Holy Supply Shocks
Russia is going to make everyone's life way more expensive long term. Here's what nobody is talking about yet.
Good Morning Decentralized Way Subscribers!
To say the last few weeks have been interesting would be an understatement, and I think we’re only getting started with the number of times you’ll hear a news anchor say something along the lines of “unprecedented events” in this decade.
With all of the focus on the conflict in Eastern Europe, it is time for us to talk about how it affects the lives of everyone on the planet, including you. I’ve seen a great deal of analysis regarding short term action and effects - but this article will not be that. This is a look at the medium to long term macro effects of the events that are unfolding today, specifically with regards to energy and food.
Every action has an equal and opposite reaction.
- Sir Isaac Newton's Third Law of Motion
At a very high level, I believe it is time to recognize that we now exist in a world that is fundamentally different from the one of years past. We’ve grown accustomed to increased globalization, free trade, open borders, open markets, and peace.
Now tumultuous markets, large-scale rising tides of violence, and uncontrollable inflation are beginning to reveal the need for a paradigm shift away from centralized powers and centralized production. After all, one is only as strong as their weakest link.
Nobody will touch Russian exports, but it’s not because of sanctions.
50% of all Russian exports leave through the Black Sea. Source.
A staggering 90% of all Russian agricultural exports leave through the Black Sea. Source.
And right now, the Black Sea is closed. Russian attacks on the Ukrainian Black Sea coastline have made all insurance policies for commercial vessels operating in the area null and void, so they simply will not venture into those waters. Source.
So what does this mean?
It means that there are an additional 3-3.5 million barrels per day of Russian crude oil sitting and waiting to be picked up by ships that will not sail in the Black Sea under current conditions. More on why this is so significant in the next section.
These barrels are being offered on the market at a discount of more than $20/barrel less than Brent crude, but still no buyers will venture into the dangerous waters of the Black Sea. Source.
Russia exports your oil.
Prior to invading Ukraine, Russia was exporting ~5 million barrels of crude oil per day, plus an additional ~3 million barrels of refined oil per day in total. Source.
The world currently consumes ~97 million barrels of oil per day, meaning that the lack of Russian oil will leave an ~8% deficit each day. Source.
The world as a whole isn’t going to magically decrease oil consumption levels, so two possibilities exist. One is that oil production from other sources ramps up to fill the gap. The other is that instead, prices rise as demand outpaces supply once again. My bet? Both happen.
As mentioned above, 3-3.5 million barrels of crude oil are accumulating each day in the Russian oil reserves. Russia has the capacity to store ~80 million barrels of oil, making it the 8th largest reserve in the world. Source.
Below is some napkin math and before we dive in, I want to be clear – I’m glossing over a ton of variables. Know that I know that, and I would expect nothing less than a watchful eye from a Decentralized Way Subscriber!
With that in mind, here we go.
If absolutely none of the oil was being used, Russia would only have ~26 days until they reach capacity, assuming their reserves are currently empty (which they’re not).
But of course, some of this Russian oil is being used in their own economy, as well as being shipped out from other ports. Since only the Black Sea is closed and ~50% of Russian exports find their way out of the country there, let’s adjust our napkin math.
Maybe you double the 26 days and call it 52? Maybe you triple it and call it 78? It’s anyone’s guess, but the point is clear - if the Black Sea doesn’t regain the ability to export Russian oil, Russia will have to stop oil production in 2-3 months at most.
That’s a big deal because restarting production is not an overnight process. And since Shell, Exxon, Chevron, and BP have cut ties with their Russian oil over the Ukrainian invasion, it is safe to assume that even after this is over, Russian oil production will not be anywhere near as reliable as it was with American companies running the show. And here’s why.
Russia is ranked 39th out of the 42 countries monitored by OECD (Organization for Economic Cooperation and Development), an organization that tracks productivity through GDP and other metrics. In numbers, Russia produces $24.61 in GDP for every hour worked, which is half of the OECD average of $48.15. Source.
For reference, in the United States, each hour worked adds $73.30 to the GDP. That’s 3 times the productivity of the same hour worked in Russia.
For these reasons alone (ignoring for the moment a myriad of other factors), oil has already increased in price dramatically, and will likely continue to do so.
The results in higher prices at the pumps across the globe, higher prices for heating your home, and higher prices for your food. And speaking of food…
Russia exports your wheat.
Russia is also the world’s largest wheat exporter, accounting for 18.2% of the world’s wheat production last year. If you factor in Ukraine - the world’s 5th largest wheat exporter - the two account for about a quarter of all global wheat exports. That’s 25% of all the wheat production in the world!
