’s invasion of Ukraine takes hold and turns into a regular occupation of areas favorable to Russian domination, then the crisis will quickly pass.

It is possible if Mr. Putin decides to occupy Ukraine slowly, bit by bit. Take territory, stabilize it, then destabilize more neighboring areas and also settle there in a few years.

This scenario will incorporate small geopolitical risk price premiums to all of the above energies.

However, all three commodity prices are already very high due to the Covid disruptions. So these price premiums will likely disappear amid the price crashes as Covid supply-side bottlenecks dissipate and as Western central banks, particularly in the US, raise interest rates.

This scenario presents the possibility of an easing of inflation and a soft landing for developed economies. In the case of Australia, the effect of the rise in energy prices on activity is more or less neutral. Our LNG export revenues are increasing as our oil import bills are also increasing. Most importantly, it represents a transfer of wealth from households to energy producers, so most of us are likely to feel worse off as the gas pump sucks up revenue, with little overall impact on interest rates or on the currency.

What if Russia enters aggressively?

A more aggressive Russian push into eastern Ukraine will increase these price premiums and the bloodier it is, the worse it will be.

In this scenario, foreign central banks would be forced to raise interest rate even faster. Australia still doesn’t have the same inflation problem as other developed economies, so it will only pressure the RBA to rise at the margin. And he can just “look through”.

However, global rate hikes would put pressure on bank margins and may well increase “off-cycle” mortgage rates. It may not be very comforting to know that this will make the RBA even more patient.

Especially since faster and stronger US rate hikes could accelerate equity market volatility and most likely drive prices down. This would greatly disrupt consumption and send a trade shock to China and the world.

This is the boom and bust scenario.

What if it triggers a bigger conflict?

The third case is one in which Russia loses control of its Ukrainian push and the conflict threatens to spill over into all of Ukraine and even into neighboring countries. War is inherently unpredictable and when bloodshed in occupied populations, very unfortunate outcomes become possible.

Curiously, this scenario could offer less economic damage than the second as central banks could suspend their tightening regimes. If oil were to hit $150 or more, the economic shock alone might be enough to give authorities pause.

That said, it would also be enough to significantly hurt global growth, including Australia, as consumers buckle under pressure from pump prices, other transport and the shock of utility bills.

We are not in the 1970s and we have the time and the options to mitigate the Ukrainian economic fallout. The most important finding is that the worse Ukraine deteriorates, the more global energy prices are likely to rise, with each escalation compounding the damage to households.

David Llewellyn-Smith is chief strategist at MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economics editor of The Diplomat, Asia-Pacific’s leading geopolitical and economic portal. He is co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review. MB Fund is underweight Australian iron ore mines.