Businesses' profits under pressure from price increases due to military conflict

Russia and Ukraine hold a limited share of goods and services in world trade. Nonetheless, the effect of the military conflict on the global economy has proved substantial. Weakened confidence has been the leading factor in the price increase of oil, gas and numerous inputs and the further disruption of the trade chain. As a result, profitability in many sectors is under considerable pressure.

In contrast to the invasion of Crimea in 2014, the current war is sending a massive shock wave through the input markets. Oil and gas prices have hit record highs. Wheat prices have increased by +40%. And nickel trading on the London Metal Exchange had to be shut down last month. Since then, although most input prices have declined somewhat, they remain at high levels.

Businesses are suffering from this. In some sectors, the majority of operating costs are related to the purchase of inputs. For example, 80% of the operational costs in the metal sector are related to energy and metals. In the agri-food sector, 60% are related to agricultural inputs.

There is also significant price pressure on inputs that are crucial for electronics: palladium for chips and sensors; neon, xenon and krypton gas for semiconductor lithography processing. Even before the war, there was tension in the air. The current crisis is increasing the pressure and shortages. The automotive sector has been impacted because Russia produces aluminum, nickel and lithium, which are essential for batteries for electric vehicles.

Will current price levels for oil, gas and inputs remain this high throughout the year? If so, the energy and metal sectors will be the most severely affected. This is because they have relatively low pricing power. This means it is difficult for them to pass on the higher purchasing costs to customers. Both sectors will however remain profitable at current price levels.

A further rise in input prices could wipe out all profits in some sectors. If the Brent crude price stabilizes around an average of 140 dollars a barrel, the aviation sector will find itself in the red if the airlines cannot pass the cost increase on to consumers. Other sectors, such as the chemical sector, have much more leeway. The metal sector is taking a double hit as a result of the high oil price and higher inputs. Both make up a large part of their operating costs.

A further 15% increase in the prices of industrial metals could push the profitability of the household appliances sector down to zero if the cost increase cannot be passed on to consumers. A further +60% price increase in agricultural inputs or +50% in metal prices would have the same effect on the agri-food and metal sectors. At the other end of the spectrum, the ICT and chemical industries appear to be able to absorb higher input prices.

As the war intensifies and the global economy moves into our blackout scenario (resulting in continued increases in input prices), retail and leisure services will also be adversely affected. The latest mobility data already shows that consumers in the US, France, Germany and the UK are visiting shops and restaurants less frequently. If grocery costs and monthly energy bills continue to rise, it is likely that consumers will postpone or cancel unnecessary expenses.
Because of COVID-19 and the government support that has been offered, the bankruptcy figures have artificially fallen to a very low level. In the event of a prolonged crisis, the normalization of bankruptcy figures will be further delayed. If energy and input prices continue to rise, some governments will reintroduce support programs for businesses. On 16 March, the French government announced support measures that could amount to 130 billion euros by 2022. The government is offering up to €30 billion in energy subsidies and up to €100 billion in additional state-guaranteed loans. These kinds of measures prevent businesses from going bankrupt. We now expect the number of bankruptcies to grow by a modest +8% in 2022.

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