What Would a Russian Invasion Mean for Energy Markets?

The growing threat of Russia invading Ukraine has rattled global commodity markets—and underscored how the continued crisis could prolong Europe’s energy woes as the West rolls out punishing new sanctions on Moscow.

The Kremlin’s recent decision to deploy forces to Donetsk and Luhansk, two breakaway regions in eastern Ukraine, has jolted markets and hiked up commodity prices. Just this week, crude oil prices climbed to their highest levels since 2014, approaching nearly $100 per barrel, while coal and energy prices also spiraled.

“The threat of [military action] has really sent a lot of shockwaves in the energy markets,” said Eugene Chausovsky, a nonresident fellow at the Newlines Institute.

The Biden administration’s announcement on Wednesday that it was imposing sanctions on Nord Stream 2, a controversial Russian gas pipeline project in Europe that would have directly transported 55 billion cubic meters of gas between Germany and Russia every year, has further strained energy markets on the continent. More economic retaliation is likely if the crisis becomes more acute, as the Wall Street Journal and other outlets report, saying Ukraine received intelligence that a Russian offensive could begin in the coming days.

Russia is the second-largest producer of gas and third-largest oil producer in the world. It is also one of the world’s top exporters of coal and wheat and a leading producer of other important resources, such as palladium and ammonium nitrate.  

New Western sanctions aimed at buckling Russia’s economy could significantly curb those exports to most countries abroad—or convince Moscow to halt exports on its own, depending on the severity of the sanctions and the Kremlin’s response. 

Some experts believe the commodity markets have not taken into account the crisis’s severity. In other words, prices aren’t as high as they probably should be given the immediate risk of war. 

“I do not think that the market is pricing in right now, in any way, a full invasion scenario that results in weeks of really serious … financial sanctions that could, in turn, lead Russia [to] withholding supplies,” said Helima Croft, global head of commodity strategy at RBC Capital Markets, an investment bank. 

Moscow “could make the decision to try to change calculations in the West, use commodities as a form of hybrid warfare by essentially curtailing exports, making sure Ukraine cannot export, and then you have a big inflationary spiral coming,” she added. 

Europe is deeply reliant on natural gas from its eastern neighbor, with Russia accounting for nearly 40 percent of its supply. U.S. and Eastern European leaders have repeatedly warned that the Kremlin won’t be afraid to wield its gas supplies as a geopolitical cudgel if it decides to launch its own counteroffensives in the spiraling economic warfare. In the past, Russia has weaponized its supply to Ukraine over pricing feuds by cutting it off from exports.

“Europeans are worried that military action in Ukraine could impact supply flows,” Chausovsky said. “We’re at a stage where that could happen at any moment.” 

U.S. President Joe Biden had previously held off on expanding Nord Stream 2 sanctions despite immense pressure from Congress, but on Wednesday, he announced new sanctions on the company managing the project, Nord Stream AG, and its corporate officers, including CEO Matthias Warnig. Although the company is registered in Switzerland, it is a wholly owned subsidiary of Russian state gas giant Gazprom. Warnig, a German citizen, is a former agent of the East German secret police who maintains close ties with the Kremlin. 

“We will not hesitate to take further steps if Russia continues to escalate,” Biden said after confirming the new sanctions. “Through his actions, President Putin has provided the world with an overwhelming incentive to move away from Russian gas and to other forms of energy.”

Biden’s decision comes a day after German Chancellor Olaf Scholz announced he would freeze the pipeline’s certification. Halting the pipeline’s certification was “a hit to Russia, financially speaking,” Chausovsky said. “They had invested a lot of money into this.”

Biden’s sanctions announcement added salt to the wound, since the company and officers are now blocked from U.S. trade and financial institutions.

Since the pipeline was still awaiting certification and wasn’t operational, experts said the decision wouldn’t impact Europe’s existing gas supply—but would likely spook nervous traders and investors in an already volatile market. 

But Russia immediately hit back after Berlin announced it wouldn’t certify the pipeline by previewing more market shocks to come. “German Chancellor Olaf Scholz has issued an order to halt the process of certifying the Nord Stream 2 gas pipeline. Well. Welcome to the brave new world where Europeans are very soon going to pay €2.000 for 1.000 cubic meters of natural gas!” Dmitry Medvedev, deputy chairman of Russia’s Security Council, tweeted on Tuesday. 

On the oil side, Europe energy companies are heavily enmeshed in the Russian market, with companies such as BP, Royal Dutch Shell, and TotalEnergies involved in multibillion-dollar oil exploration and production projects. “Second- and third-order sanctions could make it really complicated for international oil companies to operate in Russia,” Croft said.

Additionally, some of the major Russian banks on the target list for Western sanctions—such as Sberbank, VTB Bank, and Gazprombank—are heavily invested in the energy sector. 

In recent months, Biden administration officials explored plans to allay supply shocks to Europe, including options to ship U.S. liquefied natural gas (LNG) to Europe and push Qatar, a top gas exporter, to divert more supplies to Europe. But experts said those efforts couldn’t make up the difference of Russian imports if Moscow decides to turn off the tap to Europe. Even then, most of Qatar’s gas exports are already spoken for. 

On Tuesday, the Qatari government said it would be “almost impossible” for any country to fully substitute Russian gas to Europe, with most LNG already tied down in existing contracts. According to Saad al-Kaabi, the Qatari energy minister, only 10 to 15 percent of the Qatari supply could feasibly be diverted to Europe. 

As long as this dependence on Russian gas continues and the conflict escalates, experts warn Europe will bear the brunt of the supply crunch, even as it affects commodities globally.

“The Europeans have more to lose than we do from either sanctions on the energy sector or Russia’s retaliation to sanctions,” said Samantha Gross, director of the Energy Security and Climate Initiative at the Brookings Institution. “Over the shorter term, it’s really painful for Europe.”