Ban on Russian oil set to deliver devastating blow to UK economy

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As tankers carrying Russian oil, liquefied natural gas and diesel are turned away from British ports, the implications of the UK’s ban on Russian energy is only now starting to sink in.

While the impact of the Ukraine war and sanctions on Russia have already reverberated around the globe, driving commodity prices ever higher, the UK’s move to phase out Russian crude imports by the end of the year has stoked further concerns of stagflation — inflation accompanied by slower economic growth.

The British public now faces a cost-of-living crisis on an unprecedented scale, with Conservative MP Robert Jenrick saying that the UK is on track for “the most difficult year that we’ve seen in our lifetime” with an energy crisis unrivalled since the 1970s.

The government must “level with the public that standing up to Putin could cause the most difficult year for household incomes”, Mr Jenrick said.

Inflation is now expected to peak at 10 per cent, he said, amid increasing pressure on energy bills for consumers and energy-intensive industries and businesses alike.

“Household incomes could fall by a larger percentage this year than any time since records began in 1955,” Mr Jenrick said.

While the implications for household finances is monumental, there will also be a fallout for Britain’s push to hit net zero by 2050 as an energy balance is sought between the shift to renewable energy and ensuring homes and businesses can still heat their homes.

With the US also banning Russian oil and major energy firms such as Shell and BP halting new purchases, there are already growing signs of stress in the energy market. The price of oil could soar to $240 a barrel if more western nations roll out sanctions against Russian crude.

Fawad Razaqzada, market analyst at Think Markets, said the UK must now face the consequences of its decision: high gas prices coupled with even more inflation and retaliation from Russia.

How bad will the UK economic hit be from the Russian oil ban?

As well as stagflation, a world recession is back on the table, with S&P Global Ratings expecting global growth to decline by 70 basis points to 3.4 per cent this year, with the impact of lower Russian growth the largest contributor.

“Europe is the region hit hardest by the conflict. Eurozone growth falls by 1.2 per cent this year, driven by its exposure to Russia and much more expensive energy imports and 2023-2024 growth is largely unchanged,” S&P Global Ratings said.

In the UK, the National Institute of Economic and Social Research expects the Ukraine war to reduce gross domestic product growth by about 0.8 per cent to 4 per cent in 2022 and to 0.5 per cent in 2023.

However, that estimate was made on March 7, before the ban on Russian imports was announced, with other analysts expecting the fallout to be even greater.

“Traders fear that current decisions taken by the US and its allies are likely to accelerate the economic slowdown trends as the current sanctions are mainly about disrupting supply chains,” said Naeem Aslam, chief market analyst at Avatrade, as sanctions also drive up energy and food prices, further flattening the yield curve.

“The global economic recovery before the invasion of Ukraine was losing its momentum as inflation was picking up speed and interest rates were set to rise.”

While the two previous recessions during the financial crisis of 2008-09 and the Covid-19 pandemic in 2020-21 mainly created shocks on the demand side, those shocks were resolved by lowering interest rates, purchasing bonds and cutting taxes, said Mr Aslam.

The Ukraine invasion is a very different landscape as the subsequent sanctions are supply-side shocks that have reduced global production capacity and cannot be offset in the same way.

What's next for UK inflation?

Inflation jitters are now commonplace following the US and UK oil bans, said Howie Lee, an economist at Oversea-Chinese Banking Corporation.

“We all saw that coming, but still, it feels like a roller-coaster drop moment. With this ban, oil is easily expected to trade at new records,” he said.

Inflation was already high before Russia’s invasion of Ukraine, hitting 5.5 per cent in January with expectations from the Bank of England it would escalate past 7.25 per cent in April, when energy bills will rise by up to 54 per cent and the government pushes ahead with a rise in National Insurance contributions.

The widely held expectation now is that inflation could hit double digits as a result of the ban on Russian oil, increasing to 10 per cent in October, Bloomberg Economics reported.

UK think tank the Resolution Foundation has a more modest inflation expectation of 8 per cent but that was made before the ban on Russian oil imports came into force.

How high will energy bills go?

An unprecedented surge in the wholesale cost of power and natural gas will mean an extra £38 billion ($49.8bn) for UK consumer bills at the next adjustment in October, assuming a 35 per cent increase in the price cap for 22 million homes, calculations from Aurora Energy Research show.

It is a huge extra burden for households to bear, equivalent to adding 7 pence per pound on to income tax, Dan Monzani, a managing director of Aurora and former government adviser, told a committee of politicians.

“It strikes me as essential that we try to spread that cost over time and that requires the exchequer to intervene in the short run, but be clear how it will get that money back in the longer term,” Mr Monzani said.

The price cap is already set to jump 54 per cent in April to £1,971, with a further increase in October widely expected.

It could be even more acute because of rising wholesale costs driven by fears about disruptions to the gas supply from Russia. One estimate from Investec Bank pegged the level at £3,000 — a figure that would leave 8.5 million British households unable to pay their bills, charities reported.

The price of UK gas touched a record 800 pence a therm on Monday, 20 times higher than the price this time last year. The cap is calculated based on prices over a six-month period, but these look likely to stay elevated with a rush to fill European gas storage before next winter starts in October.

What about petrol — can Britons afford to fill their tanks?

While oil was hovering around the $130 mark on Wednesday, prices could escalate as high as $240 analysts warn, making running a car extremely expensive.

The average price of diesel in the UK hit 165.2 pence a litre on Wednesday, up 30 pence on the previous day, while petrol hit 158.2p — with more rises expected.

