The Economic War in Ukraine a Year On - The energy war, politics & production

The Economic War in Ukraine a Year On - The energy war, politics & production

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Russia's full-scale invasion of Ukraine began in the winter of 2022. And as winter now nears its end I thought it was finally time to look back over what both sides had achieved over winter, and where the physical and economic battlefields stood after more than a year of war. Both sides entered the winter with the ambition of moving the needle in their favour, as the war was waged with two interrelated but also somewhat distinct struggles.

On one hand there was the political and the economic, where Western sanctions targeting Russia were matched up against Russian energy warfare targeting the European economy and their will to support Ukraine. Bankers and spreadsheet warriors the world over went to work. While around the world defence industrial bases struggled with the rapidly expanded demand for, well, just about everything. That economic, industrial and political battle is probably going to be critical to the way the war in Ukraine plays out.

And it's the side of the last year that I'm going to be looking at specifically today. But it's important primarily because it informs a very real military struggle playing out on the battlefields of Ukraine. There in a brutal attritional struggle that tests men and materiel to their absolute limits, both sides again went into winter hoping to turn the tide of battle in their favour. Now as winter comes to an end and the mud has returned, I wanted to look back and see what each accomplished.

And in order to make that judgement, whether we're talking about the economic side of the war or the military one, we need to make some assumptions over both side's objectives. War is not a game, it's not a sport, there's no internationally agreed rule book that points out how you keep score. So one of the only ways to effectively judge the situation is to ask which side achieved their goals, and that unfortunately means making assumptions. For Russia it appears its primary winter objectives were to break down allied cohesion with its energy war against Europe.

It was to undermine Ukrainian will and its capacity to resist using its strategic bombing campaign. And it was to achieve a series of military objectives which we'll talk about next time, but with the key focus still being on taking the Donbas. For the West the goal seemed to have been to wound the Russian economy and its war making potential through sanctions and other means. To support Ukrainian force regeneration efforts.

And militarily to both undermine Russian force regeneration and to set conditions for a future Ukrainian offensive. Today I'll be talking about the economic, political and industrial side of those objectives. With winter ending, I'm going to look at what the Russian energy war on Europe achieved - or rather fail to achieve. I'll look at the state of Western allied cohesion and support for Ukraine, the effect of sanctions on the Russian economy, the impact on Ukraine of strategic bombing.

And close out with the really fun stuff, a look at war production in Ukraine, the West and Russia, the barriers those efforts face, and what we might expect going forward. So let's start with a relatively easy one, the energy war and the threats that Europe would freeze over winter without supplies of Russian gas. When I first covered this topic about 6 months ago, tensions and concerns were at their height. Putin was threatening to leave Europe to "freeze". Gazprom went so far as to release a video showing Europe basically frozen over, like something out of a disaster movie. Implying that without them, their customers were doomed to suffering and misery.

A move you could argue, that marked them as at least 5% more evil than your average utility company. The goals commonly expressed on Russian state TV and through other fora were to drive up prices in Europe, to inflict economic damage, and in so doing build political pressure on European governments to fold to some of Russia's demands. And if there was a time that that strategy was going to work, it was during the winter - where temperatures were at their coldest, the demand for gas was at its highest, and the consequences of people not being able to heat their homes would be the most dire.

When I made that video 6 months ago I highlighted that the European gas market had gone into shock. Prices had multiplied many times over from their pre-war levels, impacting government, business and individuals. But I also highlighted the variety of measures that Europe was putting in place in response. And another 6 months on it is truly incredible what has been accomplished. They attacked the problem from just about every direction. Norway and other European gas producers squeezed out additional production.

Industry and private individuals were encouraged to make savings. And then some of the truly bizarre stuff started. A German government that included the Greens party, reactivated coal-fired generation capacity and agreed to extend the life of several nuclear reactors. LNG import infrastructure that would normally take years to put in place was assembled at record pace. Under ordinary circumstances German bureaucracy can be pretty slow and plodding.

But faced with the choice between economic disaster and expediting processes, they chose the latter and unlocked some of that traditional German efficiency. About halfway through winter Germany was already opening its third new floating LNG import terminal for business. And it wasn't the only country making those sort of strides. Storages were very expensively filled, and every alternative energy generation method that was available was accelerated or put into service.

It's almost a truism to say that wartime conditions make normally impossible policy positions possible. And that certainly held true in Europe over the last year. The same governments that signed off on re-lighting coal-fired generators also signed off on deploying renewable energy technologies across the European Union at breakneck pace. It mattered not from where the power flowed, as long as it flowed.

The pace of the energy transition doesn't really have much historical precedent. In January 2021 a majority of the EU's gas imports came from Russia. By October that number was just a little bit over 10%. And at time of recording, well, it's now in single digits.

As predicted 6 months ago, Russia's primary gas market largely disappeared. Unlikely I would argue, to ever return to anything like its former glory. But perhaps it all would have been worth it for Russia if it had caused Europe to change course. If costs had become too high to bear and as a result people had demanded that some sort of rapprochement be made with Moscow, then maybe this just would have been a blip on the radar economically.

It may even have left Russia on net in a better financial position, as it had cashed in on the extremely high prices through the middle of 2022. But that's not how that story ended, gas storages were filled ahead of schedule, and then much of Europe was treated to one of the most mild, warm, toasty winters in recent memory. It's often said that General Winter traditionally fights on the Russian side in war, but this time around the Europeans must have paid him a hefty amount to change sides. Temperature records across the continent were shattered over New Year's. And residents in Prague were forced into a double take when they realised that on New Year's Eve, in the middle of winter, the daily temperature topped out at 17.7 degrees Celsius (64 in American units).