Wheat futures prices have already risen by almost 60%, the largest jump since 1959 – a move more extreme than our modern economy has ever seen before. Source.
For those unfamiliar, the wheat planting season starts around the end of March/beginning of April. If the conflict in Ukraine isn’t resolved by then, there may not be any wheat production from Ukraine this year. Recognizing that Russian production/exports will likely be limited, the world is facing a massive wheat supply shock.
Decentralized Way Subscribers know that a massive supply shock results in price hikes and shortages.
According to geopolitical strategist Peter Zeihan, it is likely that global wheat prices in some regions will quadruple (4x!) in price. History is our only guide to what may happen in that case, so let’s look one decade back in time.
The last time wheat prices tripled in a region…
It resulted in the Arab Spring. A massive uprising that started in Tunisia in 2010, sparked by a food vendor setting himself on fire to protest government corruption. The uprising resulted in nearly 61,000 deaths and the overthrow of the governments of Tunisia, Egypt, Yemen, and Libya.
Backing up, here’s how it went down. Beginning in 2006, a rise in global oil prices combined with drought resulted in global grain prices spiking. This resulted in average food prices in Egypt rising by ~19%, and bread prices rising by ~37%. Source.
In the Middle East, a region that has very little arable farmland, nearly 50% of the calories consumed by the average Egyptian originate from outside their borders, according to a study done by the World Bank. Source. This leaves the entire region incredibly susceptible to supply shocks and price increases, and threatens the stability of the entire region when food prices rise.
Every society is only three meals away from chaos.
-Vladimir Lenin
I’ve massively oversimplified the Arab Spring, but for sake of article length, expect rising violence and political unrest across the world as food prices rise.
Russia and Belarus export your fertilizer.
Speaking of food prices, Russia and Belarus combined are the world’s largest producers of potash, otherwise known as potassium fertilizer. Russia is also the world’s largest supply of urea, the most nitrogen dense fertilizer available on the market. Source.
Potash and urea increase yields of crops all over the world, increasing supply and lowering cost.
As long as there’s enough artificial fertilizer to go around, industrialized farming pays very little attention to the damage monocultures do to the fragile and decreasing layers of topsoil required to produce food. More on this another time.
But the situation looks bleak. Last week the Russian Ministry of Industry and Trade called for fertilizer exporters to cease their exports. Source.
Brazil, the world’s largest fertilizer importer, is already having issues getting enough fertilizer for their crops to grow in their decimated topsoil. Source.
And a railway strike in Canada is now threatening the world’s second largest supply of potash. Source.
Where does this take us? A one way ticket to higher food prices for starters. But there’s one more piece of the equation we haven’t touched on yet and that is…
You need natural gas to make fertilizer.
And as luck would have it, Russia is the world’s second largest producer of natural gas!
But don’t take my word for it, hear it from Alexis Maxwell, a Bloomberg Green Markets analyst.
“Replacing their [natural gas, urea, and potash] volumes would take nearly half a decade at the very best, and in some cases prove nearly impossible as Russia is a large source of mineral deposits found in few other global locations.”
If the supply of natural gas from Russia declines, so does the amount of fertilizer. This creates a positive feedback loop, or my favorite term - a snowball rolling downhill - when it comes to food yields decreasing and prices increasing.
Mind you, the EU is the world’s largest importer of natural gas, with over 41% of their supply coming from Russia. Source.
So what happens if Russia were to cut off natural gas supply to Europe? Well, timing is the biggest advantage here. With winter drawing to a close, the EU would likely have enough supplies in reserve to make it through until the fall. At that point, it is possible that leaders could enact some form of rationing if alternative solutions are not implemented.
Is there any good news?
The good news is that the majority of Decentralized Way Subscribers live in the United States. Despite the domestic issues we may have here, we are not surrounded by hostile countries and have a wealth of natural resources to draw upon.
Yes, prices will rise and your supermarket may never be fully stocked again. But allow me to remind you that we are the lucky ones. Many will be caught in the crossfire of political unrest, suffer from famine, freezing, or drought.
Original Decentralized Way Subscribers know that I’ve written extensively about monetary policy and supply, always hinting at the possibility of a recession. Those in Washington have managed to kick the can down the road further than I originally thought, but you can’t print your way out of supply shocks. You simply need more goods.
Once more - This isn’t the stock market, or a bunch of numbers on a screen that can be manipulated by policy. This is food. Resources. Commodities and tangible assets.
Will this be the straw that breaks the camel’s back and finally triggers the next “once in a lifetime” recession? It’s anyone’s guess and for you to decide.
And with that, I’ll see you in the next edition of the Decentralized Way.