Simon Williams at the RAC said with wholesale fuel prices rising this week, more pump price increases in the coming days are “inevitable”.

Petrol is now on track to top 160p a litre on average this week, he added, with diesel heading towards the 170p mark.

Queues are forming at cheaper forecourts as consumers try to beat the daily price increases, as some petrol stations are already charging 219 pence per litre for diesel and close to 200p for unleaded.

How bad will the UK’s cost-of-living catastrophe really be?

The cost-of-living crunch was already very real for many Britons who were preparing themselves for rising inflation, higher energy prices and higher taxation from April 1.

Now consumers are under even more pressure as Europe and the UK seek to reduce dependence on Russian oil and gas and as trade in wheat, corn and sunflower-based products from the region is disrupted.

“Putin’s murderous attack on Ukraine changes matters for everyone that has an involvement in energy and food,” Clive Black, an analyst at Shore Capital, said. “If Putin is not to succeed and if the West is to play a part in that, then consumers in the UK and further afield should expect to pay a price.”

Mr Black adjusted his expectations for UK food inflation last week, forecasting a peak of about 5 per cent in May from previous forecasts of 3.5 per cent to 4.5 per cent in April.

Chicken producer 2 Sisters Food Group said on Wednesday that the UK was facing a major threat to food security as a result of the war in Ukraine. The company — the biggest producer of chickens in the UK — said food prices could rise by 10 per cent to 15 per cent in 2022 — the highest in 50 years — if the conflict is not resolved soon.

It is no wonder then that British consumers are more pessimistic about their financial prospects than at any time in at least a decade.

A reading of how households expect their financial situation to change over the coming year plunged by 19.3 percentage points in February to the lowest level since the index began in late 2012, a report from YouGov and the Centre for Economics and Business Research showed.

“Against a backdrop of accelerating inflation and the coming increase in the energy price cap, households are understandably nervous about the outlook for their personal finances,” said Kay Neufeld, head of forecasting and thought leadership at CEBR.

Will interest rates go up, too?

Money markets are betting on more than 100 basis points of Bank of England increases by June — two 25-basis-point increases and one 50-basis-point increase spread out over the next three meetings — to offset the effects of higher inflation.

BoE policymakers Michael Saunders and Catherine Mann, who both voted last time for a 50-basis-point move, have previously stressed the importance of an initial quick pace of increases to tame inflation and ultimately limit the extent of rate rises in the future.

“The Bank of England will likely keep hiking into a sharply slowing economy amid inflation expectations already running at uncomfortably high levels,” Bank of America strategists said.

However, if energy prices remain at current levels, the National Institute of Economic and Social Research said the UK would face a recession in the second half of this year, putting a limit on how aggressive BoE policy could be.

“I find it questionable that the BoE would choose to add an interest shock to an energy shock for the economy,” said Antoine Bouvet, a rates strategist at ING Bank. “If the UK is heading into a recession because of higher energy prices, medium-term inflation expectations should be lower, not higher.”

Will the energy crisis derail Britain's race to net zero?

If more western nations roll out sanctions, this could lead to a hole in the market of 4.3 million barrels a day that cannot be replaced by other sources of supply, Rystad Energy said.

“If 4.3 million bpd of Russian oil exports to the West are halted by April 2022, and where China and India only keep current import levels intact, Brent would need to spike to $240 per barrel by the summer of 2022 to destroy demand,” said Bjornar Tonhauge, head of oil markets at Rystad Energy

“This collapse would be the largest potential oil supply shortage since the 1990 Gulf War, when oil prices doubled.”

However, a shift to renewables to offset supply challenges is not something that can happen overnight.

“There are big questions about how the world deals with both the current crisis and the longer-term shifts in supply and demand,” said AJ Bell financial analyst Danni Hewson.

“Will it stimulate new exploration for those much prized and incredibly lucrative oil and gas supplies or will it speed up the transition to cleaner, greener fuel sources?”

While Britain has committed to reaching a net-zero goal for carbon emissions by 2050, those plans have come under pressure during the crisis in Ukraine, with the government already saying it would step up domestic production of oil and gas on Wednesday to offset the phase-out of imports of Russian oil.

Some MPs are reportedly urging Prime Minister Boris Johnson's Conservative Party to re-examine the UK’s net-zero pledge, in light of higher energy and petrol bills and potential supply challenges.

Ministers may be forced to consider ramping up North Sea output, extending the lifetime of nuclear plants and even burning more coal to ensure households can continue to be heated and the country does not have to resort to energy rationing.

Even fracking is being reconsidered as part of plans to boost the UK’s energy security, No 10 says.

This week, Mr Johnson said the UK would examine the possibility of using more of its own hydrocarbons.

“That doesn’t mean we are abandoning our commitment to reducing CO2 … We have to reflect the reality that there is a crunch on at the moment. We need to intensify our self-reliance as a transition with more hydrocarbons,” he said.

Climate change protest group Extinction Rebellion said on Wednesday it intends to block major British oil refineries next month as part of its campaign to force the government to end reliance on fossil fuels.

Tim Crosland of Plan B said the Ukraine conflict and the climate crisis have the same underlying cause: “the imperialist pursuit of land and resources for profit, concentrating power in the hands of toxic individuals and corporations".

“By decarbonising our economies we can take power back from warmongers and change course, averting climate breakdown and collapse,” Mr Crossland said.

“But it must happen now, before governments use the conflict as an excuse to get off Russian oil and gas, only to begin drilling closer to home.”

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