That's less freezing-to-death temperature and more the kind of level where the Brits will start breaking out shorts and t-shirts. Now I don't want to pretend that this was all about the weather, although that absolutely helped. The failure of the energy war was primarily driven by a robust policy response. Where European nations identified the measures that had to be taken and then found the money and political will to do it.

From the Russian perspective the damage to the European economies is likely at once to be somewhat uncertain, but also extraordinarily disappointing. Some impacts are easier to identify than others, like when France came up with a 45 billion euro fund in order to shield consumers from increasing energy prices. But in other respects it's hard to separate the effects of the energy war from other global economic pressures. But whatever the drivers, the results were hardly apocalyptic. The end result of the concerted campaign to destroy the European economy was EU real GDP growth of 3.3% in 2022, that's growth beyond inflation. Growth in 2023 meanwhile, is expected to be largely stagnant.

At 8.5% inflation was uncomfortably high, but it is expected to come down to 6.1% in 2023, and moderate down to 3% in 2024. Unemployment actually hit a low in September. And government GDP deficits in 2022 were notably high at 3.4% of GDP and are expected to remain elevated. But at the same time, those figures were significantly lower than they were during other crises like the Covid era.

And also lower than the federal deficits routinely seen in the United States. So as far as governments were concerned, the crisis was very expensive. But as a whole the European Union has pretty broad financial shoulders, it was able to carry the weight. But perhaps even if the policy couldn't inflict enough damage on governments, it might be able to get at the people of the European Union.

And so I pulled some statistics from late last year when gas prices were at their highest to see how the European population was responding. And on one hand it's clear that people were definitely noticing. 46% of respondents had reported that their standards of living had been reduced, whether as a result of the Covid pandemic, the war in Ukraine, or global economic disruptions. A further 39% said they hadn't felt the difference yet, but they expected to see it in the next year.

In most countries a clear majority of respondents also didn't think that their national governments were doing enough to deal with rising prices. In Estonia that was feeling some of the worst inflation in the European Union, a massive 81% of respondents in October and November said the government wasn't doing enough. Keep that figure in mind, because we'll come back to Estonia a little bit later on. And in southern and central Europe, where complaining about government is basically national tradition, numbers were similarly dire.

But if you zoomed the question out and ask people how their lives were going as a whole, people remained very optimistic. When asked if they thought their lives were going in the right direction or the wrong direction, there wasn't a single respondent country where more people said "wrong direction" than "right direction". In Germany the ratio was close to 6:1. In protest-loving France the ratio was 2.3:1. And I don't know what was going on in Luxembourg, but I'm now interested as to whether or not they'd let me in, because there more than 80% of the population said things were going pretty well, as compared to 7% that said they weren't.

I wouldn't normally focus on statistics like this, but I bring them up for one particular reason here. People will often complain about particular issues, they will almost always complain about government. But if they're freezing to death and one step away from revolution, they usually won't be telling you that their life is going pretty well. And in the midst of an energy crisis, that was apparently a majority opinion.

Jumping forward to the end of winter 2023 and it is clear that the energy crisis isn't entirely over. Europe now faces the challenge of refilling its storages for next winter. But inflation, energy and the economic situation are actually a fading, if still very serious concern for the European population. The Eurobarometer survey showed a steady decline in concern over rising prices, energy supply and the economic situation. Instead people seem to be increasingly concerned with immigration, public finances, and notably, the EU's influence in the world. So I think it's fair to talk this one up as a loss for energy blackmail.

But I wanted to highlight an element of this whole campaign that is commonly missed. Because there are countries around the world that suffered horribly as a result of that energy war. Because remember, a lot of that Russian gas that was going into Europe was piped gas. It couldn't be turned into LNG and re-exported into the market. When it stopped going into Europe, a lot of it simply stopped being exported.

And Europe reached out to LNG markets around the world to help make up the difference. In Europe that manifested as a financial price, because the continent took out its rather extensive chequebook and just paid what the asking price was in order to secure cargos. But while gas prices are now at an 18-month low in Europe itself, the shock to the LNG markets through 2022 was very real. And that had significant consequences for poorer countries that didn't have the money to spare to buy up those cargos. Countries like Pakistan, Bangladesh or Sri Lanka that are already under immense financial pressure, face difficult choices of either further draining their foreign exchange reserves to pay for LNG cargos, or in some cases, as happened to Pakistan and a number of other countries, bidding for cargos and then just not securing any, leading to domestic shortfalls. In many ways this mirrors the impact we'll see if Russia ever fails to renew the Ukrainian grain export deal.

Europe and the United States are not going to run out of energy and they're not going to starve. Those products are commodities, they can be purchased with cash and those countries have a lot of cash. Instead those who suffer the most when supply exits the market are those with the fewest financial resources, those who can't afford to pay inflated prices.

And unfortunately often those who have few other options. Allowing the export of Ukrainian grain isn't going to make or break the lives of those in the European Union, but it might mean impoverishment or even death for those elsewhere in the world. So how would we summarise the economic impacts of the energy war against Europe? And I know I normally caveat my findings or hedge my bets, so hopefully it means something when I say this straight. If the goal of the energy war was to break the European economy, then it was a massive failure. The impacts on Europe were financially painful but certainly not critical.

