Introduction and Summary
The invasion of Ukraine and sanctions against Russia have disrupted global energy and other commodity markets and exacerbated tensions in global supply chains.
These and other effects of the war are pushing up inflation, dampening global growth, and raising risks of recession most acutely in Europe that is directly exposed to the conflict and that is highly dependent on Russia for its energy and other critical inputs.
Recent developments have served as a terse reminder of the vulnerability of economies to the control of critical commodities by one or few producers that are not committed to a peaceful global order and to high standards of market conduct.
Like Europe, North America is experiencing higher inflation, moderating growth, and a tense geo-political environment. However, there is modest direct exposure to Russia and Ukraine.
For Canada, there are positive offsets to high input costs through higher prices for our exports. Earnings from oil and gas, cereals, fertilizers, minerals, and forest products have improved markedly, raising national income and aiding the improvement of the fiscal balances of government.
In the current context, Canada is in a position not only to earn higher prices for its resources but to also to be part of the solution to the search by key partners of stable, secure, and responsible supply of energy, food, minerals, and forest products.
To date, there has been little reinvestment of the higher export earnings into productive capacity to realize long-term benefits. Infrastructure constraints and an uncertain policy environment are among key factors that are holding back investment. Thus, the overall impact of high commodity prices on the growth outlook for Canada may be muted.
The future path of commodity prices is uncertain. Moreover, in the best of cases, there will be limits to Canada's ability to fill global supply gaps or to displace supplies from less reliable producers. Market and policy conditions will be different across commodities.
Nonetheless, there should be collaborative business and government efforts to utilize fully existing supply capacity and infrastructure, to unlock any potential increment in the short term, to capitalize on market demand and to invest proceeds in productivity enhancement and decarbonization for long-term sustainability and competitiveness.
Recognizing long project lead-times, large costs, uncertainty, and risks, investment in new supply capacity should be driven by the structural trends that will shape demand and prices, supported by a policy framework that must also be responsive to market conditions.
Absent a focus on investment, and calculated risk taking, the higher export earnings will flow largely to consumption. Canada will not sustain the positive contribution of its resource endowment to the economy and it will fail to lay critical groundwork for long-term prosperity.
Recent Trends and Disruptions in Commodity Markets
Mounting geopolitical tensions and the invasion of Ukraine by Russia late February have provoked a set of supply shocks for the global economy that have intensified already strong inflationary pressures and slowed down the recovery from the COVID crisis. The impacts are significant. The Organisation for Economic Co-operation and Development (OECD) estimated in March that the war could subtract one percentage point to global growth in 2022, while adding 2.5 percentage points to the global rate of inflation this year.1 In June, ascribing much of the adjustment to its projections from December 2021 to the cost of war, the OECD lowered its projection for global growth for 2022 by 1.5 percentage point, to 3%.2
One of the key channels through which the war, and the global response in the form of sanctions on Russia, have disrupted the global economy is commodity markets. Russia produces 14% of the world's petroleum and it is a dominant exporter of both crude oil and refined products.3 It is also the second largest producer, and the largest exporter, of natural gas. Russia and Ukraine together account for some 30% of global wheat exports and 14% of corn exports, while Russia captures close to one quarter of exports of fertilizers. Russia also is the source of a high proportion of exports of key minerals such as nickel (14%), or palladium (25%), a key input for catalytic converters.4 The war has differentially impacted these industries. Agricultural production in Ukraine will be sharply curtailed. Infrastructure to move product is compromised. Economic sanctions are impeding transactions for Russian goods. If energy flows from Russia have continued because of necessity, notably in Europe, tactical manoeuvers by Russia, plans by the European Union (EU) to lessen its energy dependence, and the risk at any time of a serious aggravation of the conflict have nonetheless disrupted global markets profoundly.
The supply shocks caused prices of key commodities to spike regionally and globally. Brent crude that had already started to rise from below US$70 per barrel in early December, to over US$90 just before the invasion, shot up to above US$130 in early March, and in early June trades in a range of US$120.5 Other benchmarks, including West Texas Intermediate (WTI) and Western Canadian Select (WCS), followed a similar track, with the WCS price pushed to above US$100 per barrel. Natural gas prices in Europe moved even more abruptly. Spot prices reached stratospheric levels through successive spikes before and after the invasion. Today, they are at least 10 to 15 times prices of only two years ago. Asian LNG prices and to a lesser extent North American spot prices are also multiples of their levels of summer 2020. With the outbreak of the war, prices of some other commodities, including wheat and fertilizers, almost doubled in a span of one month. This reverberated through wider commodity markets, and downstream, for example in agriculture that uses the fertilizers, and corn for feed, and in manufacturing that relies on key minerals. While prices of most commodities have come down from their peaks, they remain high and volatile.
The supply shocks were felt intensely in an environment where the world was already shifting from one of demand deficit to one of supply deficit. For some commodities, for example critical minerals for the energy transition, upward pressure on prices was already exerted by rapidly rising demand, COVID-related supply breakdowns, and by the effect of years of under-investment in global supply capacity.
The market disruption has not only affected prices; it has generated deep concern about security of supply of energy, food, and other commodities, in Europe and in other countries heavily reliant on Russian or Ukrainian exports. Critically, countries of the EU, in diverse proportions, together import 90% of their natural gas, of which 45% is sourced in Russia. The EU also imports 25% of its oil and 45% of its coal from Russia.6 The vulnerability for the EU is real. The Bundesbank estimates that a Russian energy blockade and a rationing of energy use could pull German real GDP down by five points in 2022 relative to a baseline, while pushing the rate of inflation yet higher. The European Commission (EC) is charting a plan for the EU to achieve independence from Russian fossil fuels "well before the end of the decade"; at a special meeting of May 31, the European Council agreed to ban the equivalent of 90% of imports of Russian oil by the end of 2022.7 For the EU, weaning off Russian energy entails identifying new sources of supply and accelerating the transition to renewables and hydrogen. In countries like Tunisia, Israel, Egypt, or Turkey that rely heavily on imports of cereals from Russia or Ukraine, and others that may be affected by knock-on effects, the concern is one of food security. The United Nations World Food Program has warned that the blockage of Ukrainian ports on the Black Sea threatens the waste of tons of grain and the worsening of an already catastrophic world hunger crisis.8
Footnotes
1. OECD Economic Outlook, Interim Report March 2022: Economic and Social Impacts and Policy Implications of the War in Ukraine. https://www.oecd-ilibrary.org/ sites/4181d61b-en/index.html?itemId=/content/ publication/4181d61b-en
2. OECD Economic Outlook, June 2022, The Price of War, https://www.oecd.org/economic-outlook/#gdp-growth
3. See details in International Energy Agency, Energy Fact Sheet: Why does Russian oil and gas matter? 21 March 2022. https://www.iea.org/articles/energy-fact-sheet-why-does-russian-oil-and-gas-matter
4. OECD, ibid.
5. Prices as listed for selected benchmarks on Oilprice.com. https://oilprice.com/oil-price-charts/
6. European Commission, REPowerEU: Joint European action for more affordable, secure and sustainable energy, press release, March 8, 2022. https://ec.europa.eu/commission/ presscorner/detail/en/ip_22_1511
7. Opening remarks by President von der Leyen at the joint press conference with President Michel following the special meeting of the European Council of May 30, 2022, https://ec.europa.eu/commission/presscorner/detail/en/ STATEMENT_22_3382
8. UN News, WFP appeals for re-opening of Ukraine ports to avert looming famine threat, May 6, 2022, https://news. un.org/en/story/2022/05/1117722
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