April 2022
The Russia-Ukraine crisis has created a new negative supply shock for the global economy. AME now expects global economic growth of 3.9% this year, down from our previous forecast of 4.5%. In 2023, AME expects global GDP growth of 3.2%.

The war is fuelling high energy and commodity prices that are pushing up already surging inflation, reducing consumers’ real incomes, and weighing on global activity. In the US and Europe, prices have climbed at the fastest pace in four decades.

Even though Russia accounts for less than 2% of global GDP, it is a major commodity exporter. The country supplies 11% of the world’s hydrocarbon liquids supply and 8% of LNG. Russia is also a key supplier of palladium, used in catalytic converters for cars, and nickel, used in steel production and battery manufacturing. Together with Ukraine, Russia supplies 29% of wheat exports and 75% of sunflower oil exports.

AME expects Russia’s economy to contract 10% this year, on the impact of western sanctions and soaring inflation. Further sanctions, which have been floated by the US and the EU, following alleged civilian killings in Ukraine, will add further economic pressure. Russian growth is expected to remain negligible until 2023, given that a more sustained recovery for the country will require a peace deal, which still looks a way off.

In a sign of the pressures facing the country, Russian manufacturing activity in March contracted at its sharpest rate since May 2020, during the early stages of the pandemic. Meanwhile, the impact from the crisis will be felt the most severely in Europe and Central Asia (ECA). We expect the war to shave 0.9% off ECA GDP this year, which has been revised to 3%.

Russia is moving to diversify into new energy markets. In February, state-owned gas giant Gazprom agreed to supply Chinese state energy major CNPC with an additional 10Bcmpa of gas via pipeline. That puts the deal at 38Bcmpa of gas supplies by 2025. The Power of Siberia pipeline, which runs from Russia’s Far East to northeast China, exported 16.5Bcm of gas to China in 2021. Despite Russia’s pivot to China, sales to Europe are a key source of income for the country, as 70% of Russian gas exports and half of its oil exports go to Europe.

India, which imports 80% of its oil needs, usually buys only about 2-3% from Russia—but with oil prices up over 30% this year, the country is snapping up discounted Russian oil. India has bought at least 13Mbbls of Russian crude since 24th February, compared with nearly 16Mbbls in all of 2021. Russia already has trade with India in another crucial realm—defence—supplying as much as 60% of the country’s military hardware.

Russia’s energy diversification strategy, which will take place over the next two years, recalls a similar move by Australia, which successfully found new buyers for its coal exports after China slapped an import ban on the country’s products in late-2020.

Looking to the Eurozone, surging energy prices are causing a sharp spike in costs for businesses and households and lashing the region’s economic rebound from the pandemic. As a result, we expect the region to grow 3.9% in 2022, down from our earlier forecast of 4.3%, and 2.5% in 2023.    

The US economy is booming with employers continuing to hire at a breakneck pace, adding 431k jobs in March alone. The unemployment rate has fallen to 3.6%, barely above the pre-pandemic level, in a good sign for supply chain recovery.

However, there are clouds on the horizon from high oil prices, rising interest rates and the end of federal pandemic-era aid programs. On the brightside, strong corporate profits, household savings in excess of US$2tn, and low debt levels, will help protect against any slowdown.  

US growth will slow this year, but from the best year for economic growth since the mid-1980s. AME expects US economic output to come in at 4% in 2022, from 5.6% in 2021, and then rise 2.6% in 2023.

In China, the sudden lockdown of Shanghai on 28th March is raising difficult questions about the country’s Covid-zero approach. While it is unclear how effective the lockdown might be against the highly transmissible Omicron variant, official data is pointing to a decline in the country’s economic health. PMI data for both factory and service-sector activity plunged into contraction in March compared with a month earlier—the first time they have simultaneously shrunk since early 2020.

The impact of lockdowns on consumer activity, coupled with a slowdown in its crucial property sector, will result in a sharp slowdown in March and April. We expect to Covid-zero strategy could last for between six and 12 months. AME expects China to grow 4.8% in 2022, down from our earlier forecast of 5.9%, and 5.2% in 2023, down from previous expectations of 5.7%.

 

Russia and the European Energy Saga

The likelihood of major disruptions to Russian oil production is threatening to create a supply shock. The US, Britain and Canada have stopped importing oil from Russia, while many oil companies, trading houses, shipping firms and banks have voluntarily ceased purchases of Russian energy products.

