The war in Europe is changing the world. First, there was the Covid pandemic, rapidly followed by the Russian invasion of Ukraine, the second major crisis in a relatively short time. What impact will the sanctions have, how is inflation developing and how will this affect the energy transition?

KPMG has assessed the scenarios and several experts share their thoughts. Moderated by KPMG director Pamela de Maaijer, Michael Quigley, Global Geopolitics Manager, Johan Smits, Supply Chain leader and Jaap van Roekel, Energy sector leader, discuss the situation.

Ukraine infographic

Effect of sanctions continues

“Russia did not expect this level of unity and coordination regarding sanctions,” Michael states. “The EU and the US continue to exert pressure on the Kremlin and on people close to Putin. Additional sanctions packages are likely throughout the duration of the crisis, the effects of  which will be felt for some time afterward. There is now also talk of import bans on such things as oil and gas. Even a traditionally neutral country like Switzerland is joining in.”

Michael: “The future impact of the sanctions will have a direct affect on business compliance functions. Regulations are currently undergoing widescale change and the changes will continue to happen. One way to deal with this is to know your customers and ensure automated customer screening tools are well positioned for increasing regulatory change.”

Johan adds: “This is a major concern from the perspective of supply chains. The disruption caused by the Covid crisis is being superseded by the disruption of the war. We shouldn’t focus on the sanctions only. Russia is trying to tap into markets in China and India and if we buy products from them, we are essentially continuing to support Russia. Companies must bear in mind to look at the consequences for their entire supply chain”.

Volatility of energy prices

Energy prices have a huge impact on consumers and businesses. Especially on low-income households. Hence the government’s intervention to (partially) soften the blow for consumers through lower VAT and excise duty and income support for low incomes. The business community cannot count on the same level of support given that the government views the high energy prices and the resulting suspension of business activities as a business risk.

Jaap says that the situation calls for long-term solutions. “We have to think carefully about the ‘security of supply’. The Netherlands is dependent on Russian gas. There are solutions to reduce that dependence, but the European problem is larger. Germany in particular is heavily reliant on Russian gas. If Germany has a problem, we have a problem.”

Supply chains remain under considerable pressure

The Covid crisis made us more aware of the vulnerability of global supply chains. Johan: “Trade flows with Russia and Ukraine are now entirely disrupted, trade flows from China through the Suez Canal were already disrupted, but now trade via the so-called Silk Route (Belt and Road Initiative) is also hindered because an important part of the route runs through Russia and Ukraine. This involves millions of containers and forces China to reconsider its investments in the Silk Route. It also compels Western companies to become more resilient to disruptions in the logistics chain and perhaps to produce and transport goods closer to home”.

Is this crisis comparable to the credit crunch? Jaap: “The credit crunch was a crisis of confidence. Governments intervened by stabilising the financial system with a great deal of money and nationalisations. This time we are dealing with a physical crisis, specifically with respect to the physical flows of oil and gas to Europe and the supply chains. This cannot be solved with financial resources alone. No matter how much money we have, financial means cannot solve this problem.”

“If the energy supply stops, so do industrial activities.  Which might mean that we end up in an economic crisis not seen since World War II. We need an alternative infrastructure that will take three to five years to set up. We need European planning and legislation to get our energy infrastructure in order. We are talking about interconnection capacity between countries’ electricity grids, pipelines, LNG terminals, hydrogen development, offshore wind, solar, etc. Swift action is needed.”

Structurally higher inflation

The EU will therefore have to review its energy system to be future-proof. Major investments will be needed. Another issue is investment in defence. In the coming years, hundreds of billions will be invested in European defence. Finally, industrial policy must be formulated. Jaap: “The pandemic confronted us with the vulnerability of supply chains. We now agree that production relating to defence and healthcare should be located closer to home. I expect EU industrial policy to focus on defence, clean tech (energy) and high tech (chip production). This will come at a price, which will be paid by higher taxes, more debt, or a combination of both, and will impact the development of the economy (GNP) of the European Union.”

First of all, a major component of the current high inflation is energy, but food prices are also rising. So even if energy prices fall, we are still dealing with relatively high inflation. Jaap: “Secondly, the market has already priced in higher inflation than the ECB standard of 2% for the next five years. That means salaries will probably go up. As a result, labour costs will increase and companies will raise prices. Thus, the higher inflation becomes structural.”

Perfect storm

Michael names a development that KPMG Geopolitics has dubbed the ‘FIRE Agenda’: Fragmented Interventionist Regulatory Environment. This indicates a departure from the economically liberal world order that has prevailed since the Cold War. Instead, countries now seem more inward-looking and strive to be less dependent on foreign nations when it comes to sourcing strategic industries like  semiconductors, pharmaceuticals and raw materials.

Johan: “Right now, we are in a 'perfect storm'. By producing at the lowest possible cost to satisfy consumers, companies moved production to low-wage countries, especially those in East Asia. Bringing production back to Europe is, therefore, a major challenge, and one that could also drive up the prices of products. The question is: Will consumers be willing and able to pay for this?”

Greener faster

Is there also good news? Jaap believes that there is: “Initially, we thought the energy transition would decelerate due to the Russian invasion of Ukraine, but now we think it is accelerating. This is mainly due to European plans. Through its RePowerEU plan, the EU has decreed that dependence on Russian gas must be reduced without delay, by as much as two-thirds for the coming gas year. This gap can be filled partly by LNG and demand reduction, but in the long run, renewables will have to step in. Renewables should phase out fossil energy (including oil) from Russia completely by 2030. The market is also helping: higher energy prices help to finance the development of renewables, which also hastens the energy transition.” In addition, we’re seeing companies taking active steps to reduce their CO2 “footprint”, partly under pressure from their customers, employees and the financial markets, but also because they now realise that this is essential to their survival in the long run. 

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