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Welcome back everyone, just a quick video today to talk through the recently announced sanctions
on Russia’s Central Bank and the likely economic effects of Russia’s invasion of
Ukraine. Obviously, there are much greater concerns than these economic issues. The ongoing
situation is being described as the worst crisis in Europe since the second world war and the human
impact of this invasion is both horrific and immeasurable. My heart goes out to the people of
Ukraine who are in a truly awful situation. Now, obviously this is a very fast-moving
situation, so I’m rushing to get this video up quickly. I don’t usually upload on weekends, but
the most recent news is that the United States, Canada, and European allies have all agreed
earlier today to remove certain Russian financial institutions from SWIFT, but more importantly to
impose major restrictions on Russia’s central bank. There has been a lot of discussion around
blocking Russia from SWIFT and I made a video on the topic two days ago, but this move to target
Russia’s central bank is much more of a big deal and it comes with very little precedent.
Russia’s central bank has more than $640 billion in foreign exchange reserves, much
of it is held at various western central banks. 23% of their reserves is held in gold, and that
is all stored at the Russian Central Bank, 14% is in China – which is probably safe from sanctions,
and the rest appears to be held at various central banks around the world. This means
that around 400 billion dollars of Russia’s central bank reserves have just been frozen,
leaving them with around 240 billion dollars in available reserves and a war that is possibly
costing them $20 billion per day. Freezing or quarantining the country’s reserves like this will
put huge pressure on the Russian financial system. It could trigger bank runs, tank the ruble,
and cause panic among Russian businesses. The United States had already sanctioned
Russia’s largest banks, but Moscow was still able to use its foreign reserves to prop
up those banks. Removing that option, blocks Moscow’s ability to bail out its banks.
This action is the most severe financial measure imposed on Russia over its invasion of Ukraine.
The United States has previously only imposed sanctions on the central
banks of Iran, Venezuela and North Korea. Cutting Russian banks out of Swift will make it
more difficult for Russians to make cross-border transactions, but as I mentioned in my prior
video, SWIFT is really just a messaging system. SWIFT sends payment instructions and
confirmations, but the actual money is transferred by central bank RTGS systems. RTGS stands for
Real-time gross settlement. The sanctions on the Russian Central Bank are much more significant,
as they block money from moving at all. Other market news relating to this conflict
is that S&P cut Russia’s credit rating to “junk” status on Friday after the invasion. Additionally,
Fitch lowered Ukraine’s credit rating and Moody’s warned that both countries could face cuts.
The S&P credit downgrade strips Russia of its investment grade rating,
meaning that Russia would have to pay higher borrowing costs. Obviously, the credit rating
barely matters now that Russia’s central bank is being sanctioned. A low credit rating is the least
of their problems, when no one can lend to them anyhow. The credit rating agencies specialize in
closing the door after the horse has bolted… So, what are the other economic effects of
the Russian invasion of Ukraine? Well, first up, Russia is the third-largest
oil producer in the world they produce around 10 million barrels of oil per day.
Russian oil was already trading at a discount in the lead up to the invasion of Ukraine as nervous
buyers backed away from dealing with Russia. There has obviously been a lot of talk in
the press about Russian oil and gas exports, and of course some of the slow international
response that we saw relates to how dependent some countries are on Russia for their energy needs.
Nuclear power made up just over 13% of German electricity supply in 2021,
and this was generated by six power plants, three of which were switched off at the end of
last year. The remaining three are scheduled to be shut down in December of this year.
This shutdown is part of a plan put in place by Gerhard Schroeder 20 years ago and then after
the 2011 Fukushima nuclear disaster, Angela Merkel set 2022 as the final deadline for
shutting down all nuclear power in Germany. On top of this, the EU has been cutting the
use of coal and other hydrocarbons in electricity generation, to reach their climate goals and have
been focusing on the buildout of renewable energy. The problem is that this buildout isn’t happening
quickly enough, so Europe is quite dependent on Russia for natural gas at the moment.
