Moody's Talks - Inside Economics - Bonus Episode: Russia-Ukraine Conflict

Episode Date: February 15, 2022

Gaurav Ganguly, Senior Director of Economic Research at Moody's Analytics, joins the podcast to focus on the Russia-Ukraine conflict and what it means for the global economy.Full episode transcript. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Sandy, the chief economist of Moody's analytics. And this is a special bonus edition of Inside Economics. We are going to be tackling the question of Russia, Ukraine, and what it all means for the global economy. And I'm joined, well, we're missing one of our co-hosts, Ryan Sweet, who's struggling to get in. I'm sure he'll figure it out at some point. And also Chris Dreadies. Hi, Chris, Deputy Chief Economist. Welcome. Hi, Mark. Thanks. Good to have you. And the man of the hour, Garav Ganguly. Garab is our colleague in Europe, and he is the head of Amia economics, European, Middle East, and Africa. And welcome, Grav. Thank you, Mark. Hi, Chris. Good to be on the show. Yeah. And we have a lot to talk about. As I said, we are focused on the Russia-Ukraine conflict. I thought about using the word kerfuffle, but that doesn't feel significant enough, right? So I should say conflict.

Incursion? Incursion. I think Biden said incursion. He used the word incursion? Okay. How are you too strong? I sort of flip between saying incursion and invasion depending on how I feel about the whole thing.

Oh, well, yeah, good point. There is a dark view in Europe. Robert Harbeck, Vice-Chancellor of Germany, said that we're facing a prospect. of war in Europe soil for the first time in 70 years. So certainly on this side of the Atlantic, some of the views around this conflict and the escalation of this conflict,

quite somber. Yeah, appropriately so. Hey, one other nomenclature issue, do you call the capital of Ukraine Kiev? I believe that's the way the Ukrainians pronounce it, or Kiev. I believe that's the way the Russians pronounce it. How do you pronounce the capital?

Well, I should probably indicate my sympathy and say Kiev. Yeah, okay. That's my instinct here. And I think most major media outlets, at least here in the U.S. are now saying Kiev, you know, because it's the way the Ukrainians pronounce the capital's name. Okay, so that, we set the ground rules here. So it's an incursion until it becomes an invasion, and it's a capital's Kiev. Okay.

And I should say, Amia, you're, I said your opinion. in Middle East and Africa, and Garab, you joined us now, wow, almost five, six months ago now, I think. Five and a bit months ago. Yeah. Well, we got you on the hot seat here. So thanks for doing all this work. And we've got a lot planned with regard to our efforts to analyze this incursion. This is the first thing that we're doing this podcast, so we give you a sense of how we're thinking about things. We do have a webinar. Grav is going to lead the way that comes next week. I think February 24th, invitations are going out for that.

We are running a number of different scenarios. Obviously, a lot of uncertainty here. Who knows how this is going to play out? So we are considering different scenarios. We're running that through our global model and producing forecasts based on those different assumptions around what happens in Ukraine and Russia. And putting that into databases for people to use. And that'll be available sometime next week.

as well. And finally, Grav, I think you said you're writing a white paper to kind of explain all this. That's right. You got the time line exactly right. So by the end of next week, we pretty much have all our analysis available for clients to use and for people to take a look at. But here we are. And, you know, how are things going there? Can you always, Garab, just give us a lay of the land politically? I mean, I know it's very difficult because it's very fluid. A lot of things changing. this morning. Here we are talking the morning Eastern time of February 15th, Tuesday, February 15th, and already a lot of news today. So how are you thinking about things? What's the lay of land with regard to this issue? Well, as I said a moment earlier, at least in some quarters in Europe,

the mood is quite somber. And it is a fairly worrying situation. Some say that this is fairly path of the course that about every year this time for several years, Putin's true. close to the Ukrainian border. But what's happened this year, I think, sort of made some of the events of previous years, bail in comparison. We've seen significant troop buildup for the last couple of months. We were worried about troops in the eastern part of the country first, but now we're increasingly also worried about troop buildup in the northern part of the country,

fairly close to Kiev. Now, Putin says that that's all been planned and signaled in advance. These are joint troop movements with the Belarus, typically conducted around this time of year, but the timing is curious, and the troop movements have been quite alarming, at least from a NATO perspective. Now, when we look at some of the things, some of the demands Putin has made, it seems like they are quite extreme. So he issued a set of demands to NATO, as you're aware, as I think everybody's aware now, everybody's following this quite closely, asking for NATO to pull back their troop movements and basically revert to

their 1997 position. Now, that's unacceptable to NATO, I think. So if that sets the bar below which he's not willing to negotiate, then that's a bar that's just impossible to meet. NATO's advanced in successive stages since the fall of the Soviet Union and with plans, and it had actually planned to include the Ukrainious part of NATO, which I think is completely unacceptable to Putin, but equally to roll back to 1997 would be absolutely impossible.

So then that means that if that's the bar that he said, If that's not a bar that's ever going to be met, then where do we go from here? I think that's the key question. There are a couple of possibilities that would still avoid conflict, and I think that is what's keeping up hope in Europe, that we don't have to necessarily go down the route of an incursion, far less a full-blown invasion, that there are diplomatic possibilities available to Europe and to Russia.

