Leeds Business Insights Season 1 Episode #6
S1E6: Sanjai Bhagat - The Economic Impact of the War in Ukraine
[00:00:00] Amanda: Welcome to the Leeds Business Insights Podcast, featuring expert analysis to help you stand out from the herd. My name is Amanda Kramer. We are excited to have Leeds professor Sanjai Bhagat here, discussing the energy implications stemming from the conflict in Ukraine.
The conflict in Ukraine has been anything but the brief invasion Vladimir Putin envisioned. As the conflict drags on, there's been a dreadful human toll, but also an economic one, as sanctions reverberate through interconnected global markets and bans on imported Russian oil create surging demand in Europe. What does this mean for businesses, both those domestic and international? Here to help us make sense of it is Leeds professor Sanjai Bhagat, a recognized expert in finance, who has spoken to NPR, CPR, and Fortune Magazine, and others about the rippling economic effects of the conflict in Ukraine. Welcome to Leeds Business Insights, Sanjai. And thank you so much for being here today.
[00:00:55] Sanjai: Thank you, Amanda. Happy to be here.
[00:00:57] Amanda: Set the foundation for us. Tell us a little bit more about the energy landscape as it relates to Russia, Europe, and the United States, from a historical perspective.
[00:01:07] Sanjai: History is always a good place to start. And one of the lessons of history that we should recall is no empire, or no country has ever been militarily strong that did not have a strong economic base. We just haven't ever seen that. However, the converse is not necessarily true. For example, modern-day Japan and Germany are economically very strong countries, but they have made a choice to not be strong militarily. Though, of late, they may be rethinking their choice.
So, let's get to taking a closer look at the Russian economy. So, while Russia has a very strong presence in the space, satellites, and in their military hardware, it is technologically otherwise not a very developed country. For example, Russia does not have companies like Apple and Microsoft that we do. So, their economy is very heavily reliant on their oil and energy exports.
Now, who does Russia export oil and natural gas to? A good fraction of that goes to Germany, a smaller fraction goes to Italy and Tokyo. China is now becoming an increasingly important energy customer for Russia, but it is still a small fraction of what Germany buys from Russia. That's the situation of the Russian economy that most of it is heavily dependent on the international oil prices. So, oil, as an international commodity, is traded in international markets. And there are many standard oil prices. The one that I'll talk about is this Brent crude price, but there are other prices we can talk about. They're all very highly correlated.
So, if you look at the Brent crude oil price, which is the one that's used in Europe, over the last decade, you will see peaks and plateaus in that price. The first peak that you see in the price of the Brent crude oil is around the middle of 2008. Now, when did Russia invade Georgia? Middle of 2008.
Moving forward in time, we see a plateau of the oil prices around 2013, 2014. When did Russia invade Ukraine the first time and occupied Crimea and other Eastern parts of Ukraine? Early 2014.
Going forward in time to this current episode, we again see a spike in the price of the Brent crude oil. And we are seeing the conflict in Ukraine. So, I'm not suggesting that the Brent crude oil price is causing this conflict. What I am saying is that, when the Brent crude oil price is at a relative high, that fills up the Russian treasury's coffers. And that makes Mr. Putin feel economically strong. And then he feels economically strong, then he goes out on his military adventures.
What we see from Mr. Putin's behavior is that his economy is heavily dependent on oil exports and natural gas exports, mostly, that's exported to Germany and Italy. And when these oil prices have reached a relative high, that's when he feels that he has the economic strength to go and engage in a military expansion.
[00:05:44] Amanda: So, what's the role of the US and its European allies in this?
[00:05:48] Sanjai: Let's talk about US first. US, until the recent embargo, was importing oil from Russia—very small amount of what we consume. But that was still providing Russia several hundred million dollars worth of foreign exchange every day.
Now, what's the oil production's situation in the US? Over the last decade, or even longer, if you'll look at the net oil imports, the net oil imports in the US have been declining over the last decade. In fact, by 2019, the net oil imports in the US was negative, meaning that US was a net exporter of oil in 2019. So, while in the US, we consume a lot of oil, we produce also a lot of oil. In fact, we are one of the world's largest oil producers, such that, in 2019, we were a net exporter of oil.
