What does Russia’s invasion of Ukraine mean for energy and petrol prices?

Russian president Vladimir Putin has for months refuted claims that Russia is invading Ukraine. But on Thursday, those fears turned into reality after Russia announced a “special military operation” – AKA invasion – in Donbas, eastern Ukraine.

The oil market jumped: Brent crude, the international benchmark, crossed $105 a barrel for the first time since 2014. Meanwhile, the price of gas and other fuels also soared.

So what does Putin want and what does the situation mean for fuel and energy prices?

What just happened?

Early last week, Russia said it would withdraw troops from close to Ukraine’s border, having built up a force of around 150,000. But then On Monday, Putin declared the independence of two pro-Russian rebel-controlled territories of Luhansk and Donetsk, in eastern Ukraine.

That itself was a significant provocation – a violation of Ukraine’s sovereignty. It also signalled the end of a diplomatic solution to the crisis, and to the Minsk Agreements – a series of agreements made in 2015 that aimed to end war in Ukraine’s eastern Donbas region – and made war seem inevitable.

Then today, the invasion was launched. Blasts have been heard in Ukraine’s capital, Kyiv. Russian troops have launched attacks from all sides – attacking from Ukraine’s northern border with Belarus, its eastern border with Russia, and in the south from Crimea, reports the Financial Times. In short, it’s a “full-scale military invasion” with Putin demanding that Kyiv’s army “lay down its weapons”.

Why has Russia invaded Ukraine?

The Kremlin ostensibly wants the US and Nato to guarantee that Ukraine will never be allowed to become a Nato member. Putin furthermore wants Nato to stop all military activity in Eastern Europe and pull back troops from countries that joined after 2017.

For years, Putin has cast doubt on whether Ukraine is even a separate country, going so far as to publish an essay last year in which he appeared to be “rewriting Ukraine’s history”, notes the FT. He echoed these views in a scathing televised speech on Monday.

Recent tensions come after Russia first invaded and then annexed the Ukrainian peninsula of Crimea in 2014. Donetsk and Luhansk broke off from Ukraine and war reverberated in eastern Donbas and eventually spread to West Ukraine.

Why now? There is no obvious answer, but it’s hard to argue that there’s ever been a better time, with Russian and Chinese interests currently aligned against a West which has proved divided on how to react to Russian aggression in the area. Then of course there’s the post-pandemic chaos and Europe’s ongoing reliance on Russia for energy exports at a time where Europe is already reeling from higher energy prices.

How has the oil market reacted?

The price of Brent crude oil jumped by 8% to a seven-year high, breaching $105 a barrel for the first time since 2014. At the time of writing, it is trading around $104.90.

Russia’s influence on the oil market cannot be understated as it is the world’s second-largest oil exporter only after Saudi Arabia and also the world’s biggest natural gas producer.

The oil market was already battling higher prices in recent days after countries including Saudi Arabia and the United Arab Emirates refused to increase oil supply to ease higher prices.

Vishnu Varathan, head of economics and strategy at Mizuho Bank, said “the scale of disruption and corresponding difficulty in substituting for lost Russian supply mean that price sensitivity to Russian oil disruptions are high.”

He expects oil prices to rise by a further 15%-30% if around a third of Russian oil exports are affected. So there is further pain ahead for the oil market, with prices “as high as $115-$130 (a barrel) is not unimaginable amid elevated risks of a head-on conflict between Russia and the West,” he said.

What about gas prices?

News of Russia’s invasion caused a 20% jump in Dutch gas futures, one of Europe’s most liquid markets, while EU gas prices spiked by 30% to €115 per megawatt hour on Thursday – a two-month high. German power prices for March also rose by as much as 31%.

European and UK gas prices were already on the rise this week after the suspension of Nord Stream 2, an $11bn gas pipeline project owned by the Russian state-owned enterprise Gazprom, which runs from western Siberia to Germany. The project was intended to double the capacity of the Nord Stream 1 pipeline which is already operational.

A sardonic Tweet by Dimitry Medvedev, Russia’s former prime minister and now deputy chair of Russia’s Security Council, underscores how much higher European gas prices may rise. Medvedev, who tweeted in response to the project being cancelled on Tuesday said: “Welcome to the brave new world where Europeans will soon be paying €2,000 per 1,000 cubic meters of gas!”

For comparison, European gas prices were trading at around €830 per 1,000 cubic meters of gas before the invasion took place.

How will this affect UK energy bills?

While the UK is less reliant than its European peers on Russian energy (the UK only takes 3% of its gas supplies from Russia), wholesale prices rising in Europe means prices will jump in the UK as well.

Jonathan Brearly – the chief executive of the UK’s energy regulator Ofgem – warned earlier this month that a Russian invasion of Ukraine could send prices higher in the UK and ultimately result in an even higher energy price cap.

The energy price cap, which is the maximum price per kilowatt hour (kWH) that energy providers can charge consumers for gas and electricity, increased by £693 (for the average household’s usage) at the start of the month and Russia’s conflict with Ukraine is just one of many factors that are likely to see the price cap rise even further in October.

How will it affect petrol prices?

The RAC warned yesterday that the average price of petrol is likely to hit £1.50 a litre soon, and £1.54 for diesel. As RAC spokesman Simon Williams put it, this represents “another unfortunate landmark”.

And with crude oil prices surging further, it’s unlikely to be the last. As the Daily Mail points out, if crude prices rise to their previous record of around $140 per barrel, the RAC reckons that would push petrol up to £1.70 a litre.

For perspective, in 2000, when fuel protests erupted over rising petrol prices (partly focused on high levels of fuel taxation) in the UK, the price per litre had just hit 80p a litre for unleaded.

What about interest rates?

One bigger concern with higher oil prices due to the conflict is that it may exacerbate inflation, which is already running high in major economies such as the UK and the US.

This will make life even trickier for central banks. Higher energy and petrol prices push inflation higher but they also cut into the disposable income available to consumers, which is in itself recessionary.

Jason Hollands, managing director of online investing platform BestInvest, says: ‘There is now a real possibility that the Bank of England’s forecast CPI inflation peak of 7.25% in April will be exceeded, and inflation at those levels will be totally unprecedented for many of today’s investors.”

 

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