The pace and scale of the continent's response has been impressive. And while there are still long-term economic concerns, like the cost pressures on German industry and its global competitiveness for example, the stats so far do seem to suggest that the economy is holding together. And as for the extended goal of breaking up public support for Ukraine and shattering the Western alliance, we'll talk about that in just a moment. Because first I want to do something I hope I don't regret and talk quickly about the bombing of the Nord Stream pipelines.

And specifically about the claim that the United States and Norway were responsible. Now let me say this up front, over the last 6 months I've largely tried to stay out of the myth-busting game. And to be very clear: I do not know who destroyed the Nord Stream pipeline. But what I'm pretty confident about is that this claim doesn't deserve the headlines it's getting.

To give you the SparkNotes, which are just my personal opinion, recently we have seen politicians and media figures around the world pick up the story of this report that the US and the Norwegians were responsible for the Nord Stream bombing and demand an investigation, or run with it, or make accusations on its basis. What basis exactly, you might ask? Well I'm glad you posed the question. The claim originates in a Substack article by an American journalist called Seymour Hersh.

He sets out this incredible story that could be straight out of a Tom Clancy novel or a Bond film, of this elaborate plan that resulted in the bombing of the pipeline. And as evidence for it he cites, you guessed it, an anonymous source. Which in journalistic terms is sometimes understandable, but also one step away from "I made it the hell up." And while a writer's identity is usually not a reason to discount a story if the evidentiary base is strong, here the evidentiary base is basically zero. So who is Mr Hersh, and why did he put up a Substack article? Well, Seymour Hersh is an award-winning American journalist. In particular he's famous for exposing US war crimes, the My Lai Massacre during the Vietnam War, and also for some of his articles during the time of Watergate.

But that's the better part of 50 years ago, and his recent work should be considered as context. For example, he expresses a pretty high opinion of Bashar al-Assad. His views on some particularly infamous events during that conflict directly contradict the findings of international investigators without the sort of evidentiary basis you'd expect for making those claims. I bring that up because of the implication that, as a US journalist, what he writes is probably going to be in line with America's policy view. Nothing really could be further from the truth.

And then there's just the weird stuff in his article. For example, he says that Jens Stoltenberg, the current Secretary General of NATO, is an avowed anti-communist who's been cooperating with the CIA since the Vietnam War. Now if that's the case then the CIA has truly broadened its recruitment strategies, because Stoltenberg was still literally a child when the Vietnam War ended. Not just that, his sister was involved in a Marxist-Leninist group called Red Youth. And Stoltenberg himself participated in rallies out the front of the US embassy in Oslo, protesting against some of the bombings that took place as part of the Vietnam War. But I'm sure that was all part of some CIA long con to use his communist credentials to somehow in the future become a reliable Secretary General of NATO.

Heavy sarcasm intended. Now I could go on, there's a whole bunch of stuff in the article that just doesn't make sense. But my main point is this, the information space right now is full of noise.

And in that environment more than ever, extraordinary claims should require extraordinary evidence. And while the fog of war may be very real, it should take more than a blog post, a single anonymous source, and a completely bat-shit claim in order to cause an international incident. Again, I don't know what happened with Nord Stream, I just don't think Seymour Hersh (who has been repeatedly interviewed by or written for Russia Today) knows either. So with that rebuttal out of the way, let's turn to the political considerations.

Because economic damage to Europe was probably only a means to an end when it came to the energy war, the real goal of course of it (and information warfare) was likely to break up the Western alliance. Because, as I've argued in the past, as long as the Western powers continue to accelerate aid to Ukraine then Russia is in an incredibly difficult position. And I won't bury the lead here, European opinion in support of Ukraine remains really strong. Specific divisive measures, like sending battle tanks from Germany into Ukraine, did have an impact on public opinion in some respects.

There were some Germans for example, that got nervous once the Leopards were freed. But the overall numbers are still decisive. 88% support for taking in Ukrainian refugees, 77% for extended financial support. And 65% for the EU stepping in and directly financing or supplying military equipment to Ukraine.

Which is a step beyond individual countries choosing to do so. At the same time, there's been some notable electoral successes for pro-NATO and pro-Ukraine candidates. We've already talked about the election of Petr Pavel in the Czech Republic, whose publicly stated opinion is that Ukraine should be given everything short of nuclear weapons. And then there's the re-election a couple of days ago of Estonia's pro-Ukraine Prime Minister.

Prime Minister Kaja Kallas' victory is particularly notable because of the figures we talked about earlier, Estonia suffered terribly from inflation. A vast majority of Estonians didn't think that the government did enough in order to protect them from cost of living increases. So the economic damage component of the Russian plan clearly was there.

But it didn't stop the election going in Kallas' and, by extension, Ukraine and NATO's favour. It may well be that Estonians hated inflation, but it hated Russian coercion more. I suspect we should all now be watching both the Bulgarian and Finnish elections that are coming up relatively soon to see if this pattern is repeated.

And while we don't have recent country-by-country statistics, I've thrown some up on screen there from late last year that illustrate another point. Public opinion on the EU support for Ukraine varies greatly country to country within the bloc. Some of the numbers are truly extraordinary, like 97% in Sweden and 95% in Finland. It's pretty rare in a democracy that you'd see 97% of people agree on anything.