So, the US oil companies, the small-size company, the mid-size, the big oil company, they have shown that they have the ability to generate, to produce enough oil domestically within the US, such that we do not have to go and buy oil from anywhere else. However, under the current Biden administration, there have been lots of disincentives for oil companies to explore and produce the oil. And that was one of the reasons why we were importing even the small amount of oil.
Now, we can, in the US, if we gave the correct oil exploration and manufacturing incentives to our oil companies, they can produce more than enough oil for all our oil needs at the current prices, and we will have excess oil and natural gas that we can supply to our European allies, especially, Germany and Italy. So, if Germany can buy their oil and natural gas from the US, they will not have to buy from Russia. The Russian treasury coffers are not going to be very full when oil prices go up.
And that is an important point here because, as the Europeans are realizing, energy is not just about energy and the manufacturing part of the economy, energy is also about national security. While it may be very hard to show conclusively, most commentators think that one of the reasons Mr. Putin thought that he could invade Ukraine and not meet a lot of oppositions from the Western European countries, like Germany and Italy, because he thought that those countries were very much dependent on Russia for their oil and natural gas, and that would be a reason they would not want to intervene in any significant way. Now, of course, his calculation was wrong on that front. But that's what he was thinking about.
[00:09:32] Amanda: I'm wondering if you would be able to address what the cost implications would be to providing incentives to our US oil companies and, potentially, other implications of these policies. Because I think that's something that's on a lot of people's minds.
[00:09:47] Sanjai: Why are our oil companies not immediately starting major exploration projects and major manufacturing projects immediately? So, what the oil companies are looking at are expected prices when their oil wells would be ready and when the oil comes out from the ground. And that takes anywhere from 18 months to three years to do the exploration, build all the oil wells, and get the oil out. So, the oil companies are looking at prices and regulations, not today, but the oil prices and the regulations that are likely to exist one year from now, two years from now, three years from now, five years from now.
So, it is the expectation of the oil price in a year from now, two years from now, three years from now. It is the expectation of what the regulators if they're going to impose additional regulations down the road once this Ukraine conflict subsides or if the regulators will allow for more oil exploration. That is what the oil companies have to take into their calculus when they decide whether or not, and how aggressively, they should go out and explore for oil and get it out, eventually.
So, if the international oil producer in the Middle East and elsewhere, if they think that the oil prices are going to go down in year two and three, compared to what the oil prices are now, they're going to say, "Well, let's bring our oil up now and sell the oil today at these higher prices." But as they bring their oil up and try to sell them at a higher price, the price of oil starts to go down. But as all of those oil companies start to bring up the oil, the price—there's more oil in the world market. As you have more oil, more supply, the price of oil goes down.
So, the regulatory impact that's in the US can impact oil prices today. If the oil companies in the US and the oil companies abroad are convinced that the regulators are not going to ramp up their regulations in the years to come, the EPA regulators and other energy industry regulators, they can actually impact the oil prices today by simply declaring in a credible manner that they are not going to ramp up the regulation. In fact, they're going to start ramping down the regulations. And that's going to lower the price today, even though it'd be several years from now before those oil starts coming out from the ground.
So, that's something that I think is not widely appreciated or even understood, but that's the way that the markets work.
[00:12:59] Amanda: I'm thinking about some of our audience members will be business owners of various sorts who may be wondering how this conflict in Ukraine may impact them. What is the impact on local business owners and people who may not be in the oil and gas industries?
[00:13:16] Sanjai: Oil and energy impacts all industries. So, higher gas prices will be felt by the companies through their employees being more concerned about driving to work. The energy cost will also go up, and almost all businesses use energy. If they have a manufacturing base, they use it, maybe, more intensively. If not, it's just whatever their office energy needs are. The petroleum is a basic ingredient that's used in a lot of things—all the way from the nice ski jackets that we wear. Even some of our ski components are made from petroleum. So, in a way, it impacts the entire economy.
