Ukraine counter-attack shows permanent shift in commodity flows

Ukraine's military has launched its long-awaited counter-attack to evict Russia, the world's second-largest oil exporter, from its territory, with battles raging in the Donbas area this June potentially deciding the fate of the conflict which began when Moscow's forces invaded last February.

Oil and gas prices have shrugged off any concerns over the inherent geopolitical risks of war, suggesting commodity flows have made a permanent readjustment. Dated Brent assessed by Platts -- part of S&P Global Commodity Insights – peaked at $137.64/b Feb. 23, 2022, as Russian tanks were poised to attack Kyiv. The measure has fallen 47% in value over the last year of fighting. European gas prices paint a similar picture. The benchmark Dutch TTF month-ahead gas price peaked at Eur319.98/MWh in August last year. It is now trading well below that level, and was assessed at Eur30.575/MWh on June 12.

The subdued performance of key commodity benchmarks is partly due to a dramatic shift in trade flows caused by the war and subsequent sanctions on Russia. Before the invasion, Russian gas accounted for around 45% of EU imports, but this has since fallen to less than 10%. Regarding oil, more than 90% of Russia's seaborne crude reports are now headed to Asia, including Turkey, up from pre-war levels of 34%, according to S&P Global Commodities at Sea data. Prior to the conflict, Russian oil accounted for 24%-31% of total EU imports, but has plunged since.

Squeezed by sanctions these flows have now dwindled, with Russia selling more of its key export commodities to Asia, where buyers have taken advantage of discounts created by the price cap on Russian oil imposed by the G7. Russia has now overtaken Saudi Arabia as China's biggest supplier of crude and has grown its market share in India exponentially as a result of the conflict.

"The EU crude import ban dramatically reduced Russian pipeline flows to Europe," said Paul Sheldon, chief geopolitical advisor for S&P Global Commodity Insights. Even if the war ends suddenly this summer in defeat for the Kremlin, or in a bitter stalemate, commodity flows from Russia to traditional markets in Europe could be slow to return.

Oil diplomacy

In response to sanctions and Ukraine's fight back, which has been supported by massive shipments of weapons from the US, UK and European nations, Russia has used its partnership with OPEC as an effective counter. Despite concerns from the administration of US President Jo Biden that OPEC has aligned itself with Russia through its oil supply policy-making, OPEC continues to view the Kremlin as an important partner in the OPEC+ alliance of crude-producing countries.

Saudi Arabia and Russia have dismissed the suggestion of any friction over oil policy despite the negative impact the conflict in Ukraine is now having on global oil markets. Russia's lead OPEC+ negotiator, Deputy Prime Minister Alexander Novak, said June 4 that the OPEC+ agreement had operated for several years and was mutually beneficial. Russian seaborne crude exports were at a post-war high in May, according to tanker tracking data, while the latest Platts survey of production showed that Russia had failed to fully implement the 500,000 b/d of cuts it agreed to as part of a combined 2 million b/d output reduction agreed by OPEC+ last year.

Power infrastructure

A more immediate threat to commodities from the intensifying conflict is to physical infrastructure, especially electricity networks and agriculture, with operations at power projects in the conflict zone and export infrastructure in the Black Sea still at risk.

Analysts expect the Ukrainian military to cut off supply lines and attempt to take back control of Crimea, with some fearing attacks on production and supply projects could spark renewed price volatility. Ukraine is also expected to continue targeting Russian supply lines, including oil products storage and supply infrastructure as it looks to regain territory in the Donbas and advance towards Crimea.

"If they can cut off oil, diesel and jet fuel supply lines, they will stop the Russian war machine advancing and functioning," military analyst Jens Wenzel Kristoffersen said.

There has already been an uptick in attacks on oil infrastructure in Southern Russia, targeting the Afipsky and Ilsky refineries, as well as oil loading terminals and depots.

The recent escalation in the conflict has also resulted in major damage to other facilities. An attack on the Kakhovka hydroelectric power plant June 6 threatens water supplies for cooling to the Zaporizhzhia nuclear power plant and Kryviy Rih steelworks, as well as for irrigation to key agricultural regions. Separately June 7 a pipeline used to transport ammonia fertilizer from Russia via Ukraine was damaged.

During the initial phase of the invasion in spring 2022 infrastructure including oil refineries and storage was damaged, as Russia made gains. There were also disruptions to metals and power production, as well as some suspensions of crop sowing and shipping due to mines. As the front line stabilized, some of these operations resumed.

In fall 2022 there was another wave of damage to commodities infrastructure. The Nord Stream gas pipeline network was attacked in September, while Russia also launched a wave of attacks on civilian infrastructure across Ukraine, with the UN estimating that Russia destroyed 50% of Ukrainian energy infrastructure.

New sanctions

In addition to the supply impact of attacks, the escalation in the conflict threatens new sanctions on Russia, as well as a breakdown in the Black Sea Grain Initiative. The deal was brokered by the United Nations and Turkey in July last year to allow exports from Ukraine and was most recently extended for 60 days on May 18, but Russia has already pulled out of the agreement once in response to strikes on Crimea, with officials from the country saying they may pull out again in response to attacks.

Western officials have also indicated that there may be changes to sanctions affecting oil supplies. The G7 introduced price caps, and the EU banned imports of most Russian crude and oil products supplies from Dec. 5, 2022, and Feb. 5, 2023, respectively. Options to ramp up sanctions include lowering the level of price caps on crude and products, as well as bringing forward the phase-out timetable for remaining oil supply volumes into Europe. They could also look to sanction commodities that have so far avoided blanket embargoes, including natural gas and LNG. In recent weeks Western officials have indicated that they could also clamp down on sanctions circumvention. In mid-May G7 leaders said they remained committed to upholding price caps and will enhance efforts to counter their evasion.