Will Russia sanctions batter rest of world? A lot will depend on oil.

The military outcome of Russia’s invasion of Ukraine remains unknown, but its economic fallout is clear.

Higher prices, lower growth, and more inflation. The remaining questions are: how much higher and for how long?

The world is already feeling the initial effects from the sanctions wall the West is quickly erecting around Russia. Oil prices have reached an 11-year high. Wheat is trading in record territory. And this may only be the beginning. The longer the war drags on, especially if civilian casualties mount, the more the pressure will grow for the West to do even more to squeeze Russia. And that would mean closing the giant gap that remains in the West’s sanctions wall: Russian energy.

If the United States uses its powers to stop Russia from exporting oil, the fallout for Western economies is likely to become far more extreme than anything seen so far.

“Oil and gas prices will go bananas,” says Henning Gloystein, director of energy, climate, and resources at Eurasia Group, a political risk consulting firm based in New York. “That would cause a recession,” at least in some countries. That’s one reason Mr. Gloystein is fairly confident the Biden administration will not pull that trigger.

Other analysts are not so sure. “I suspect that we are going to have more demands for action” against Russia, says Chris Miller, professor at the Fletcher School of Law and Diplomacy at Tufts University in Medford, Massachusetts, and author of two books on the Russian economy. “At this point, the next big step is energy.”

Existing sanctions, already severely squeezing the Putin regime, also have side effects for the rest of the world – boosting inflation and slowing growth. The effects vary by region.

In the U.S., inflation is likely to rise and stay higher for longer than expected. The Oxford Economics forecasting firm on Friday revised its inflation forecast for the year to 6.5%, up from 5.9%. This will be reflected most prominently at the pump, where average gas prices edged up 8 cents per gallon over the past week to an already high $3.61 per gallon, according to the AAA auto club. These price pressures will slow real economic growth, but not kill it, according to Oxford. 

Worldwide, the conflict in Ukraine should shave about 0.2 percentage points from growth this year, Oxford says. Europe will be hit harder. The reason is energy prices.

Uncertainty over oil

Uncertainty about whether the Russians will reduce or stop the flow of natural gas to European Union nations had already sent gas prices to record highs Wednesday, rising 60% from the day earlier. And there are no ready alternatives for EU nations heavily dependent on Russia for their gas – Germany (about 50%), Poland (80%), Bulgaria (100%), and others. The amounts of liquefied natural gas that could be imported from the Middle East and the U.S. are too small to make up for the potential loss of Russian natural gas. Of course, it’s a two-way street. Russia currently has no real alternatives to selling to Europe, says Mr. Gloystein. It has but one pipeline of significance going to China, whose total demand for gas is roughly one-tenth what Russia sells to Europe.

But it is oil – not gas – that is the Achilles’ heel for Russia and the West’s trump card. Crude oil alone accounts for nearly half of all Russian exports. And unlike gas, it can be exported practically anywhere. So even if the West refuses to buy it, Russia can sell it to India, which currently is purchasing it at a hefty discount, and China. 

“That’s the mother of all sanctions,” says Tyler Kustra, a professor of politics and international relations at the University of Nottingham in England. “The U.S. can’t do a lot more than it is doing without blowing up the European energy market.”

If the U.S. decides to extend its banking sanctions on Russia to oil – energy is currently exempted – then it will be much harder for anyone to buy it, China and India included. The West has largely accomplished this oil-export cutoff with Iran. Such an action against Russia, a much bigger exporter, would have much bigger implications. Some analysts say oil could go well above $100 a barrel (it was trading at around $111 on Thursday morning) and stay there until the market adjusts and other oil producers ramp up production. Europe, already reeling from high natural gas prices, could see its expected post-pandemic recovery undercut. 

There are several strategic reasons the Biden administration might not take this step. The U.S. wants to maintain a united front with Europe against Russia. It does not want to appear to be escalating the conflict. It may want to give Russia an incentive to stop short of a full takeover of Ukraine, nor does it want to drive President Vladimir Putin into a corner where he feels he has nothing to lose by pursuing his current plans.

But the most important reason for inaction may be economic. With a public already sticker shocked by the rise in prices for everything from cars to food (for reasons that have nothing to do with the Ukraine conflict), the administration is reluctant to send American gasoline prices soaring. 

When asked Wednesday whether the U.S. would move to ban Russian oil exports, President Joe Biden said: “Nothing is off the table.” However, a White House spokeswoman later that day tamped down expectations, saying the White House was “very aware” that such a move “would raise prices at the gas pump for Americans.”

Ripple effects for food in Africa

Other regions of the world face effects of the West’s sanctions wall. Russia and Ukraine are both major exporters of wheat, supplying mainly the Middle East and North Africa. And with stocks already at a five-year low and prices at a record high last year, the threat of a further cutoff in supplies – due to sanctions or the war itself – has pushed wheat prices up roughly another 10% in the past month. This will have inflationary effects around the world. But the harshest impact will be in North Africa, which is in the midst of a severe drought.

Egypt, for example, relies on Russia and Ukraine for 70% of its wheat needs. The cutoff of supplies will make it more expensive for the government to provide subsidized bread to its low-income citizens. For other African countries on the edge of famine, any increase in wheat prices will put bigger populations at risk.

“Wheat is the single most important question right now,” says Pat Westhoff, professor of agricultural and applied economics at the University of Missouri in Columbia. “The markets have been gyrating like crazy in the last three or four days.”

Another area of concern, he says, is fertilizer. Russia is a major exporter and the withdrawal of its supply from the world market will send prices higher. For other reasons, fertilizer prices were already trending upward. 

Wider effects: money, parts, labor

Then, there are the secondary effects from the private sector, which will play themselves out in the months ahead and further isolate Russia from markets for parts, capital, and expertise. Some of these are visible and high profile. ExxonMobil, BP, Shell, and Equinor in Norway have said they’re pulling out of Russia, despite billions of dollars in investments there, and TotalEnergies in France has halted new investments. Apple has stopped selling its products in Russia and limited its access to digital services, such as Apple Pay. Ford is suspending operations, and Boeing and Airbus are pausing parts and technical support in Russia. 

Less visibly, tanker companies and refineries are reconsidering whether to take Russian oil, because of the heightened risk. Insurance companies are backing away from covering business transactions with Russia.

Spillover effects span many nations. A Boston-based partner in two tech companies in Russia-allied Belarus (who asked not to be named because of the political sensitivities involved) talked with five clients last week. Four were sticking with the company; one was leaving because of concerns about its reputation. Another potential client was not signing on because of the rising financial risk. Both of the Belarus firms have looked at contingency plans, such as moving software developers from Belarus into Poland and how to transfer money if its Russian bank can no longer operate. 

“The logistical problems I think we can probably solve,” says the Boston-based partner. “Uncertainty will be the problem going forward.”