In an effort to help ease soaring fuel prices, the US will release up to 180Mbbls of oil from its strategic reserves—the biggest release since the stockpile was formed in the 1970s. However, this will only cover around 56 days of lost output (~3.2Mbpd) from Russia.

The release won’t be accompanied by higher output from OPEC+, with the oil cartel sticking to plans to raise output by 432kbpd in May. Only Saudi Arabia and the UAE hold spare capacity large enough to offset the shortfall from Russia.

In 2022, AME expects Russian liquid hydrocarbon production to fall 3.2Mbpd (~3% global production) to 7.547Mbpd, down 29% from the previous year. Russia is the world’s second-largest oil exporter and supplies more than 25% of Europe’s crude oil.

However, we expect that, from 2023, Russia’s oil production will recover by 2,880kbpd (90% of the loss) to 10,198kbpd. A return to normalcy is expected in 2024. This is because Russia will find new buyers for its supplies, mostly in Asia, in a trend we are calling ‘commodity musical chairs’.

AME’s Brent crude spot price averaged US$112.35/bl in March, soaring 19.5% on-month and 71% from the same month in 2021. Oil prices will remain hot in the coming months, but gradually moderate as increased supply hits the market.

AME’s Brent crude oil spot price is forecast to average US$100/bbl in the June quarter of 2022, up from US$97.83/bbl in the March quarter. In 2022, the price is forecast to average US$95.50/bbl, the highest annual average since 2014, and up from US$70.92/bbl in 2021. In 2023, AME expects the Brent crude spot price to remain strong at US$90/bbl.

Supply concerns have driven European gas prices to high levels, putting pressure on consumers and energy-intensive businesses. AME’s European composite gas price averaged US$41.82/MMBtu in March, surging 56% from February and an incredible 577% from the same month in 2021, when it averaged just US$6.18/MMBtu. The EU imports 90% of its gas, with Russia providing around half.

AME's composite natural gas price is forecast to ease to US$31/MMBtu in the June quarter, steady with US$32.93/MMBtu in the March quarter, as supply remains tight, but lower seasonal demand offsets further increase. In the June quarter of 2021, the price was just US$8.83/MMBtu.

Russian President Vladimir Putin has insisted that foreign buyers open rouble accounts with Russian banks in a clear effort to bolster the country’s currency— which plunged in value after sanctions froze the Russian central bank’s foreign assets.

But Germany and Italy, Russia’s two largest energy customers in Europe, said they would continue to pay in euros. “It is important for us not to give a signal that we will be blackmailed by Putin,” said Robert Habeck, Germany’s minister for the economy and energy.

Germany and Austria have activated the first phase of their gas emergency laws on expectations that supplies from Russia will drop. AME expects payments will continue to be made in euros—but to Gazprombank, which has not been sanctioned by the EU. Without energy imports from Russia, Germany’s inflation rate could rise to between 7.5-9%, said economists from Frankfurt University, who advise the German government. Germany’s gas storage facilities are about 26.5% full, after hitting a four-year low of 24.6% this month, according to Gas Infrastructure Europe.

Both Germany and Italy have been rushing over the past month to diversify their gas supplies, after years of heavy dependence on Russia. Last year, Germany received 60% of its gas from Russia, with supplies of 50.6Bcm, up 10.5% on-year, while roughly 45% of gas burned in Italy came from Russia. Meanwhile, roughly a quarter of Germany’s natural gas capacity is held in facilities owned by Gazprom.

A meaningful shift away from Russian gas imports will not be realistic in the short term, given the lack of spare capacity, coupled with the high cost of importing LNG from elsewhere. However, European efforts to reduce dependence on Russia’s energy imports will become a reality over the longer term.

Germany wants to stop Russian coal imports by the end of the northern summer and oil imports by the end of 2022, but it does not plan to end its reliance on Russian gas until mid-2024. Europe’s largest economy has plans to build two LNG import terminals, a proposal that was previously dismissed as being too costly. The country is also planning to accelerate its push into clean energy, earmarking about EUR200bn (US$218bn) for investments through 2026.

As Europe looks outside Russia for LNG supplies, under-development projects in the US have had their prospects brightened. New Fortress Energy is advancing plans to build the first offshore US LNG export facility and have it up and running by the March quarter of 2023. The proposed terminal would produce about 2.8Mtpa, less than a third of onshore plants—which usually take four to five years to complete, costing billions in the process.

