The impact of the conflict between Russia and Ukraine on commodity markets: electricity prices rise and supply is limited

Wood Mackenzie, an international market research firm, said in a new report that trade chaos, high electricity prices and disruptions of production facilities in conflict areas were the three major threats to the metals and mining industries caused by the escalating conflict between Russia and Ukraine.

First of all, sanctions. The most likely result of a strict EU sanctions regime is that affected goods from Russia are redirected. The shift in trade may lead to a pick-up in European demand. But this change can be chaotic. Suppliers hesitate when there is no guarantee that sanctions will last. The price premium resulting from this shift is usually much larger than a simple analysis of changes in supply and demand.

Woodmac's analysis of the supply share of Russia's global metals and mining market shows that commodities are the most at risk. Russia supplies multiple commodity markets and accounts for 5 per cent or less of the production or trade of base metals and rare earths compared with more than 15 per cent of global seaborne metallurgical coal and thermal coal trade.

There is no substitute for coal supply to Europe.

But it is worth noting that Russia supplies almost all low-sulphur PCI (coal injection) and 60 per cent of high-energy thermal coal to Europe. According to Woodmac, assuming a total ban on Russian coal imports by the EU, although this is unlikely, there would be a huge gap in EU coal supply.

Given the current limitations of these markets, it will be difficult for thermal coal suppliers in the United States and Colombia to fill this gap, and US coal may also cause problems with sodium, chlorine and sulfur content.

At the same time, it is almost impossible to replace low-sulfur PCI in the short term. Spot PCI supplies to Australia, the only other major supplier of PCI coal, have almost completely dried up since mid-2021.

There is a good chance that energy prices will continue to rise.

Russian supplies are not insignificant for base metals, but sanctions could lead to regional rather than global price changes. Woodmac expects that in most cases, China will be able to receive some of the material redirected from Europe. For example, 75 per cent of Russia's 300000-400000 tonnes of lead concentrate is shipped to China each year and most of the rest to Kazakhstan.

The analysis pointed out that another major threat caused by the escalation of the conflict is the possibility of rising electricity and energy prices, especially affecting the supply of energy-intensive products. The relationship between natural gas and electricity prices has emerged in the EU market, and any further increase in natural gas prices will push up electricity prices.

"Natural gas supply and its impact on other energy markets are mainly concerns about the impact of the conflict. All industrial activity in Europe will be affected by rising electricity prices. For metals and mineral commodity markets, energy-intensive smelting is the most risky, particularly aluminium and zinc, although all base metal production and steel are under pressure. "

Affected in the base metal area

According to Woodmac, electricity accounts for an average of nearly 35 per cent of aluminium manufacturing costs, which is higher in some European smelters. Rising electricity prices across Europe have led to a sharp reduction in aluminium production. If energy prices rise further, the additional 400000 tons of annual capacity will be at risk of being shut down.

Europe accounts for 15 per cent of aluminium supply outside China in 2021, so a reduction in supply could have a significant impact on the price of refined metals.

Zinc smelting is also vulnerable to rising energy prices. Europe produces 2.2 million tons of refined zinc annually, accounting for 16% of the global refined zinc production.

There are also direct risks to production facilities in Ukraine's potential conflict zones, particularly in border areas. Ukrainian steel production accounts for only a small portion of global supply, and it is difficult to see a long-term impact on global steel prices. But the export of semi-finished steel does have a certain amount in the world. If Ukraine's 4 million tonnes of annual exports to Europe are affected, steel prices in the market will inevitably face further upward pressure.

Logistics is limited and supply is chaotic.

At present, Ukrainian coal exports have almost disappeared. However, they still import 1000-13 million tonnes of metallurgical coal a year, of which Russia and the US typically account for 65 per cent and 25 per cent, respectively. Imports of thermal coal remained between 300 and 4 million tons, mainly from Russia, the United States and Kazakhstan.

From a market perspective, coal could be affected as US, Polish or Australian suppliers attract extra demand from Ukrainian steelmakers. But this assumes that coal can be sent to steel mills in logistics.

At present, transportation to the Black Sea port has been interrupted, and there is no guarantee that imported coal can further enter the interior of eastern Ukraine. For other basic metals and mined commodities, Ukraine's production facilities are usually small.

The ultimate impact on the market will depend on the geographical scope of the conflict and the scope of retaliatory sanctions. Woodmac predicts that strict enforcement of the trade ban will eventually lead to the diversion of Russian products to other markets.

"but as we have seen in other market interventions, rebalancing can be chaotic and often have a price impact that exceeds the additional cost of obtaining alternative supply," Woodmac said. "there is no doubt that any conflict will exacerbate the increasingly inefficient supply of goods because of resource nationalism, trade disputes and pandemics, which has been a feature of the market in recent years."