Russia’s invasion of Ukraine sends shockwaves through supply chains

News
31st March 2022

Article by Adam Duckett, Amanda Doyle and Amanda Jasi

Conflict impacts energy markets and feedstocks

Russia’s invasion of Ukraine is causing irrevocable changes to supply chains as industry navigates disruptions in energy and feedstocks, seeks replacement supplies in what were already contracted markets, and faces surging commodity prices.

In the last 12 months the cost of UK natural gas has risen 390%, oil by 80%, wheat 80% and fertilisers 30%. Prices were already on the rise, in part because economic demand in the wake of Covid-19 outpaced supply, and now the war is pushing them higher. Taken together, Ukraine and Russia are significant suppliers of energy, food and manufacturing inputs (see table). Sanctions and tariffs imposed on Russian companies and products are shrinking the supply pool, there is the risk that Russia will hit back by shutting off key exports, and some companies are unilaterally severing ties with Russia (see boxout).

“This has wreaked further havoc on already disrupted supply chains,” says Tim Doggett, CEO of the UK Chemicals Business Association. This builds on the significant administrative burden and haulage disruptions that UK companies have been dealing with following Brexit.

Companies quit Russia

Multinational companies are severing ties with Russia in the face of ratcheting sanctions and public pressure.

Energy: BP is divesting its 20% stake in Russian state oil company Rosneft, which accounted for around 20% of its profits last year. ExxonMobil has said it will cease operating the 250,000 bbl/d Sakhalin-1 oil project and will make no further investments. The Sakhalin-1 partners had been planning a US$9bn Russian Far East LNG export plant. Shell is exiting its ventures including a 27.5% stake in the
Sakhalin-II LNG plant and a 10% stake in the Nord Stream 2 pipeline that would have brought natural gas from Russia to Europe but was shelved by Germany. Total will stop buying oil from Russia but has not promised to leave.

Chemicals: Solvay, Clariant and Dupont are suspending operations in Russia. Dow and BASF have halted investment in Russia but continue to provide what they deem essential or humanitarian output including food production for BASF and packaging and hygiene for Dow. Similarly, Bayer will halt investments but is not withholding its agricultural products due to concerns that it could escalate food shortages, or health treatments.

Pharma: medicines have been excluded from sanctions and drugmakers have pledged to continue supplies to Russia to avoid suffering. However, Pfizer, GSK and Lilly have all pledged to conduct no more clinical trials there, and will donate profits from subsidiaries to humanitarian efforts.

The common key message from many is that they are prioritising the safety of staff in both Ukraine and Russia.

Energy markets changed forever

The war has provided a stark reminder of Russia’s dominance over globalised energy markets, but especially in Europe. The EU relies on Russia for 45% of its natural gas, 20% of its oil and 45% of coal.

The UK has said it will phase out Russian oil imports by the end of the year, and is establishing a Taskforce on Oil with companies to help source replacements. Russian oil imports account for about 8% of total UK demand. Natural gas from Russia makes up 4% of UK supply and the Government said it will explore options to reduce this further.

The US has banned imports of Russian oil, LNG and coal. In 2021, it imported around 700,000 bbl/d of crude oil and refined petroleum products from Russia.

“Russia’s use of its natural gas resources as an economic and political weapon show Europe needs to act quickly”

Given the level of its exposure, Europe is having to wean itself off Russian hydrocarbons much more slowly with plans to turn off supplies by 2030. But the pipelines have taps at both ends, and Russia’s Deputy Prime Minister Alexander Novak has warned that Russia could counter by shutting off supplies at any time, pushing prices even higher.

Fatih Birol, Executive Director of the International Energy Agency said: “Nobody is under any illusions anymore. Russia’s use of its natural gas resources as an economic and political weapon show Europe needs to act quickly.”

There is no doubt that in the interests of security, energy markets – and the supply chains that connect them – will be permanently redrawn but there is not enough spare capacity in the market to bring about fast change.

In December 2021, Russia exported around 5m bbl/d of its output. The IEA puts global oil demand at 99.7m bbl/d through 2022 but warns that sanctions could shut in 3m bbl/d of Russian output from April. The Organisation of Petroleum Exporting Countries and its allies (OPEC+) has agreed to increase supplies by only 400,000 bbl/d. There is spare capacity available from Saudi Arabia but it has its own economic interests in keeping prices high, plus its relations with the West have soured. Iran could contribute 1m bbl/d but this relies on a nuclear deal being agreed and talks have stalled. Additional supplies from elsewhere including the US and Canada are possible but not in the short-term.

Michael Connelly, a refining analyst at Independent Commodity Intelligent Services (ICIS), said that restricted imports from Russia will present a huge challenge to European refineries.

“There might have to be a shift in the type of crude people are buying, which then comes with the consequences of how does that change the yield structure and how does that change the splits on gasoline, naphtha, jet fuel and diesel production?”

Though he also countered that a restriction of refined product coming into Europe could also help refiners improve margins. Ultimately, he expects refiners will have to accelerate plans to modify operations or enhance logistics so they can accept supplies coming by sea rather than piped from Russia.