 

Has Globalisation Peaked?

The pendulum of globalisation has been swinging back as countries seek greater supply chain security. The shift, which began after the Global Financial Crisis in 2008-09, has been gaining momentum in the aftermath of the momentous supply chain disruptions caused by the pandemic and amid rising geopolitical tensions.

The Russian invasion of Ukraine will prompt companies to further examine dependencies and is expected to lead to increased onshoring or nearshoring of operations. Trade patterns are expected to be reshaped into East and West spheres of influence and friendly trading blocs.

These expectations come even as global trade is booming. In February, the Port of Los Angeles reported its highest-ever activity level in its 115-year history. A month earlier, overall global trade volumes hit a new record, about 9% above pre-pandemic levels in December 2019. However, the boost to global trade as countries rebound post-pandemic is increasingly looking like a last hurrah.

Governments are increasingly promoting security interests and investing more in domestic production. Just last week, US President Biden invoked the Defence Production Act to increase domestic production of battery metals, such as lithium and cobalt, to reduce dependence on “unreliable foreign sources”.

China is looking to reduce its dependence on foreign agricultural products, partly because the Ukraine and Russia supply almost a third of the world’s wheat. Last month, China’s President Xi Jinping said month that the “the rice bowls of the Chinese people must be filled with Chinese grain.”

If globalisation resulted in cheaper consumer goods, its opposite could raise costs and prices for goods and services.

Over the past five decades, military spending has fallen by nearly half worldwide, according to the IMF. The decline has been attributed, at least in part, by higher global economic interdependence.

By contrast, deglobalisation could have the opposite effect. In February, Germany announced it would increase its defence budget by EUR100bn (US$110bn), in a sudden reversal of decades of foreign policy that has favoured deterrence over conflict.

 

The Inflation Game

As energy and commodity price spikes put new pressure on already hot inflation, central banks will look to gradually normalise monetary policy. However, a slower pace is expected in countries where the economic fallout from the crisis is greatest. Inflation will come down over the next 12 months as rates rise, demand moderates and supply disruptions ease.

US inflation continued to run at the fastest pace in 40 years in February, reaching 7.9%, the highest level since 1982. In March, the US central bank lifted its benchmark rate by 0.25 percentage points and signalled plans for further rate rises in the months ahead.

In the Eurozone, inflation also rose to a 40-year high in March, soaring to 7.5%, as the impact of the war in Ukraine courses through the region’s economy. Energy prices skyrocketed nearly 45% from a year earlier. Soaring prices are adding increased pressure on the European Central Bank to begin raising interest rates, possibly before the end of the year.

Rising prices are increasing the cost of living and fuelling inflation, prompting governments to implement price controls and tax cuts. In the US, gasoline prices have risen nearly US$1.50 a gallon over the last year. To ease pain at the pump, Maryland, Georgia and Connecticut have suspended gasoline taxes, with more states expected to follow suit.

The cost of diesel—used by primary producers, miners, manufacturers and shippers—has risen even more, in a further pressure to already tangled supply chains. Diesel is averaging US$5.19 a gallon in the US, according to government figures, up from US$3.61 in January.

In March, Japan raised the ceiling on its temporary fuel subsidiary to JPY25/litre (US$0.20) and extended the programme, implemented in January, to the end of April. The subsidiary is expected to be expanded once more. After years of deflation, Japan’s consumer price index rose 1.1% in February, almost double the previous month’s 0.6% gain, as energy bills rose 20.5% on-year, while real wage growth stagnated. The CPI is likely to surpass 2% in April. Since 2000, real wages have risen just 0.39% and South Korea now exceeds Japan in average pay, according to data from the OECD.

On 5th April, South Korea said that it will further expand its tax cut on oil products by 30%, from the current 20%, for three months to minimise the impact of soaring energy prices. South Korea's consumer inflation accelerated to 4.1% in March, the fastest increase since 2011, fuelled by rising commodity prices.

In March, Brazil’s congress passed a bill to cut taxes on diesel and cooking gas by 25% through the end of the year. The tax change will likely cost states about US$3.2bn in revenue this year, according to Brazil's Economy Ministry. Brazil’s inflation hit a seven-year high in February to 10.54%.