There are a lot of countries out there where if the government took a stance saying the earth wasn't flat, there would inevitably be some political opponents who embraced flat earth theory simply on partisan grounds. But even in cases where numbers are lower, places like Bulgaria or Greece, things are often slightly more pro-Ukraine than stats make it appear. Mostly because 48% approval doesn't mean 52% disapproval, because there's always a percentage of respondents who say they have no opinion or do not answer the question.

Jump forward to aggregated statistics from I believe February of this year, and you can see how well Putin's charm offensive in the EU has gone. 78% of respondents say that by standing against Russia's invasion of Ukraine, the EU is defending European values. 76% view Russia's invasion of Ukraine is a threat to the security of their country. 84% want to reduce dependence on Russian energy imports.

And something like 68% think more should be spent on defence in the European Union. Now to be clear, some of these numbers have moderated down from the start of the war. But I wouldn't call widespread public support for increased defence spending and EU level defence cooperation a strategic win for Russia's energy war.

Especially since in a lot of places in Europe defence spending used to be basically a dirty word. Something either to be outsourced to other countries, or simply not necessary at all. Now opinions have changed, and we'll see the industrial impact of that change a little later on in this presentation.

But that's Europe, what about America? US opinion is a more mixed bag, but also I feel often not fairly reported. Because one of the most popular headlines you will see whenever US opinion on the war in Ukraine is covered is the idea that US support for Ukraine has "softened", or words to that effect. And looking at a range of polls, so AP, Gallup and a number of others, that's certainly true. The number of Americans for instance, who think the United States is currently providing too much financial and military assistance to Ukraine has definitely increased from the start of the war. To which one might glibly respond, "Yes, because American support has increased significantly from the start of the war."

But another equally important way of framing this story is that this is still a largely bipartisan issue in the US with majority support. Looking at the overall US population, 30% said not enough was being done to support Ukraine, 28% said too much was being done, and 39% said it was just about right. Majorities supported more sanctions, taking in more refugees, and providing more weapons. But the nuance when analysing the US position, and I have to admit Americans, this is kind of fascinating for an outsider to look at, is the increasing partisan split. The Republican Party is heavily divided, with about half saying too much aid is going, and the other half (still a slight majority in that Gallup poll) saying either that current aid is about right or not enough. Basically it seems the Republican Party includes both those who would like to leave Ukraine largely to its own devices, but also some of those who still wish Ronald Reagan was around and would like to see the arsenal of democracy ramp up to speed.

Fascinatingly enough however, according to another poll, very, very few Republicans trust Biden to respond effectively. Which means the vast majority agree that they don't like Joe Biden, even if it's for completely different reasons. I don't bring this up to throw stones at the US political system, a lot of countries around the world suffer from political polarisation or their own distinct political issues.

I bring this up to highlight that there are very few bipartisan issues in the United States, and yet statistically speaking Ukraine is still one of those. There aren't many issues that will get 60% or 70% of Americans voicing their support. Acting on the dangerous assumption that most politicians would like to be re-elected and that going against public opinion is usually not a very good way to be re-elected (although it obviously depends on your electorate and your base) for the moment at least, it seems like US support is holding. For completeness I'll also include a quick aside on global opinion here.

Because it's important to remember the world isn't just the West plus Russia. And as Russian supporters will often point out, countries representing a majority of the earth's population haven't actually sanctioned Russia. So where do those countries stand? Well in the UN general assembly voting for an immediate Russian withdrawal from Ukraine, 141 countries voted in favour, 32 abstained, and 7 countries (including Russia) voted against the motions. As usual Russia was joined by its superpower allies: Nicaragua, Belarus, North Korea, Eritrea, Mali, and the Syrian Arab Republic. I also dug up some Ipsos polling that looked at 28 nations around the world, including some notably "neutral" states like India and South Africa. Although I will note that South African arms companies are helping to supply Ukraine.

And sure enough, that showed that the majority of the population surveyed in non-European Union states didn't support sending for example, military equipment to Ukraine or imposing sanctions on Russia. Strangely enough though, that survey series also showed a narrow increase in the surveyed population who would support sending troops into Ukraine. 27% of Americans were happy to send the Marines, 30% percent of the Dutch, 33% of people in the United Kingdom, and there was also a surprisingly bloodthirsty population in Canada and Australia. Then I found a truly weird result, and with it an opportunity to provide a warning on interpreting survey data.

Because according to the Ipsos "The World's Response to the War in Ukraine" poll, the country with the greatest support for sending troops to Ukraine was India. Which is really strange because 66% of respondents wanted to maintain close diplomatic ties with Russia. Which means, statistically speaking, there must be a portion of respondents who wanted to maintain diplomatic ties with Russia but also send in the troops. Now how does that work? And as always my warning would be read the methodology, read the question, read the details of the survey sample. Now on one hand the sample did skew towards richer, more urban Indians. But I don't think that's what's at play here, instead I suspect the problem is the question.

The question was: "Would you support the government if" and then [insert action here] in relation to the war in Ukraine. And then about 43% of respondents said "support" in response to basically everything. And 66% said "yes" in response to maintaining ties with Russia. And given the overlap between the responses, my working theory is that there is a portion of the Indian population, a not insignificant one for example, that will simply support whatever it is the government chooses to do.

They may have a different opinion on what the government should do. But the question didn't ask what they thought the government should do, the question asked whether they would support the government if it did it. I can't prove that point, but America doesn't have a monopoly on partisan politics. And I mostly include this section as a warning against jumping to hasty conclusions based on apparently surprising survey data.

