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| Economic meltdown scenario piles pressure on Russia and the west | Economic meltdown scenario piles pressure on Russia and the west |
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| Oil prices above $200 a barrel. Energy shortages in western Europe. The return of recession to the still-fragile global economy. A slump in Russia. That's the fear haunting policymakers as they contemplate how to respond to the shooting down of MH17 over eastern Ukraine last week. | Oil prices above $200 a barrel. Energy shortages in western Europe. The return of recession to the still-fragile global economy. A slump in Russia. That's the fear haunting policymakers as they contemplate how to respond to the shooting down of MH17 over eastern Ukraine last week. |
| The meltdown scenario can be easily sketched out. Every global downturn since 1973 has been associated with a sharp rise in the price of energy. Russia is one of the world's biggest energy suppliers and is responsible for about one-third of Europe's gas. America's economic recovery from the deep recession of 2008-09 has been weak by historic standards, while the European Union's has barely got going. From the car plants of Germany to the finance houses of the City of London and French defence firms, there has been pressure on politicians to be wary of provoking Vladimir Putin into retaliation that might rebound on the west. | The meltdown scenario can be easily sketched out. Every global downturn since 1973 has been associated with a sharp rise in the price of energy. Russia is one of the world's biggest energy suppliers and is responsible for about one-third of Europe's gas. America's economic recovery from the deep recession of 2008-09 has been weak by historic standards, while the European Union's has barely got going. From the car plants of Germany to the finance houses of the City of London and French defence firms, there has been pressure on politicians to be wary of provoking Vladimir Putin into retaliation that might rebound on the west. |
| "The possible involvement of Russian-backed separatists in the airliner's destruction has raised the risk of further sanctions against Russia by the international community," says Adam Slater, senior economist at Oxford Economics. "These would further damage Russia's economy. Russia's next moves remain uncertain but an escalation of the conflict is still a significant risk which would have potentially negative global spillovers in particular via the impact on global energy markets." | "The possible involvement of Russian-backed separatists in the airliner's destruction has raised the risk of further sanctions against Russia by the international community," says Adam Slater, senior economist at Oxford Economics. "These would further damage Russia's economy. Russia's next moves remain uncertain but an escalation of the conflict is still a significant risk which would have potentially negative global spillovers in particular via the impact on global energy markets." |
| The extent of that economic damage depends on two factors: how tough the west gets and how Russia responds. | The extent of that economic damage depends on two factors: how tough the west gets and how Russia responds. |
| Given the public outrage at the loss of life on MH17 some increase in the severity of the sanctions looks inevitable. In Brusselson Tuesday, there was talk of imposing restrictions on capital movements from Russia and of curbs on exports of defence and energy technology. These measures would certainly increase the pain for Russia, and would run the risk that Putin would retaliate by choking off oil and gas exports to the west, looking instead to energy-hungry China as an alternative market. Slater estimates that UK growth next year would be 1% lower than expected were Russia to halt gas supplies through Ukraine, with the impact felt through higher energy prices, higher inflation, falling share prices and weaker consumer confidence. Closing the gas taps could then trigger the "phase three sanctions" being resisted by many EU countries, including Germany, France and Italy. These would target entire sectors of the Russian economy, blocking their exports to the west and preventing them doing business with companies in the European Union and North America. | Given the public outrage at the loss of life on MH17 some increase in the severity of the sanctions looks inevitable. In Brusselson Tuesday, there was talk of imposing restrictions on capital movements from Russia and of curbs on exports of defence and energy technology. These measures would certainly increase the pain for Russia, and would run the risk that Putin would retaliate by choking off oil and gas exports to the west, looking instead to energy-hungry China as an alternative market. Slater estimates that UK growth next year would be 1% lower than expected were Russia to halt gas supplies through Ukraine, with the impact felt through higher energy prices, higher inflation, falling share prices and weaker consumer confidence. Closing the gas taps could then trigger the "phase three sanctions" being resisted by many EU countries, including Germany, France and Italy. These would target entire sectors of the Russian economy, blocking their exports to the west and preventing them doing business with companies in the European Union and North America. |
| It is this prospect that has prompted fears of rapidly rising oil prices. Slater calculates that Russian energy exports to the rest of the world could be cut by as much as 80%, with less than half the shortfall made up by the Opec oil cartel. "In such a scenario, world oil prices could soar above $200 per barrel and gas prices would also rise steeply." | It is this prospect that has prompted fears of rapidly rising oil prices. Slater calculates that Russian energy exports to the rest of the world could be cut by as much as 80%, with less than half the shortfall made up by the Opec oil cartel. "In such a scenario, world oil prices could soar above $200 per barrel and gas prices would also rise steeply." |
| Julian Jessop at Capital Economics notes that the biggest losers from this would be Russia, already in recession. Other suppliers would have an incentive to keep prices low in order to grab Russia's energy customers. The west could draw down on strategic oil supplies to limit the impact of the loss of Russian supply. | Julian Jessop at Capital Economics notes that the biggest losers from this would be Russia, already in recession. Other suppliers would have an incentive to keep prices low in order to grab Russia's energy customers. The west could draw down on strategic oil supplies to limit the impact of the loss of Russian supply. |
| It is the potential for Russia to damage the west and for the west to cause even more damage to Russia that explains the belief that the crisis will not escalate into a full-scale economic war. The European Union will talk tough but fall shy of imposing wide-ranging financial and trade sanctions as punishment for the Kremlin's alleged role in the attack on the Malaysia Airlines jet. Meanwhile, hopes that Putin is putting pressure on the separatists in Ukraine boosted share prices. | It is the potential for Russia to damage the west and for the west to cause even more damage to Russia that explains the belief that the crisis will not escalate into a full-scale economic war. The European Union will talk tough but fall shy of imposing wide-ranging financial and trade sanctions as punishment for the Kremlin's alleged role in the attack on the Malaysia Airlines jet. Meanwhile, hopes that Putin is putting pressure on the separatists in Ukraine boosted share prices. |
| But events of a century ago show that the optimism of markets is not always to be trusted. It was only in the last week of July 1914 – once Austria-Hungary had delivered its ultimatum to Serbia – that bourses woke up to the fact that the assassination in Sarajevo had the potential to lead to a war involving all the great European powers. Up until then, the death of Archduke Franz Ferdinand was seen as merely a local affair and nothing to worry about. Similarly, the expectation now is that Europe will huff and puff but be wary of provoking Putin. For his part, the Russian president will be aware of the economic damage that even limited sanctions are doing and so be inclined to put quiet pressure on the rebels in the Ukraine to co-operate with the international investigation at the crash site. Russia's economy was already contracting before the west imposed its most recent set of sanctions in the spring. The fear now is that things could unravel quickly – just as they did in 1914. | |