BP and TotalEnergies are the European oil producers that have the greatest
exposure to Russia. BP owns almost 20 per cent of Rosneft - one of Russia’s largest oil producers.
This stake generated profits of more than $2.4bn for BP last year.
Next up, nitrogen is a key component in most synthetic fertilizers, and this is made by
combining nitrogen from the air with hydrogen derived from methane to produce ammonia.
The ammonia is then used to create other forms of nitrogen including ammonium nitrate and urea.
Natural gas is needed both for the methane and as a source of heat for the process. An
increase in fertilizer prices can be expected to push up food prices around the world.
The cost of fertilizer is not the only thing that could push up food prices around the world.
Russia and Ukraine are both big grain exporters. The two countries combined make up almost a third
of the world’s wheat exports. Ukraine’s output of grain and potatoes is among the highest in Europe,
and it is among the world’s largest producers of sugar beets and sunflower oil.
Wheat and other grain prices have soared since the Russian invasion of Ukraine.
A number of western food companies and brewers have operations in Ukraine. Mondelez, the maker
of Cadbury chocolate and Oreo cookies announced last week that they were suspending operations
at their two Ukrainian factories. Carlsberg, the world’s third-largest brewer, said
that work at all three of their breweries in Ukraine have been halted. Cargill,
the US agricultural trading group and Nestlé, the world’s largest food company
both have significant operations in Ukraine too that will be disrupted. Nestle announced that
they have “temporarily closed” their three factories and service center in Ukraine.
The disruption of grain exports from Ukraine and Russia will possibly lead to physical food
shortages, particularly in countries that typically buy from Russia and Ukraine.
These shortages could impact millions of people living in places like Egypt, Tunisia,
Morocco, Pakistan and Indonesia. These food shortages could of course then have
political consequences in these countries. Food shortages often lead to uprisings.
“Wheat is the currency of currencies” according to Lenin, and even in the depths of the cold war,
the Soviet Union had to buy huge quantities of wheat from the United States. If Russia wants to
sell wheat, they do have rail links to China and could use these links to export grain.
Now, you could argue that other grain producing parts of the world could just plant more wheat
to offset the Russian and Ukrainian shortage, but that would be dependent on the availability
of fertilizers. Russia has prohibited the export of nitrogen fertilizer until April
and China has prohibited the export of phosphate fertilizer until at least June,
other producing areas around the world might struggle to increase production.
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Next up let’s talk about metals. Russia is a major source of widely used metals that are
needed in manufacturing. Russia produces aluminium, nickel, palladium and titanium
and Ukraine is the world’s third-largest exporter of high-grade iron ore pellets.
Excluding China, Russia accounts for 14 per cent of the world’s aluminium production. This is used
in everything from drinks cans to automobiles. The price of aluminum is also strongly dependent
on the price and availability of electricity. The cost of electricity makes up almost a third
of the total price. So we have a few moving parts here that could drive up prices.
The financial strain inflicted by high natural gas prices, which jumped 30 per cent on Thursday,
has already forced several big metal producers to cut their output.
Next up, Russia is the third-largest producer of nickel worldwide after Indonesia and the
Philippines. Russia exported three billion dollars’ worth of nickel in 2020. Nickel is
an important metal used in batteries. Its price has already more than doubled over the last five
years leading carmakers to look at alternative materials for their electric car batteries.
Russia is also the leading global producer of palladium,
making up 40% of global palladium supply. In 2020, Russian palladium production
was 91 metric tons. Palladium is used in catalytic converters, electrodes and
electronics, the top palladium consuming regions are China and North America. A
reduction in the availability of palladium can be expected to hit the auto manufacturing sector.
Russia is the number two global source of platinum which is also used in catalytic
converters on cars. Russia produces 12 per cent of the global platinum supply.
This is however well behind South Africa which produces 70% of the world’s total platinum output.
Its major uses are in catalytic converters, lab equipment, electrical contacts and jewelry.
