Russia & Ukraine

Russia and Ukraine

The recent invasion of Ukraine by the Russian army has placed European security into sharp reverse. The days of peace since the end of the Cold War and the Yugoslav warof the1990shaveended. Inthisarticle we will look at:

• Why Russia has invaded Ukraine • How long could the conflict last • What this means for geopolitics • What this means for the world economy • What this means for investors

Why has Russia invaded Ukraine President Putin has long resisted the eastward expansion of NATO into the countries of the former Warsaw bloc, or thosethatwerebehindtheironcurtain. He has been even more sensitive about any encroachment into the independent countries that were once part of the Soviet Union,suchasUkraineandGeorgia. Putin followstheteachingsof AlexanderDugin,a radical theorist and far right thinker who proposes a rebuilding of the territories and influenceof theSovietUnion. Duginisalso an admirer of the the methodology of Hitler,andsomeof Hitler ’ smethodscan be seen in Putin ’ s strategy. Putin has been using the pretext of saying Russian minorities in former Soviet Union territories are under threat from local majoritynationalities,whichisrarely,if ever, thecase. Perhapshebelievesitistrue,butit is most likely to be a pretext to exercise leverageusedforterritorialexpansion. This hastakenplaceinAbkhazia,SouthOssetia, Transnistria and now in the Donetsk and Luhansk Oblasts (regions) in Ukraine.

In the case of Ukraine, the illegal seizure of Crimea and the ‘independence movement of the Donbas ’ has created a strategic problem for Putin. The Donbas separatists are little more than Russian created movements, aided and abetted by Russian special forces. The strategic problem is that CrimeaislinkedtotheRussianmainlandby asinglebridgeandtheDonbassregiondoes not have control over the whole of their administrative regions, the Oblasts. Putin now wants to carve a landbridge between the two, and since 2014 we have viewed the situation in Ukraine as unfinished business.

Putin tried to solve the problem by

‘ cutting the head off the snake ’ by removing the democraticallyelectedZelenskygovernment and get a puppet government to recognise the conquered territories in the South of Ukraine. When this failed, he has now changed his war objectives.

How long could the conflict last PutinhadhopedtoconquerUkrainewitha lightning, one week push to take Kiev, expectingtheUkrainiangovernmenttofold ratherthanfight. Thismiscalculationcame fromtheretrainingof theUkrainianarmed forces since the seizure of Crimea and parts of theDonbassin2014andtheantipathyof the Ukrainians to the Russians dating back to the Stalinist period. In the 1920s and 1930s over 1.5m Ukrainianes were murdered by Stalin in what is known in Ukraine as the ‘Holodomir ’ .

However, Putin ’ s new strategic objective, which is to create a landbridge to Crimea alongtheBlackSeaterritoriesfromRussia ’ s border, is more achieveable. Russian forces are pushing south from their current positions and pushing outward from Crimea. It seemed unlikely that the Ukrainians would be able to resist these movements without a lot more military hardware, and Nato has to date only sent light, handheld weapon systems.

The recent change in strategy by western countries, in particular the arrival of heavy weaponsfromEuropeandtheUS,maywell help to slow the Russian advance. For example, Poland has sent 240 Russian T72 tanks to Ukraine. President Biden ’ s recent $33bn request from Congress, which is almost certain to be approved, would mean a considerable step up in the support given to the Ukrainian military and economy at a critical point in the struggle.

If Putin does manage to carve out this landbridge, it seems likely he would then agree a ceasefire. This for Putin would be the end of his war. What we don ’t know at thisstageiswhetherUkrainewouldagreeto those terms. If they don ’t agree, then a low intensity,guerillawarwouldprobablyensue.

However,weretheWesternworldtoactually stop using Russian oil and gas, particularly those countries in Europe, then the war would probably stop far quicker. This embargo should also extend to metals ’ supply. Dr Andrei Illarionov, Putin ’ s chief economic adviser (2000 – 2005), estimated that a full oil and gas embargo would end Russian hostilities within 1-2 months. Europe is sending billions of US$ every day to Putin ’ s coffers. President Zelensky ’ s requestforatotalbanistherightcall,rather thanincreasingsufferingviaweaponssupply and protracted conflict.

What this means for geopolitics Russia has tried for many years to disrupt the unity of Western institutions. Putin has provided loans, holidays and other incentives to populist politicians in Europe andhasclearlyintervenedinelections. This has been quite effective, with the proof clearly in Trump ’ s election, Brexit (via funding for Vote Leave through Arron Banks), Italy ’ s Matteo Salvini, France ’ s Marine Le Pen and Hungary ’ s Viktor Orban.

However the Ukrainian invasion has united NATO and the EU in an unexpected way. The EU has implemented some sanctions (albeitnotenoughduetoalackof onoiland gas embargo) and NATO has supplied sophisticated light weaponry to Ukraine which has been effective in stopping the Russian armour in certain areas. Furthermore, Finland and Sweden, historically neutral countries, have applied to join NATO.

Russia continues to occupy an independent country,whichithasdonepriortotherecent hostilities, overtly in Crimea and covertly in Donetsk and Luhansk oblasts (all citizens there have Russian passports). Were Russia to gain control of its landbridge to Crimea

andthevastmajorityof theareainbetween, then it is likely that it would retain these areas. Putin is unready or unwilling (or both) to surrender any territory he has acquired as a result of the war.

