Nordea Warns Of EU Recession And $150 Oil If Russia Retaliates

Authored by Thina Margrethe Saltvedt and Aurelija Augulyte of Nordea Bank,

  • Russia as important oil as gas supplier to Europe
  • Disruptions to Russian oil flows will have huge impact on oil prices
  • Embittered political climate, oil prices at USD 150/barrel and high financial market uncertainty can tip EU back into recession
  • Oil price spike and flight to safety a recipe for broad-based USD strengthening and lower global rates: three risk scenarios
  • US shale oil or SPR release will not prevent oil price spike

Oil prices have increased by more than USD 2/barrel today as tension in Ukraine has escalated and raise concerns about the risks of disruption in Russian energy exports. There is a risk that the security situation in the east Ukraine will worsen even further ahead of the 25 May elections.

Memories have been awakened of episodes in 2006 and 2009 when Gazprom halted all Russian gas flows through Ukraine, amid pricing disputes, completely cutting off supplies to Southern Europe and partially other European countries. Not nearly as much attention has been paid to the risk of a disruption to the oil flows.

Russia is as important an oil exporter to Europe (of both crude and refined products) as it is a gas exporter, but unlike for gas, only a relatively small portion of its overall oil exports to Europe transit through Ukraine. Oil, in contrast to gas, is easy to store, ship and trade, which means that the markets more flexible and a single customer has less immediate scope for action. Nevertheless, the consequences of a cut in Russian oil supplies could be as rave since the oil global oil market has little back-up capacity to lean on, European commercial oil stocks are low and there is no real substitute for oil in the transportation sector (which accounts for more than 60% of total oil consumption worldwide).

As a result a halt in the oil deliveries from Russia to Europe will spark a sharp spike in oil prices and in a worst case scenario an oil crisis. A longer-lasting disruption to oil supplies and an extended period with high oil prices will curb the potential for Euro-zone economic growth and slow down growth in the global economy. If the oil price spike is accompanied by a sharp fall in confidence and financial players recede to safe havens, the impact on global growth and financial markets will be even more severe.

The questions are therefore how vulnerable the European oil market is to a halt in oil deliveries from Russia and whether the European economy can withstand a protracted period of high oil prices?

Brent oil and NBP gas prices will react sharply to supply disruptions

Disruptions to Russian oil flows will have big impact on prices

The sabre-rattling and threats will no doubt continue for a while, but so far tensions between Russia and the West over Ukraine have had minimal impact on physical oil balances. What if an escalation of the crisis in Ukraine, in a worst case scenario, leads to disruptions in the oil supplies from Russia to the EU as a consequence of for example a halt in oil deliveries via Ukraine, a halt in deliveries of oil and gas from Russia to EU as a retaliation of stricter sanction imposed by EU/US on Russia and attacks on infrastructure following increasing political turbulence – what would then be the effect on Brent oil prices and economic growth in the current tight oil market environment?

Any disruptions to the oil flows going from Russia to the European market will presumably have a big impact on oil prices, as commercial inventories are low (three major OCED 2013 year-end stock levels lowest in 10 years), the current European supply/demand balance remains tight and the world’s spare production capacity is fairly low. Supply outages remain severe in aggregate at roughly 3.5 mb/d in the MENA region alone, mostly in Iran, Iraq, Libya, Syria and Sudan (PIRA). Commercial stocks are not ample enough to weather significant ongoing physical supply disruptions and definitely not to withstand a curtailment of supply arising from a growing political dispute between Russia and the West.

A sharp rise in oil prices – if prices remain elevated for a period of time – will have a negative effect on economic growth and in a worst-case scenario push the EU back into recession. Clearly, higher oil prices and weaker growth in the EU will also have an impact on the growth potential of the global economy. How long a price spike will last, and thus the impact on the EU and the global economy, depends on the volumes held back from the market and the reason for the halt – whether the production/transportation infrastructure is damaged or the taps are turned off.

Three risk scenarios: a halt in oil deliveries from Russia – impact on oil prices and EU GDP growth

We have looked at three different scenarios and the potential effects on oil prices, economic growth, the EUR/USD cross and rates depending on the period and severity of the disruptions.

Oil Price Scenarios: Russian oil export is cut by one-half

In all three scenarios we assume that Russian crude oil exports to Europe are cut by 50% or around 1.5mb/d. The GDP calculations are based on the International Monetary Fund GEM simulations.

Scenario 1: A short-term halt to oil deliveries lasting only two weeks, pushing oil prices up by 10-20% (from Q1 average at USD 108/barrel).


Scenario 2: one-half of Russian oil supplies to Europe is locked in, but this time for two quarters. Global spare capacity will fall to lows last seen in 2008 to 2.2% of global demand from the current 3.9%. We expect that Saudi Arabia’s spare capacity will compensate for some of the losses, but with a lag. Notably the ECB will not act against EUR/USD in this scenario, since it will see the advantages of a weaker EUR towards the USD for energy imports and increasing competitiveness for Euro-zone products and services abroad.


Scenario 3: oil supply disruptions are expected to lead to a cut in oil flows to Europe by 1.5m b/d and push oil prices up to USD 150/barrel. Saudi Arabia will increase production (the spare capacity buffer will fall), and the market situation will call for an IEA Strategic Petroleum Reserve (SPR) release (see box), but with a lag. As the market is concerned that the disruptions will be more severe than in scenario 2, the price spike is followed by a huge spike in risk aversion triggering a flight to safety by financial players away from risky assets, a widening of credit spreads – recipe for broad USD strengthening and we will likely see global rates go much lower. In this case the impact on the global economy would be much larger and the EU will most likely tip back into recession.

Potential impact of the three scenarios

The oil market is global and a sharp spike in Brent oil prices would of course raise prices of other crudes and oil products as well. Since Russia is one of the largest oil producers and exporters in the world with total exports of 7.1m b/d crude and products, it would be close to impossible to compensate for the full amount in the short to medium term if these barrels do not reach the market. Even a smaller volume, say 50% of the crude exported to Europe (the amount used in the scenarios above), would be very difficult to replace as the quality of the replacement needs to match.

Oil Price Spike: Three scenarios and impact on EURUSD

Embittering political climate and higher oil prices can push the EU back into recession

In the absence of Russian barrels, world oil prices would undoubtedly spike – causing economic pain for the large oil import-dependent countries such as the EU and reducing the growth potential of the world economy. An embittering political climate and an oil price spike would most likely be followed by a huge drop in market confidence, triggering a flight to safety in financial markets which in turn would magnify the impact on economic growth and push the EU back into recession.

As Russia and Europe remain closely linked as oil and economic trading partners, we do not see this as the outcome of the crisis. But the recent escalation of the conflict in Ukraine clearly increases the risk of a supply disruption materialising. The shock of the Crimean annexation should speed up the sluggish European decision-making process on energy storage, interconnection in the gas market, diversification of suppliers, liberalisation, shale gas production and efficiency measures especially on the transportation side.

Read the full story about the Europe/Russian oil interdependency, Ukraine as a traansit country for oil and the US shale oil production /SPR release will not prevent an oil price spike and see all the graphs in the PDF below:


140502 Ukraine Crisis GDP v1