Insights & Advice

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A Russian oil embargo?

Consumers are paying more at the pump nationwide as oil prices rise.

Crude oil hit $110 a barrel this week. The price of natural gas rose in sympathy. In addition to the already-announced economic sanctions, demands to add an embargo on Russian energy exports are increasing. Be careful what you wish for.

Most of the world governments have already instituted several hard-hitting sanctions against Russia. Financially, the harshest step so far has been barring Russia’s central bank and several large Russian banks from using the Society for Worldwide Interbank Financial Telecommunications (SWIFT) system. SWIFT is a messaging network used by almost all financial institutions to quickly and accurately receive information such as money transfer instructions. As such, the entire Russian financial system has been cut off from the international financial system. It was considered a “financial nuclear weapon” by most credit analysts.

Most bystanders neither understand, nor care about this action. That indifference may be a mistake. No one really knows the ramifications of such a move on the global financial system. While the financial isolation cripples Russia, it may also have unpredictable consequences for other financial institutions.

How many of our U.S. or European banks are exposed to Russian debt, for example? How will they receive payments from Russian debtors? Are there assets, holdings, or obligations that are now in jeopardy because of these sanctions? Could the blowback take down parts of our global financial system along with Russia? Global investors are not waiting around to find out. Prices of banks and other financial institutions in world markets have been in a free fall.

As for the energy market, only Canada has said it was banning Russian oil imports. No other nation has targeted Russia’s energy complex directly (so far). Several global oil companies have announced they will be pulling out of activities in Russia. In the private energy markets, there is a clear preference to avoid buying Russian crude, which constitutes a semi-embargo situation right now. But most of the nations opposed to Russia’s aggression have kept silent on energy embargos.

The problem with an energy embargo is that, even before Russia’s invasion of Ukraine, oil supplies have been tight, with supply constraints swamped by increasing global demand. Any additional reduction in supply could not only send the inflation rate much higher but might also plunge the world and the U.S. into a recession. That said, could the worsening situation in Ukraine precipitate a Russian embargo despite the economic risks?

It could, which is why the International Energy Agency decided to hold an “emergency” meeting on Tuesday, March 1, 2022. They discussed what IEA members can do to stabilize energy markets and announced a 60-million-barrel release from strategic reserves. The U.S. is providing half of that amount. Naturally, several other nations are planning to release energy supplies from their strategic stockpiles. That would amount to a drop in the bucket, however, since those emergency supplies would only cover energy demand for a week at most. A reduction in government taxes on gasoline might help, but not by much.

There are two other avenues that the world could use to limit the rise in energy prices. One would be a breakthrough in the Iran/U.S. nuclear negotiations. The ten-month talks have been difficult, since under the last administration, former president Donald Trump arbitrarily quit the negotiation process. The Biden Administration revived the talks, but the wall of Iranian distrust has been difficult to climb.

The talks are dragging on over resolving questions over uranium traces found at several old but undeclared sites in Iran. “Significant differences” keep both sides from signing a pact. But as energy prices climb higher, the one million barrels of oil that Iran could sell on the open markets becomes increasingly attractive for a country suffering the impact of economic sanctions. From the U.S. side, those extra barrels could go a long way to corral rising oil prices, at least in the short term.

OPEC is also another wild card that could help increase supply somewhat. The oil producer’s cartel met on Wednesday, March 2, 2022, but made no move to increase supply beyond their already announced program. Both Saudi Arabia and the UAE could increase production, but that would put them at odds with Russia, a member in good standing in OPEC+.

All the above, I am afraid, might knock the price of oil down by $5 or so in the very short-term, but I suspect that given the ongoing risks of a war in Ukraine, oil will make higher highs in the weeks ahead.

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