Updated: May 25
As Russia has mounted and mobilized a nearly 200,000 strong invasion force which now encircles Ukraine on three sides, an invasion into the eastern parts of Ukraine seems like a certainty at this point. US intelligence has earlier concluded that Russian President Vladimir Putin has already made a decision and that an invasion is likely to occur in the days ahead. Though a high stakes game of geopolitical poker, Putin’s main grievance revolves around his perceived view of NATO’s continued expansion towards Russia’s western border, which (according to him), threatens Russia’s security. Though an effective talking point, this is a completely false narrative. Ukraine has expressed interest in joining the NATO alliance back in 2008 (understandably, following Russia’s invasion of Georgia), however since then, little progress has been made in order for the country to meet the strict NATO membership requirements. Even more important is that NATO’s largest European member, Germany, has been adamant in not wanting membership to expand.
The real reason behind Putin’s continued land grab in Ukraine is that following the 2014 Maidan protests in Kyiv, fears of a similar type of uprising (which caused the overthrow of the then pro-Russian President Viktor Yanukovych), are ever present. During and since the end of the cold war, these uprisings have been driven by people’s desire to live in a more democratic society with closer ties to the West/EU. Membership into NATO goes hand in hand with wanting the societal reforms of democracy, human rights and transparency, all virtues the vast majority of Ukrainians have been demanding. If Ukraine were to move closer to Europe’s sphere of influence, other popular uprisings, (such as those seen earlier this year in Kazakhstan – before being quashed by Russia) may trickle into Russia itself, thus jeopardizing Putin’s grip on power.
By mobilizing his military to surround Ukraine in an effort to further threaten the country, Putin has failed to extract any concessions and has in fact strengthened/unified NATO’s resolve and presence on the eastern front (with the US and several other western members reinforcing troop and military hardware levels in Poland, Germany and Romania). In addition to the West’s promise of targeted Russian sanctions should a military incursion into Ukraine occur, items specifically targeting the Russian oligarchs and technology export bans will be implemented. Though all NATO members have become more unified than ever, one of the more contentious items has been the fate of the $11.0B Nordstream2 (NS2) pipeline which is set to double Russian gas exports through the Baltic sea and into Germany. Though President Biden has outright said that NS2 will be cut off/terminated should a Russian invasion take place, the new German Chancellor Olaf Scholz has steered clear from specifically mentioning anything to do with NS2.
Recall that since mid-November the German regulator, BNetzA suspended the certification of the NS2 pipeline until a German subsidiary can be established (maybe sometime in 2H/2022). Despite an understandably highly geo-politicized framework, the delay does nothing to alleviate the near term economic damage due to high gas prices which have averaged $4.50/MMBtu so far this year. Sadly for Germany, there is no feasible energy alternative any time soon. Given the German plan to phase out nuclear power (a big mistake) and the fact that the Greens have sufficient representation to steer energy policy, a shift to a lower carbon intensive energy mix has been the goal, with NS2 playing a central role in that vision. This is specifically why Germany is in an unenviable position, on the one hand backing NATO commitments and western sanctions on Russia but also coming to terms that in the near term at least, their manufacturing industry is hostage to Russian gas imports.
The LNG market is unlikely to pose a credible alternative (there is currently limited European regasification capacity and bidding for LNG cargo means competing with aggressive Asian demand) for at least the next 5 years. Keep in mind that should NS2 be allowed to flow to Europe, Gazprom would be able to deliver an extra 6B-12Bcm of gas to the continent, via the Baltic Sea and bypassing Ukrainian transit fees. For context, Germany consumed 56Bcm of gas during last year’s winter (November 2020-March 2021). The associated cost amounted to approximately $400M/day or $60B to Gazprom over last year’s winter period (at current spot prices). This is equivalent to Germany’s annual defence budget. Though Europe transitions to Net Zero with expectations for a significant reduction in gas demand (upwards of 80% by 2050), Russia’s influence on European energy markets will only dwindle over a considerable length of time. In the much nearer term however, any further delays (or the outright cancellation) to NS2 will clearly have significant economic impact. That said, from a portfolio standpoint, we went underweight Russia earlier this year. This means that Gazprom, Lukhoil, Sberbank, Rosneft and Surgutneftgas were all on the chopping block.
Ultimately, Putin sees that Ukrainians wants change, as to the people of Kazakhstan and Belarus. The Russia/Ukraine issue has nothing to do with NATO. Putin sees that Ukraine aspires be a sovereign democracy with increased ties to the West and Western institutions. This is a line too far for him as it threatens his autocratic grip on power as the wave for reforms may sweep through the East and eventually erupt within his own borders, in due time.