If Putin retains Ukraine ’ s southeastern territoriesthenanewColdWarwouldstart, and this seems extremely likely. It is worth rememberingthatUkrainehadanestimated 19%Russianspeakingpopulation,although many prefer to remain within Ukraine and would not want to be part of Putin ’ s repressive Russia. 25% of NATO member Latvia ’ spopulationisRussianspeaking,and a successful Russian territorial grab in Ukraine may well embolden Putin to carry on with his territorial expansion.

The Baltic States, Poland, Romania, Bulgaria and Turkey will become NATO’ s frontlinewithRussia. Tothismaybeadded Sweden and Finland. This border will be more heavily fortified, with a concomitant increase in infrastructure in addition to militaryweaponsandincreasedtrooplevels. For many years NATO’ s defence expenditure has been shrinking, but now it will grow.

What this means for the world economy? The already difficult supply situation in the world has been made more complicated by the lack of raw materials from Russia. The lack of Russian oil and gas is causing price spikes and volatility in the energy markets, which has been benefiting all petroleum exporting countries and coal producers. The coal price has been rising as it a substitute for petroleum production, at the expense of the reduction in global carbon emissions. However, many of the European countries are heavily-dependent on these hydrocarbons for their economies, and, being landlocked, are asking for time from the EU before the mooted Russian oil ban comes into place. It is unlikely Russian gas can be replaced in mainland Europe this year or possibly next. Part of the problem has been a lack of investment in oil and gas production capacity and the ‘ shutting-in ’ or closing down of European fields due to low oil and gas prices. Reversing that underinvestmentwilltakealongtime. This lack of energy could be a brake on growth inEuropeinthecomingfewyearsunlessthe Ukraine Russia situation is resolved or new supplyandinfrastructurecanbeintroduced.

Sanctions of Russia ’ s most wealth and powerful businessmen, the ‘ oligarchs ’ , has caused significant problems. The oligarchs cannot access any of their overseas assets that are invested in financial institutions aroundtheworld. TransactionsinUS$and Euros are problematic for many of the richest Russians and their businesses. However, not all oligarchs have been sanctioned, notably Vladimir Potanin, who controls Norilsk Nickel. Norilsk supplies 15%of theworld’ sNickelthatisneededfor batteries to power the energy transition and 40% of the world’ s palladium production. Palladium is used in catalytic converters for carsandhydrogenpoweredenergycells. So thereisnotalevelplayingfieldforsanctions, and there are ways around for Russia and the oligarchs which they are exploiting. Global food supply has definitely been affected by the Ukraine invasion as the country is one of the largest grain exporters in the world. Large quantities of the grain.

is exported to the poorer countries in the world, for example Egypt. The Russian controlof theBlackSeamakesitimpossible for Ukraine to export through its primary port, Odessa. This is helping to cause food priceinflationwhich,inturn,iscausingriots and instability in the countries where large parts of the population are dependent on this food source.

The nervousness caused in Central Europe by the invasion of Ukraine has caused a boost to armament expenditure in Europe. Many European members of NATO have been spending less than the minimum 2% of GDPforalongtime. Germany,theworst offender for under-spending has committed to spend an extra EUR100bn in 2022 and 2023. It is likely that this surge in expenditure will be across NATO’ s European members.

What this means for investors World markets have been shaken up by the warinUkraine,andthesanctionsthataffect oligarchs and Russia have caused commodity prices to surge, particularly those of metals, oil, gas and food. Wars between superpowers, even proxy wars, are bound to have a large impact on economics and markets. The inflationary pressures from the war are causing problems for individuals and companies. We list below a selection of investments we hold for clients thatweperceivetobedirectbeneficiariesof the current situation.

On the day of the invasion of Ukraine we increased our weightings in Bae Systems, the UK’ s largest defence company. Several monthspriortotheinvasionwehadalready increased our holding in Chemring, another UK defence company. Our view is that the scale of increase in defence expenditure in Europe will favour these two companies, as well as others, and what were consideredtobedull,steadycashflowstocks are now growth stocks that ought to command a higher stock market rating.

We already have exposure to commodity stocks through Rio Tinto and BlackRock World Mining,andhaverecentlyswitched from BHP to Glencore on a relative valuation basis. These companies give excellent exposure to commodities where there is tight supply as well as strong demand. Valuationsremainattractiveinthe sectorgiventhehugeneedformetalsforthe energy transition.

The oil and gas sector is also a beneficiary of the recent surge in prices. We have modestexposurehere,notablyto Shell and Seplat Energy. The former has benefited fromitshydrocarbonextractioninatimeof high prices. The latter is a Nigerian exploration and production company with great potential.

There are other areas in the economy that are seeing higher prices as a result of the Ukraine conflict. Food products are one of these. These are famously difficult to invest in, with Cargill in the US being one of the largest agricultural food businesses. Unfortunately Cargill is unquoted, as are manysimilarcompanies. Furthermore,food production can increase given the large amount of fallow land in the EU and elsewhere, so price spikes rarely last a long time.