More Inflation Due To Oil Scarcity

If Europe enacts the Russian oil embargo

source

It’s the first Friday of the month and this means I’m writing about oil and gas. I think oil and gas is the best leading indicator for the chemicals industry and the chemicals industry is the best leading indicator for the global economy according to Paul Hodges over at ICIS.

Earlier this week I wrote about changing the origins of our economy away from oil. Most of the physical products we consume are dependent on oil or natural gas in some way either as a raw material, an energy source, or as a means of transportation. Often, it’s all three. When oil prices go up, everyone has to raise prices, and ultimately this is one cause of inflation. Former Dow chemical CEO Andrew Liveris used to say that dropping the price of oil is like giving everyone a tax cut.

The problem with oil as fundamental raw materials to our modern economy is that we are essentially single sourced on crude oil as our only starting material. This is why its important to transition away as soon as we can.

As of this week there are preparations going on in Europe to cut off the supply of Russian oil. This means that importing liquid natural gas and crude oil has been accelerating in anticipation of the cut-off. The major oil extraction and refining companies have been doing quite well for themselves. Joe Wallace for The Wall Street Journal reported that:

“Industry margins have increased sharply since the invasion,” Chief Financial Officer Murray Auchincloss [of BP] said of refining.

The scramble in Europe is driving up prices for consumers in the U.S. Natural-gas futures have more than doubled this year and diesel futures have rocketed 80%, adding to inflationary pressures that the Federal Reserve is trying to quash with higher interest rates.

As the war continues in Ukraine I think western nations will keep trying to apply pressure by cutting off money to Russia. Just this week Russia avoided defaulting on its debt by paying out a bond at the last minute in foreign currency that was not frozen by western sanctions. By not being able to bring in new currency through oil and gas sales the risk of defaulting again could increase as more of their bonds come due.

It’s Not Like Hitting A Switch

Not all crude oil is the same. The different fractions held within crude oil are different depending on where the oil is extracted. West Texas Intermediate isn’t the same as Brent Crude, which is also why they get different commodity pricing (both are over $100/barrel for June contracts). Switching away from Russian crude oil to foreign sources could involve reworking on upgrading refineries in Europe. Stanley Reed, Melissa Eddy, and Benjamin Novak reported for The New York Times:

Zsolt Hernadi, the head of MOL, a large Hungarian oil company, recently said it could require up to four years and $700 million to recalibrate his company’s refineries in the event of an embargo on Russian oil.

Analysts say an embargo could trigger a costly competition for alternative sources of oil.

Viktor Katona, an oil expert at Kpler, which tracks energy flows, said that of the substitutes potentially available for Russian oil, only Saudi output was a good fit. 

If the embargo hits I expect there to be a lot of scrambling on feedstocks for chemicals and that inflationary pressure will continue to increase. I suspect commodity chemicals will become pricier and this will push inflation even higher. I think western oil companies will be bringing in healthy profits on higher prices and scarcity though as they already have for Q1 of 2022. Shell and BP, reported big numbers for the first quarter of the year, and ExxonMobil also seems to be doing quite well despite all of these companies taking losses in exiting operations from Russia.

In Q1 of 2022 we already saw GDP contraction here in the US and I suspect an embargo on Russian oil and the resulting scarcity could push the EU into a recession as well. I don’t see inflation decreasing significantly, if anything it might be leveling off, but I think we are in for another quarter of contraction. I think it’s worth it too if this gets Russia out of Ukraine.

Tony