Cost of the conflict: it’s not just Ukraine that will feel the shock of war

In the next few months, the whole world will face the consequences of Russia’s invasion of Ukraine. Ukrainians will see the worst of it, in the form of actual violence. For the rest of us, the consequences will manifest mostly in terms of economic impacts. Don’t just think in the abstract, of Alan Kohler pointing at a graph of bond yields. Economic impacts are real impacts. We’re talking about families with no bread. Pensioners with no heating as the last cold snaps of winter come through. Widespread suffering.

Pain will fall on normal people. Tens of millions of them, worldwide. But to see that pain, to understand whose children will be crying, who will die in a freezing apartment, we need to go to a meta level. We do need to look at charts of prices. As we do so, it’s vital to keep the real-world consequences in mind.

Bill shock

Disruption in the global economy manifests in price changes. The Russian ruble, for example, has fallen 5% against the US dollar. The Ukrainian hryvnia has fallen 5% too. But the most consequential change so far is in the price of gas. Gas matters a lot to Europe. They use it to heat their homes. 

And the price of gas in Europe is up significantly. It was €10 per MWh before the pandemic and is now €77 per MWh.

Energy shortages in Europe have been going for a year or more. They are burning wood to stay warm, installing solar panels where possible (for what little good they do in a European winter), and simply going without heat. Manufacturing plants are closing too, unable to afford the price of energy, which compounds the problem of energy affordability by denying people work. 

It could be about to get a lot worse. Around 65% of Germany’s gas comes from Russia. A major pipeline runs through the Baltic Sea. When you import gas through a pipeline, you may not have enough port capacity to bring in substitute gas when your pipeline falters. Electricity and oil prices are rising too as consumers who can substitute do so. But prices can rise a lot further, and they might if the Ukraine invasion intensifies.

Bread too

Look at Ukraine on a satellite image and you will see its fields glowing golden. Ukraine is a major producer and exporter of grain — wheat and barley. The war will surely disrupt planting and harvesting, as well as milling and export. Ukrainian wheat exports generally head south, to the Middle East and Northern Africa. The countries that rely on Ukrainian wheat to feed their populations include Lebanon, which is in a state of collapse, and Turkey, where inflation just rose to 48%.  

Grains, however, are fungible. They are traded globally, and there’s a spot price; you just need to bid higher than the next buyer to get a vessel packed with grain heading to a port in your country. Which means other wheat-growing regions will to some extent step in and fill the gap in countries that usually rely on Ukrainian wheat. But of course limited global supply will push up prices. In Australia we’ll get mad at bread going up 40 cents a loaf, but we won’t go hungry. Somewhere like Lebanon, hunger is likely.

What about us?

Global GDP is, however, unlikely to tremble too much on the suffering of the hungry. Indeed, Australia could see economic upside. For us, rising prices for grain and natural gas create a windfall. Australia is an enormous exporter of gas, albeit mostly not at spot prices. Many of our customers locked in prices long ago. But the little gas we sell at the new high spot price is still worth many billions of dollars, so the higher prices are a benefit to oil and gas company profits and to the jurisdictions who tax them. (Santos paid over $500 million in taxes in 2021, a roughly 30% rate on its $1.4 billion in profit.)

We also still sell wheat on global markets. Wheat farmers — who are abundant in Western Australia, especially — will be in clover.

The major downside will be in fuel prices. Petrol is now over $2 a litre in parts of the capital cities as the global oil price approaches $100 a barrel. Tension in Ukraine and Russia will lift global oil prices even further, as Russia is a major oil producer. That’s going to hit Australian consumers where they are sensitive, and at the same time flow through into the costs of other goods. 

Higher petrol prices make the job of the Reserve Bank even harder. It would usually lift interest rates to combat inflation. But when the rising prices are fully imported, lifting rates risks just making life even harder for Australians and harming the economy. They may have to let rates linger at low levels for even longer. And indeed market expectations for interest rate rises have fallen as Putin’s intentions toward Ukraine have become clearer and his incursions more brazen.

But how long will this war last? Geopolitical furores have a tendency to be short lived. The energy expended in remaining outside of equilibrium is high and we eventually return to a tense peace. I’ve written several articles raising alarms about North Korea, for example, and things usually return to baseline before long. Let’s hope Putin withdraws, and these painful economic effects are temporary.