I may not know how the war is going to progress over the next 6 months, but I would bet pretty heavily it is not going to end with a massive deployment of Indian troops throwing Russian forces out of Ukraine. To put that all together, Russia has failed to break Western public opinion, and it's failed to break apart the Western alliance. There have been marginal moderations in Western opinions on support for Ukraine, but majority support is still very much there. And I'd be nervous about concluding that trends are going to continue forever. Winning the public relations war is going to remain critical. It may even be central to some Russian theories of victory, but if that's Russia's objective, well, there's a long way to go.

But now it's time to turn this around and see how the West's efforts to attack the Russian economy with sanctions have gone. Because while it's clear that Europe didn't freeze over the winter, it's also abundantly clear that the Russian economy is still alive and kicking. Western objectives seem to be pretty self-explanatory, to cause damage to the Russian economy and weaken its capacity to wage war.

In order to do so there were a raft of restrictions and sanctions we've talked about before. Sanctions on the financial system, freezing of assets, restrictions on the export of technology into the Russian Federation, and an ever-expanding mirror of the Russian energy war. Russia tried to go after Europe's dependence on Russian gas. The Western allies meanwhile tried to go after Russian revenues from oil and petroleum product exports.

Import restrictions on Russian seaborne oil into the European Union were put into place. And then we saw price caps, not just on crude oil, but also recently on petroleum products as well. When I first covered this topic 6 months ago, there were those suggesting that this would pretty quickly destroy the Russian economy. And those suggesting that commodified energy products just don't respond well to sanctions and there wouldn't be much effect. So now after a year of war, where do things stand? The short upfront answer is that it really depends. It depends on the product you're talking about, and the measure you're choosing to use.

Do you care about the quantity produced and exported? Do you care about the prices? Do you care about long-term prospects? Where do your priorities lie? To illustrate the point: consider pipeline gas from the Russian Federation that used to largely go to the European Union. Russia made tremendous windfall profits on those gas exports over 2022. Because the Europeans were still scrambling for alternative solutions like getting LNG imports stood up, or putting in place additional energy generation, they were willing to pay basically any price the market demanded for as much gas as possible to fill their storages. And that meant gas prices got very, very high and profits rose with it. But total export volumes fell and are likely to remain depressed because most of Russia's pipeline gas that was going to Europe can't really go anywhere else, at least not easily. Most fields don't have the pipelines to take them to other export customers, like to China.

Nor is there the liquefaction capacity to convert that gas into LNG for shipping. With crude oil meanwhile, well, the product is commodified, it can still travel, you put it on a ship and you sail it somewhere else. And so quantities aren't expected to decline by anything like the same volumes, there instead the question is price.

But let's start with some key headline takeaways. There was a debate in 2022 as to whether Russia would be able to find new markets for its seaborne oil. Would it be able to find people who would buy it? Would it be able to find ships that would carry it? The answer so far has been very much yes. On one hand the big new customers have been China and India, both of whom have massively ramped up their purchases of Russian crude.

But then there's also a giant shell game to get Russia into other markets more or less regardless. The whole thing is sanctions busting 101, and really could make for a decent movie. At least if the entire film-going public suddenly had a thing for creative lawyering and watching slow moving at-sea oil transfers. A third of Russian oil does still travel on European owned ships, but more and more of it is being carried by grey ships and dark ships. A "grey ship" is what happens when a European shipper that can no longer carry Russian oil that's affected by a price cap or some other restriction, simply sells its tanker to another company not based in Europe that wasn't active in the tanker business before.

And that unencumbered company now takes the ship and carries oil. Now those ships are useful for your basic kind of tasks. Then there are the so-called "dark ships", many of which are veterans of evading Western sanctions.

And they are ships that are often owned or operated by countries like Iran or Venezuela. The reporting suggests they are less about creative lawyering to get around sanctions the same way other ships might be, and instead more about things like turning off the transponder. Discussion of how Russia is still getting its crude exported could be a video of its own, there are all sorts of methods being used. Ships leaving ports but not listing a final destination for their cargo full of oil. Ships meeting up at sea and transferring oil at sea.

Or you'll have traders in countries take deliveries of Russian oil, mix it with non-Russian oil, turn it into a different product, and then re-export it. This is a gross oversimplification, but here's the core point. The Russians contend that oil production volumes and export volumes, both on net, increased in 2022. Through fair means or foul, the oil is getting out. But if you go back and read the material underpinning the European price cap and other sanctions materials, they'd all say that this is fine. In fact this was kind of the intended result. As Toril Bosoni of the International Energy Agency points out, the purpose of the price cap was "to allow Russian oil to continue to flow to the market, but at the same time reduce Russian revenues."

If all of Russia's oil exports actually ceased, yes, the Russian economy would implode, but the world wouldn't be in very good shape either. So the objective wasn't to knock down Russian export volume, so much as it was to knock down the price. And in that respect, the Russians are being taken to the cleaners.

Whether it's China, India or these various middlemen, parties that collect oil and then blend it or re-export it, all of them know they have Russia over a barrel (pun intended). And so whereas Russia used to have to trade Urals oil at about a $5 discount against Brent crude, now $30+ isn't even unusual. Now there are some debates in the oil market over who captures that difference, whether it's always the purchaser, or whether it's sometimes middlemen or shipping costs eating into that margin. But the Russian budget was put together presuming revenues of between $70 and $75 per barrel sold. Recently they've been talking about getting $50. And given that figure is pretty close to the production plus shipping costs for some of Russia's oil deposits, you won't be surprised when I talk about the effect on the Russian budget a little bit later on.

