Economic Slump Is ‘Unavoidable’ Without Russian Oil, Dallas Fed Study Says

The global economy is likely to sink into a recession if Russian energy exports are kept off the global market for the remainder of this year, according to a study by Federal Reserve Bank of Dallas economists.

“If the bulk of Russian energy exports is off the market for the remainder of 2022, a global economic downturn seems unavoidable,” economists Lutz Kilian and Michael Plante wrote in an article posted by the Dallas Fed Tuesday.

Russian exports account for about eight percent of global petroleum production. Even though oil was initially exempt from U.S. and allied sanctions, Russian oil was largely kept off global markets and out of the hands of refiners because financial institutions refused to finance purchases from Russia, shipping rates skyrocketed, and many private sector buyers decided to boycott. The result has been an unanticipated supply shock.

There does not appear to be an easy way to compensate for the shortfall, according to Kilian and Plante. Pipelines between China and Russia do not have excess capacity to allow China to shift its purchases from pricier oil from elsewhere to heavily discounted Russian oil. Likewise, there’s no realistic way for China to acquire oil tankers to ship petroleum by sea. The Saudis and the United Arab Emirates have said they will not rapidly increase production.

U.S. shale producers are unlikely to fill the oil gap because of investor demand for capital discipline and the anti-fossil fuel plans of Democrats. On Monday, for example, the Democrat-dominated Securities and Exchange Commission announced new climate change disclosure rules intended to discourage investment in fossil fuel production and incentivize companies to move away from carbon-emitting sources of energy. Two recent Biden picks for key bank regulatory posts have been advocates for the use of financial regulatory powers to push companies away from fossil fuels. Those nominations had to be withdrawn when Democratic Senators announced their opposition but the anti-fossil fuel message was loud and clear.

The Biden administration’s efforts to hold down the price of oil by tapping the Strategic Petroleum Reserve have largely failed. Larger releases would risk depleting the reserve quickly.

“Thus, unless the Russian petroleum supply shortfall can be contained, it appears necessary for the price of oil to increase substantially and to remain elevated for a long period to eliminate the excess demand for oil,” Killian and Plante wrote.

Demand destruction would hold down prices but at the cost of a broader economic slump.

The paper concludes:

There are three main implications for the global economy. First, Russia’s invasion of Ukraine will have far-reaching implications for the energy transition to renewables. The scale of the energy supply disruption is large enough to require European countries to pause their plans to move away from fossil fuels in the interest of preserving economic activity. Likewise, efforts to restrain oil and gas production in countries such as the U.S. may have to be reconsidered in response to persistent global shortages.

Second, the surge in global fuel, electricity, residential natural gas and food prices, as well as the supply-chain disruptions caused directly by the invasion of Ukraine and indirectly by the sanctions against Russia, will sustain inflationary pressures in 2022.

Third, if the bulk of Russian energy exports is off the market for the remainder of 2022, a global economic downturn seems unavoidable. This slowdown could be more protracted than that in 1991.

The 1991 global recession was triggered by Iraq’s invasion of Kuwait and the an oil-supply shock that followed. That recession lasted only about a year, thanks in part because the Saudis were willing to increase oil production.