It is April Fools’ Day and there is little about which to joke. This is week five of Russian hostilities. But at least a ray of sunshine, however glim: according to western intelligence agencies President Putin’s strategic ambitions are being thwarted by a combination of vigorous Ukrainian defence and Russian tactical military incompetence and inadequacy of preparation and leadership. Peace talks are continuing, but when and how the conflict ends remains unclear, though still the least likely outcome is a re-set to Valentine’s Day and Ukraine restored as a homogenous, sovereign nation with its pre-war borders intact. 

Energy policy on the hoof 

As we have pointed out previously in these columns since the slow-burning fuse of the Ukrainian crisis suddenly went from fizz to flash to bang, many countries reliant on imported energy from Russia have found themselves caught swimming naked when the tide has gone out. National energy ‘strategies’ (we use that word guardedly, to the extent there was much strategic planning at all involved, particularly under the section labelled ‘risk assessment’) suddenly unravelled at a rate of knots. Even if not overly reliant directly on Russia (such as the UK), the knock-on effects of the ‘weaponisation’ of energy for geopolitical leverage and the wild gyrations in volatile oil and gas prices have given significant cause for concern not seen on such a scale since the oil crisis of the early 1970s.

 

‘Energy security’ is the new mantra. New national and regional energy strategies are being rewritten rapidly on the hoof by politicians, those in thrall to the fickle demands of their electorates on a four- or five-year cycle, usually the least qualified to do the job; whether they are strategically coherent plans for meeting the long-term needs of growing, sophisticated 21st Century societies with all their complex demands remains to be seen. 

Geopolitical ramifications of Biden’s European gas coup 

As reported last week when we went to press, brokered by Joe Biden for Washington and Ursula von der Leyen at the EU Commission, the ink was drying on terms for an agreement under which piped-in Russian gas would gradually be replaced by US liquid natural gas (LNG) transported across the Atlantic by ship. The supply agreement lasts until 2030, not entirely coincidentally by which time Germany’s new government had intended to generate 80% of its energy from renewables. Leaving aside that currently there is not the dock infrastructure in continental Europe to unload and store American ship-borne LNG in bulk immediately to replace the 30% of European gas piped from Russia, superficially it is a neat solution to the conundrum of how Europe might wean itself off direct support from Putin.

 

Start, then, to think about the wider geopolitical ramifications of what is happening in energy markets as a result of Putin’s aggression. What emerges is a Gordian Knot of complexities, realpolitik, vested interests, political opportunism and brinkmanship.
Little more than a year in office and already written off as one of the worst Presidents in US history, Joe Biden has rapidly earned himself a notoriety for his lack of grip, his serial foreign policy failures and his propensity publicly to shoot from the hip with opinions while his foot is planted firmly in his mouth. But in Europe with that gas deal, he has pulled off a rare coup: the US has negotiated itself significant political leverage in its discussions about the future security of Europe, in particular on the topic of the EU’s ambitions to disintermediate America’s influence in defence policy. As Macron and von der Leyen bang on relentlessly and deludedly about an EU defence force, one which potentially weakens NATO in deliberately seeking to break the US defence hegemon, Biden or his successor can potentially wave the energy card: “play nice, or no gas”. That Europe is now mortgaging itself to the US rather than Russia for the next eight years is largely thanks to Angela Merkel, her dogmatic hostility to nuclear energy in the wake of Fukushima and her deluded belief that in buying his gas in prodigious bulk, she could exercise influence over Putin. 

Gas was one thing, oil quite another 

In oil markets, sanctions were eventually applied by the US and the UK to Russian oil exports, Biden and Boris conceding that Moscow’s unimpeded access to international oil markets was tantamount to funding Putin’s war machine. Replacing the potential 4% shortfall of global supply has proved difficult. Those with the biggest taps to open, principally Saudi Arabia, Venezuela and Nigeria, are in little or no mood to play, not least making economic hay while the sun shines on an inflated oil price to make up the significant revenue shortfalls when oil slumped in 2014 and remained weak for most of the time since.