And the price of oil and gas going up is going to have positive impact on inflation, meaning it will ramp up the inflation already from the level we are seeing to, maybe, even a higher level. So, as inflation goes up, it's going to have—in general, when inflation spikes up, that slows down the investment activities of most companies. So, it will have negative impact on our entire economy, both in Colorado and not.
[00:14:57] Amanda: What do you see regarding the contribution of various sources of energy in the US? And what does that mean with regard to our energy needs and concerns about the environment?
[00:15:07] Sanjai: That's a very important question and issue with regard to the current, I guess, discussion about oil, energy, and national security. So, the obvious facts are if we produce more oil and natural gas and use more oil and natural gas for generating electricity or for conducting our traveling and manufacturing activities, there's going to be more carbon emission in the US.
Now, let's see where we are as a country with regards to the sources of electric power. So, 40% of our electricity is produced by burning natural gas, 20% comes from nuclear energy, and the other 20 comes from coal. So, that's 80% of all energy sources. The another 10% comes from wind and solar—the renewables. And of this 10%, most of it is wind. Solar is a very small fraction of it. So, wind is 4/5, solar is 1/5 of that 10% of the energy of the electricity source. And then, of course, we have other sources, the remaining amount, hydroelectric and so forth.
Now, after 50-plus years of, what I'd say, very serious and intense research on solar energy, on how to generate solar energy and wind energy, solar and wind in the US provide us with only 10% of all electricity needs. The major part of energy still will have to come from some combination of natural gas, nuclear, and coal.
So, we have a choice here to make—either we can decide to focus more on cutting back on carbon-intensive electricity sources, that we'll be cutting back on natural gas and coal. But then that would have to be offset by nuclear because simply, even the best scenario going out for the next 30, 40, 50 years does not suggest that wind and solar can provide us with the majority of our energies. And then, of course, we have to be concerned about that.
Now, one of the issues when we talk about the environment, which is a very important issue in this entire debate, we have to think a little bit more in the macro sense or in the international sense. So, climate is global, by definition. So, if we are looking at the carbon emissions by US companies—again, there's lots of data on this. So, the US Energy Information Agency has extensive amount of data. So, if you go and look there, what you'll find is, during the last two decades, the overall carbon emission by US companies has decreased. So, again, in the last two decades, the overall emission for US companies has gone down.
Now, can the US companies do better? Should they do better? Of course, they can do better. Of course, they should do better. And we should continue to encourage technologies that cut down on carbon emissions. That's all very good. But in the same last two decades, the carbon emissions of the large Asian countries, primarily China and to a fair degree, India, their carbon emission has more than tripled. And right now, their carbon emission is more than twice that of US. Now, they're not emitting carbon for the sake of emitting carbon. They're doing that mostly to generate electricity for use by their industry. But that's the key is, if we are concerned about the global climate, as we all should be, people have to talk about the gorilla in the room, which is the large Asian countries and their amount of carbon emission today and the rate in which their carbon emission is increasing. You really are not doing much for the global climate until you are willing to address the more difficult conversation that very few environmental activists, either in the US or Western Europe, are willing to have.
[00:20:44] Amanda: Every episode, we have an LB idea or key takeaway. And the takeaway here is that oil and gas impacts every business and person in some capacity and that we are going to need to expect higher gas prices, higher energy costs, and inflation for the foreseeable future, especially as we wait for companies—both nationally and abroad—to work through the implications of various manufacturing and regulation changes related to the oil and gas industry.
Thank you so much for being here with us today.
[00:21:17] Sanjai: Thank you for having me.
[00:21:19] Amanda: Thank you, again, for listening to Leeds Business Insights, and a special thank you to my guest, Sanjai Bhagat. Don't miss a single episode. Subscribe to Leeds Business Insights wherever you get your podcasts. You can also find more information about our podcast series at Leeds.ly/LBIpodcast. We'll see you next time.
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