Ukraine is the sixth largest producer of Titanium in the world. It’s used in aircraft manufacturing
in particular by manufacturers like Airbus, Boeing and Rolls-Royce. It is also used in
jewelry, prosthetics, tennis rackets, bicycle frames, surgical tools, and mobile phones.
Russia and Ukraine are key sources of two very important industrial gases, C4F6 and neon which
are vital to semiconductor production. Ukraine produces a quarter of the world’s neon, the price
of which has tripled in the past six months due to Chinese steel mills that produce the gas as a
byproduct being shut down for the Winter Olympics. Chip manufacturers could be affected if supplies
from Ukraine are unavailable for an extended period. These gasses are essential for chip
manufacturing, particularly neon which is used in lasers that etch features on to computer chips.
The next industry we should discuss is banking. Western banks began cutting their exposure to
Russia after the invasion of Crimea in 2014. But Raiffeisen, the Austrian bank makes more than a
third of their profits in Russia. France’s Société Générale’s has a Moscow-based subsidiary, Rosbank,
that has 550 branches and 3 million Russian customers, while UniCredit operates 103 branches
and has 2 million customers in the country. Russia accounted for 6 per cent of UniCredit’s
profits last year and 4 per cent of SocGen’s. Western law firms, management consulting firms
and accounting firms all have offices in Russia and Ukraine.
Many of these firms have been busy getting their staff out of Ukraine and are preparing
to be hit with counter sanctions in Russia. These businesses would likely see a drop in profits.
Manufacturing is of course an important sector of the Ukrainian economy. Products manufactured in
the country include metal goods, transportation equipment and other types of heavy machinery,
a variety of chemicals, food products, and other goods.
Ukraine ranks among the top steel producers in the world, and then the country’s heavy industries
produce trucks, automobiles, railway locomotives, freight cars, ships, hydroelectric equipment and
electric generators. Firms like Bosch have plants in Ukraine making components for cars, and there
are other firms that manufacture electrical cables used in the automotive industry.
A number of carmakers have factories in Russia, including Renault, Stell Antis, Toyota, Kia
and Nissan. Renault has the most exposure. They have three factories there and account for just
under a third of the vehicles sold in Russia. Stellantis is the only auto maker with a base
in Russia that exports a significant volume of vehicles to Europe.
This conflict and the tough sanctions can be expected to worsen the global supply chain
disruptions which we have been seeing over the last year and a half. The interconnected nature
of the global supply chain and just in time manufacturing mean that a lot of important
products used in manufacturing around the world may be in short supply for a while.
Russia and The United States don't have strong economic ties and trade between
the two is fairly minimal. The US has actively reduced its exposure to Russia as it has been
trying to restrict Putin’s influence and aiming to protect its own security interests from Russia.
As of Saturday, the Kremlin had banned airlines from the UK,
Bulgaria, Poland and the Czech Republic from flying over or landing on its territory.
This has presented numerous operational difficulties for UK airlines, which would
typically use Russian airspace when flying into parts of Asia including China and Japan.
Virgin Atlantic had to suspend a route that transported cargo between London and Shanghai,
while British Airways confirmed it would reroute planes to avoid Russian airspace, leading to
longer flight times and higher fuel costs. It can be expected that most if not all
European airlines will be banned from Russian airspace, in fact that is likely to happen before
I get this video even uploaded to YouTube. Airline companies have most likely been making
plans to deal with this issue and will likely need to reroute around Russian airspace if banned.
This is less of an issue right now as there are far fewer flights from Europe to many cities in
Asia at present as many places are still closed to visitors because of coronavirus.
Finnair is an airline that would be more affected by these flight disruptions
as they have built their long-haul business model around routes to Asia flying over Russia.
Azerbaijan’s Air Navigation Services have opened up some additional air traffic routes for
airlines looking to avoid Russian airspace. Obviously, the Russia Ukraine situation is
developing very rapidly and theirs is a good chance this video is out of date by
the time I upload it, but hopefully you find some of the information useful.
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you should watch this one next. Have a great day and talk to you again soon. Bye.