 

Saudi in particular refuses to engage, believing Biden to be hostile, despite Saudi having been for decades a cornerstone western ally in the febrile region spanning the Middle East and Arabia. Saudi is engaged in a proxy war with its implacable foe Iran, being fought in the Yemen; Iranian-backed Houthi rebels regularly lob Iranian-sourced missiles into Saudi, including in late March firing on a major oil installation near Jeddah. Biden is cravenly seeking US restoration to the Iranian nuclear containment treaty (that horse has bolted; even if of limited capacity relative to other nuclear-armed countries, Iran is already effectively a nuclear-capable state). In return, sanctions against Iran will be lifted and Iranian oil allowed to be traded internationally. Whatever one’s views of its regime, it is not difficult to see why Saudi is a truculent counterparty. And the impact on prices? Significant. On March 7th Brent crude oil was $110/barrel; at the month-end, the price was $109; but in between times and peaking briefly at $145, the price gyrated in aggregate by more than $90 in three weeks. 

Eastward-ho! 

The other side of the coin is what Russia does now. An economy largely built and maintained on hydrocarbon exports (other hard and soft commodities are important too, but none so much as oil and gas), it has to find new markets to prevent total economic asphyxiation. As its commercial outlets to the west shrink thanks to sanctions, it will turn east, towards China and India, for the bulk of its strategic sales.

 

China and India are no mutual bosom buddies, on the contrary there are palpable tensions between them particularly in the strategically important and highly sensitive regions in the Himalayas where the ownership of key mountain areas and passes is contested. But both in their different ways are allies of Russia; in the recent UN vote condemning Russia’s Ukrainian invasion, both abstained. Since then India, which buys around 75% of its military kit from Russia, has cheerfully offered to mop up Russia’s surplus oil. China stands accused by the US of being suspected to be on the point of offering military aid to Russia (denied by Beijing). 

Perspectives on Indo-Pacific potential complexities 

But there are deeper potential complexities and long-term conflicts to the relationship between Moscow and Beijing. China is nakedly expansionist: militarily, economically and geographically if not by invasion, then by the insidious and pernicious neo-colonialism of the ‘One Belt One Road’ project.

 

Russia is isolationist while building a protective bubble of buffer states around itself to keep what it regards as toxic foreign influences at bay which might otherwise jeopardise Putin’s regime. Those buffer states are not confined to the ones with which we are most familiar: Belarus, Georgia, the intentions with Ukraine, threatening noises to Poland and the Baltic states and the other former Soviet post-1997 NATO joiners. They include former Soviet satellites in central Asia, the ‘Stan Countries’: Kazakhstan, Kyrgyzstan, Turkmenistan, Uzbekistan and others which stand in the path of, and to benefit from, China’s New Silk Road. China’s New World Order with the Chinese Communist Party under General Secretary Xi’s helmsmanship at the tiller poses a strategic threat to Russia as those satellite governments are potentially seduced by warm words and promises and pots of renminbi from Beijing.

 

How this develops over the next two or three decades is difficult to predict with any great certainty, but the knock-on effect of the sanctions against Russia and the quest for new markets for its sought-after commodities opens up a whole new vista of geopolitical leverage for both sides potentially of great significance.

 

As is already evident from the long-term strategic policy shift by the US from Europe to the Indo-Pacific region, recently bolstered by the new post-Brexit AUKUS tri-partite pact with the UK and Australia (and that row about nuclear submarines which left Macron and the French defence industry high and dry and fuming), we and the Americans have eastern opportunities to pursue and interests to protect.

 

One obvious threat to the US in any potential Russo-Sino energy lash-up is the disintermediation of the US dollar. Oil contracts are settled in dollars in a process which has been under development for some years to disestablish the supremacy of the US dollar as the world’s most important reserve currency. In this instance there would be every incentive for Beijing and Moscow to use other means, including gold, with which to settle oil payments, perhaps extending the arrangement to other interested countries in their sphere of influence. 

A complex, dynamic environment; markets are gradually thinking laterally 

And how is this relevant from an investment perspective? The key economic battleground is fixed income markets as investors play join-the-dots. The tensions between the risks posed by inflation, the possibility of the central banks being so aggressive to control it that they kill the economy in the process, and finally investors reassessing risk in a rapidly shifting and febrile environment, this time without the support of central bank QE as a back-stop, are playing out simultaneously. So far, amid headlines of “Bond Market Rout!”, the result has been a perceptible rise in bond yields, the corollary of which is falling bond prices. While currently taking a breather, one hesitates to say it has finished yet.

 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions. 

The value of active minds – independent thinking

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