Spring 2022 Economic Outlook: Commodity Markets – Oil, Gas & Electricity

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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