There's also another upcoming risk for Russian hydrocarbon exports that I'm not sure has been adequately highlighted. Russia doesn't just export raw crude oil, it also exports petroleum products, things like diesel fuel. Price caps and restrictions on the exports of those products only began in February, so it's still too early to see the impacts.

But there is a possibility that by continuing to push its crude oil out, Russia is undermining its export potential for more advanced products. For example, India is buying discounted Russian crude oil. India is an oil importer, but it has a massive amount of refining capacity to convert crude oil into other products which it can then re-export. I've received more than a few emails basically saying, "Hey Perun, Russian oil is still going to make its way to European markets because the Indians are going to buy it, refine it into products and then re-export it to Europe." That's not an outcome that's mutually exclusive with the EU and the US's objectives here.

Because all Russia is receiving in terms of profit is the discounted price of the original barrel. The person making all the money is India. And even better, India buying cheap oil and refining fuel products means India is now more able to compete with Russia's own exports of those refined products. It's a fact that goes part way towards explaining why Yale Professor Jeffrey Sonnenfeld, when he was asked on DW about what the West should do about India's purchases of Russian oil, basically said that he wished they'd buy more. But most of that is narrative and narrative is a dime a dozen unless it's backed by statistics. So let's have a look at what the impact on the Russian economy over the last year has been.

Although in some ways that's a big ask because economic statistics are difficult at the easiest of times. And getting a consensus view on the status of the Russian economy right now is more difficult than ever. Russian data is now highly opaque, they simply don't publish most of the information they used to. Rosstat's leadership has been changed several times, and I've talked before about the research done by individuals like Professor Sonnenfeld proving that a lot of what Russia does choose to publish is highly dubious. Now the Russian argument for classifying a lot of this economic data is that it could hypothetically be used to assess the impact of sanctions and to better target them.

Which instantly raises a red flag, because if the reason Russia is not choosing to publish statistics is because they might be used to assess the impact of sanctions, then it seems naive to suggest that what they are still choosing to publish can be reliably used to accurately gauge the impact of sanctions. And yet many of the statistics that have been put out there are often taken as given by commentators. I've even seen Russian figures work their way into debates ostensibly as figures that came from Western sources.

People might point to an "IMF figure" for the Russian economy and use it as evidence that everything is going fine. Now there are statistics out there that paint good picture, there are statistics out there that paint a bad picture, but my advice is always the same. Go to the original location, and I know this is boring, but read the methodology. A lot of times you may find that an organisation is simply publishing statistics that have been given to it by a source like the Russian Federation. You should also check whether or not they're including the ostensibly annexed regions of Donetsk, Luhansk, Zaporizhzhia and Kherson in Russian estimates. And yet everything I say in the following section is going to be using Russian figures.

That doesn't mean I think they are correct, there's a lot of good research out there to suggest they are very much not correct. But there's a point to be made here that stands up even if you just use Russian source material. There are a variety of Russian sources out there that are all pointing to the fact that the Russian economy is likely to decline in terms of real GDP in 2023. A survey of Russian businesses estimated -2.1%,

the Russian Central Bank estimates between -1% and -4%, and the Ministry of Internal Development estimates around -1%. Now in response to foreign estimates of larger declines in 2023, the Russian Minister of Economic Development, Maksim Reshetnikov, suggests that those estimates often don't take into account what he calls "strategic measures" that are being implemented. In other words government stimulus and government intervention in the economy in order to hold it up. Now the response of course is that, yes, most estimates are going to take those measures into account as best they can. But it's also a very important point to put some context around this prediction of the economy declining.

Because often national GDP doesn't decline during wartime, often it increases. Because when the government opens the chequebook and decides that it wants to buy 1,000 new tanks (yesterday if possible) that's going to have a stimulatory effect. A tank that is built, shipped to Ukraine, and then destroyed by a Javelin missile is still GDP. And the need to replace it again isn't realised as a reduction in economic activity or GDP, it's realised as an impact on the budget.

And according to the officially released Russian figures, the Russian budget isn't in a particularly good way. Russia set a deficit target for all of calendar year 2023 of 2.93 trillion rubles. By the end of February it had spent 2.58 trillion of that. Oil and gas revenues were down 46.4% compared to the equivalent period in 2022. Overall revenue was down by about 25%, part of that due to declines in income tax. Spending jumped by about 51%, and the National Wealth Fund, basically one of Russia's rainy day funds, declined in value from about 155 billion US dollars to 147 billion dollars over the course of a month.

Now there are a lot of moving parts with those figures, changes to tax, and expenditure timing. Veterans of most organisations know what anarchy comes towards the end of the financial year as everyone struggles to spend remaining budget before the FY ends. In Russia's case most expenditure is traditionally weighted towards the end of the calendar year.

They are saying they're trying to move more of that to the start in order to even things out a bit. But if you're telling me you've spent something like 80% of your allowable deficit, you're two months into the year, and you're trying to fight a war, then either something likely has to change, or you're probably going to sail right past your target. And there are signs that some changes might be on the horizon, mostly in the form of de facto gigantic tax increases. One form this can take is so-called "one-off contributions" by major companies like Gazprom. The company made massive profits when gas prices were high in 2022 and a lot of that money was harvested and handed over to the government.

Now there's talk about changing the way that taxes on oil are calculated in Russia. Basically instead of using the price of Russian blends like Urals in order to determine the taxes, the government is basically like, "Let's just use the price for Brent oil instead," which is considerably higher. Now the government pretending that the price of oil is higher doesn't magically make it so. All it means is the oil company has to hand over more money. Which may, to be fair, help in the short term, but in the medium to long term it's a serious issue. The Russian energy sector is actually in pretty desperate need of recapitalisation.

They lost access to technology and investment from the Western world as a result of sanctions, and they need to reinvest in order to open up more deposits if they want their industry to be sustainable or cost competitive going forward. That's hard to do when you're taxed on profits that you didn't actually earn. And I imagine we're all hoping governments around the world don't discover that particular technique. There's also talk of doing things in sectors outside oil and gas. There's talk of a one-off budget contribution by businesses, reportedly, which would basically be a one-off wartime tax for certain businesses.

And you see discussion about changing the calculation method for certain taxes. Again, I'm not generally a betting man, but if someone offered me the option to put money down to say that once those taxes are recalculated they are not going to end up lower, I'd probably take it. And then when government talks about forcibly acquiring or forcing the sale of foreign owned assets for a fraction of what they're actually worth, well, that may do something for the budget in the short term, but it also pushes long-term investor confidence out of a 17th story window. So I will concede there is uncertainty on how the Russian economy has fared over the winter, and indeed over 2022 and early 2023.

Like with most things to do with the war in Ukraine, there is actually a wide information spectrum. Which I have imperfectly chartered on the right there because I'll be using it a lot later on when I talk about casualties and force generation in the future. But the key is there's a lot of different sources out there. And online some of the loudest are actually more extreme than what the Ukrainian or Russian Ministries put out. You might see pro-Ukraine channels that are far more optimistic than the Ukrainian government itself is.

And on the Russian side I consider a lot of what the Russian Ministry of Defence puts out to be complete and easily disprovable crap. But it is nothing compared to the material that you see from some of the pro-Russian foreign cheerleaders or disinformation efforts. On the topic of the Russian economy for example, even if the Russian Central Bank comes out and says that times are tough and the economy is probably going to shrink, you'll still find those out there that say that Russia is booming economically and is in a stronger position than when it started. And they'll say it with complete confidence like it is the most obvious thing in the world. But the best evaluation I can make based on the available statistics is that the Russian economy, and particularly the Russian budget, are hurting.

The effect is likely much less extreme than many in the West hoped for, and it's also taken longer for the effects to start being seen. But the impact on the budget and the economy is very clearly there. Russia has gone from strong expected growth to economic decline. And the budget has swung from strong surplus towards deep deficit.

But my warning, and I've talked about this before, is that none of this is likely to be significant or lethal to the Russian war effort in the near future. There's plenty Russia can do to hold the economy up and to patch the budget. The key I'd focus instead on is how well Russia goes with mobilising its economy for the purpose of war production. Because having money only matters if you can convert it into combat power.

Private Conscriptovic probably doesn't care about how many rubles are in the National Wealth Fund. He cares about whether he has body armour, ammo, and something to eat. And so we'll look at military mobilisation in just a bit. Because first I wanted to give an update on Russia's strategic bombing campaign targeting Ukrainian energy infrastructure. And I know there are probably those out there saying, "Hey Perun, this probably belongs in the episode about battles."

But given, I'd argue, the primary purpose of the attacks is to damage Ukrainian will and the Ukrainian economy, I feel like the topic does belong better here. In short, Russia's attacks on Ukrainian infrastructure accelerated greatly under the former commander of the operation in Ukraine, General Surovikin. The attacks reached a particularly high tempo in the closing months of 2022, October, November, December.

With the switch over to Gerasimov's command we have seen some changes in the Russian approach, but also some continuity. The frequency of the attacks has dropped, but the targeting has remained broadly similar. Now one of the great fears back in November and December was that this campaign might plunge Ukraine into darkness during the cold of the winter months. With temperatures below freezing, a complete collapse of the electricity grid would have been catastrophic, but "could have" doesn't win any medals. I could have chosen to study something that makes for a fun conversation topic at parties, defence economics doesn't exactly make good stand-up material. Vladimir Putin could have chosen not to invade Ukraine, but he did.

And the Russians could have knocked out the Ukrainian power grid over winter, but they didn't. That's not to say that the Ukrainian power grid didn't suffer extensive damage. There were estimates towards the end of last year that 40% of the grid had suffered some degree of damage.

But the work of the repair crews, and the efforts to rebuild, rebalance, and maintain the network have been phenomenal. The Ukrainians got better at hardening the grid. That meant quite literally putting up fortifications in order to protect some locations and transformers from Shahed attacks. But also getting better at shutting down parts of the grid, managing loads, and preventing excessive damage as a result of strikes. Energy restrictions remained a reality, but by the beginning of March the grid as a whole was generally more stable than it had been in November or December. To put some figures around it, there's an internet connectivity measure for Ukraine after the most recent missile attacks, the largest in some time.

The internet devices are not magic, they require electricity, and after the attacks connectivity dropped by about 25%. But before even a day had passed, connectivity had already recovered to 91%. But I'm sure knocking 25% of the Ukrainian population off Steam for 12 hours was absolutely worth the expenditure of multi-million dollar hypersonic weapons. Back in December where the situation was at nearly its most dire, there were some estimates done by Simeon Djankov of the London School of Economics. They used a variety of economic data sets from Ukraine in order to estimate the scale of the power blackouts and the impact on economic activity. Their findings were that the attacks in September and October caused relatively short and limited disruptions.

The 10 October raid for example caused a 10% loss of productive hours on the day that it arrived, but by day +4 everything was basically back to normal. What they did find however was the attacks had a compounding effect. Because the attacks at this point were coming every one to two weeks, there wasn't enough time to address and control for all the damage.

And so the impact increased with each successive raid. Most of you will remember the 23rd of November raid and how it knocked out power across a significant part of Ukraine, at least for a while. But the impact on the economy in November, as they assess it, wasn't exactly ruinous. Power was available during 10% fewer productive hours.

Sales at caf├ęs per point of sale went down by about 10%, and imports of power generators massively increased. But single digit percentage declines in certain points of economic activity does not a successful campaign make. Now one thing I'll add to those statistics is they do not cost in the quality of life factor, or the increased costs that individuals have to bear. It doesn't take into account the fact that businesses had had to pay to run backup generators. It doesn't take into account the stress of workers who had to work all sorts of weird and wonderful hours in order to take advantage of power when it was on.

And it doesn't capture the misery of cities and towns being cut off from a regular supply of drinking water or power for days or weeks at a time. But while it's relatively limited data, it hardly looks like an economic knock-out blow. The campaign also still places a strain on Ukraine's air defences. Significant numbers of new air defence systems have been pledged to Ukraine, but not all of them have arrived and gone into service yet. The missile attacks also have forced Ukraine to pull some of its air defences back from the front in order to defend its cities. And some Russian weapons like S-300 or their hypersonics have proven very, very difficult for Ukraine's ground-based air defences to intercept.

Depletion of Ukraine's GBAD assets remains a critical threat, and Ukraine is going to need both more launchers, more radars, and more missiles in order to defend itself. But at the same time the depletion of Russian missile systems is an issue as well. Attacks have slowed closer to the rate of what Russian factories can resupply.

And hundreds of missiles fired against civilian energy infrastructure are hundreds of missiles that haven't been used to engage critical military targets. So how is the Russian strategic bombing campaign going overall? Well, I'd argue that so far it's been an abysmal failure, but that doesn't mean it isn't a real threat and won't continue. Ukrainian willpower obviously hasn't broken, and the Ukrainian economy obviously hasn't collapsed.

And while damage to the grid might compound over time, the Ukrainians have worked miracles and foreign suppliers are also working miracles to facilitate repairs. Many countries have gone to relatively extreme lengths in order to get Ukraine replacement critical equipment like transformers. Hitachi Energy for example, completely re-jigged its existing production delivery schedule to move Ukraine's requirements to the top of the list. A list of countries that provided Ukraine transformers is too long to go through, but it includes places like Azerbaijan and Croatia. One problem the Russian campaign faces is that if it takes too long to knock out the Ukrainian power grid, well then there begins to be time for long lead-time items, things that take 6 or 12 months to produce and supply, to begin arriving.

Blowing up transformers with cruise missiles just isn't a good deal if your opponent has a decent supply of replacements available. And so I'd say the campaign is a going concern. So far, the Russian expenditure in munitions far outweighs the value of the results they've accomplished. But each new strike brings new risks, and the ultimate result remains very contingent.

And so we come to the last part of this update, the question of military production. Because one thing that's become very clear in this war is that it consumes materiel, like so many wars before it, at an incredible rate. And how the war progresses is likely to owe a lot to how well the various countries involved are able to produce all the materiel needed to fight it. And I want to quickly talk first about the Ukrainian defence industry, because I don't often see the topic covered. The Ukrainian defence sector has had to face a lot of challenges.

Pre-war it wasn't particularly well funded, its factories have had to disperse, some have been destroyed, and it's had to adapt to wartime conditions. I'm sure my Ukrainian listeners would forgive me if I went into some of the horrific mess that was contracting and production in the pre-war Ukrainian defence sector, but in the interest of time I'll stick to the present day. Perhaps unsurprisingly, being invaded has had a motivational impact on the Ukrainian defence sector.

Money has flowed in from the West and some adaptations have been made. One example is that Ukraine is now producing domestically its own 152 and 122mm Soviet calibre shells. The problem based on the best estimates I can find however is the quantity. A few thousand shells a month will help, and production will expand, but it's unlikely to move the needle on a conflict of this scale. Perhaps more significant, as recently reported by Michael Kofman, is that the Ukrainians are proving increasingly capable of maintaining and repairing a lot of the Western equipment that they're being sent. Obviously the option remains available to send equipment to Poland, Lithuania, Germany or the Czech Republic for repairs, but that takes time.

And the Ukrainians are Slavs from a former communist country. Which means being able to repair things when they break down is basically a genetically ingrained survival skill. And so I wouldn't be too quick to write off the contributions that Ukrainian industry can make, not just in the area of repairs, but two other critical respects. The first is in areas of comparative advantage, where Ukraine is genuinely pretty damn good at building a particular product.

Probably the best example we've seen here is Ukraine's home-grown drone industry, where you haven't just seen innovation and workshops popping up all around the country, you've also seen foreign companies increasingly interested in partnering with Ukrainian talent and facilities. Ukraine's got pretty good for example, at producing first person suicide drones costing as little as a few hundred dollars. Which is horrifying for the future of war in general, but probably pretty useful in the near-term war effo

2023-03-16 19:12

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