And it probably might even be reflective of the comments made by Foreign Minister Lavrov, yesterday when he said that it would be possible to find a diplomatic solution to which Putin gave his assent. Now, that probably focuses on what's been happening in the eastern part of the country ever since 2014. Can I ask, so there's been a couple pieces of, I guess, good news. I mean, markets this morning are responding positively. You mentioned Lavrov, the foreign minister, saying something publicly to Putin about, you know, perhaps there's a diplomatic path forward. I'm obviously paraphrasing, but that's kind of roughly what he said, which seems somewhat encouraging.

And then we hear that the Russians have announced that they're pulling back some of the troops on the border. I don't know if they are or not, but they are announced that they are, that's what their intention is. In markets are interpreting that positively, stock prices are up, oil prices are back down. how do you handicap all of that? I mean, what do you think is going on? Is this as positive as people seem to think?

Obviously, we don't know, but what's your sense of that? So, as you said, we don't know. It's really hard to get a line of sight into what's going on and Putin's head at the moment. It probably requires somebody with considerably greater, you know, strategic acumen than I have. But if I look through some of the noise that's been going on over the last few days, the kind of noise that you outlined very, very clearly, Mark, then I'd say that

the general tone of the discussion has turned a bit darker in the last week. So I guess maybe a week ago, I would have said there's a 50-50 chance of some sort of incursion into Ukraine versus troops actually pulling back in some kind of negotiated settlement. And I get the feeling now, it's a bit worse than that. There's still a significant path to no incursion, which might be somewhere closer to 40, 45 percent, but it's probably the balance of probability is probably shifted over to some kind of incursion, 55. Interesting. So what you're saying is the improvement in market sentiment is misplaced in your view.

I mean, you're thinking has gone in the other direction here. Yeah. And actually, maybe what we look at is not just the recent, today's buildback in markets, but the fact that there's been a bit of extra volatility in markets because we're seeing in the last few days because we've seen pronouncements going either direction. Okay. I guess it's a question of degree as well, right? It's not just invade, don't invade.

There are different levels of invasion. And it could be that markets are interpreting this as a perhaps a bit of a concession, but that certainly doesn't rule out an invasion of the Dumbas region, for example. So maybe the probability of a full takeover is lower, but I think that's right. I agree or are you still pessimistic? Markets are focused on the, you know, the tail risk. And they're saying, oh, that looks less likely. But it doesn't mean that the probability that they may actually invade the Donbass region.

And we'll come back. Maybe we'll let Grav explain all that. But that's a less aggressive incursion or invasion that that feels more likely then. That's kind of what you're saying. I think. Yeah. It's a question to Garov. Is that what you're interpreting?

Or when you say you're a little bit more pessimistic, is it? Do you have a tail or is it in the middle? I think that's right. I'm probably even a little bit more pessimistic than what you've just outlined, Chris. I kind of feel that that tail kind of scenario is probably roughly the same. Maybe it's gone down a bit. There are some bits within the tail that are very remote. And I'll come back to those later.

In fact, one of our scenarios touches on some of the really remote things that could happen in the tail. But I think you're right in that markets are probably thinking that some kind of inversion, maybe into the Dunbass region is possibly slightly more likely, but that's palatable. Can I... Economic outcomes, those would be palatable. We need to go, we're going to go down these different scenario paths shortly and make that very explicit and clear in people's minds in terms of how we're framing this in terms of scenarios and probabilities.

But before we do that, and again, this is, these questions are, you know, obviously, who knows, but I'm just curious what you think. And Chris as well, what is the end game here? What do you think is going on really? Why is Putin doing this? What does he hope to accomplish at the end of the day here? Do you have a sense of that or do you have any view on that? Well, I've been thinking about this long and hard and trying to figure out what exactly Putin wants.

And I gave up on economics at this point and started reading history and discovered the really long, rich history that the Ukrainian people. have and their long connection with different parts of Europe from Poland and Lithuania through to Russia. But then I kind of fast forwarded all of that to about 2010, 2011, when Ukraine first expressed an interest, started to express a serious interest in getting closer to the EU. And there was talk of trade association with the EU, which ultimately led to Russia interfering in Ukrainian politics and having the Ukrainian Premier removed, which led to people's protests. And subsequently then, incursion into Donetsk and Lugansk and the Crimean takeover, or supporting the separatists in Donetsk and Lugansk and the eastern part of the country

and the Crimean takeover. So that was very clear that Putin was very unhappy with the state of affairs with Ukraine getting closer and closer to Europe, not just NATO's proposal to actually extend its front further eastwards and envelope the Ukraine. So all of that gets somehow Ukraine, you know, having performed as an independent state in 1971 after the fall of the Soviet Union, now actually being absorbed into Europe,

absorbed into nature seems to be completely against Putin's thinking. He feels, I think he feels that he needs to have a, leave his legacy. And in his legacy, it's got to be that Ukraine or the Russian favored part of Ukraine actually returns to the vote, which does make me think that there's still a significant possibility that he will be content with an outcome where that happens without necessarily having to send his troops in. And there are different ways we can get onto that later. there are different ways in which that can actually happen.

So that's what I think his motivation is. I think that by setting the bar so high with NATO, he may have, he may have miscalculated or he may not, to be honest, it's really hard to tell. But I don't think that's what he's after. He's not after NATO actually going back to its 1997 border because he must surely recognize that that's completely impossible.

Yeah. Yeah, okay. So it's really not about, NATO per se, it's just really about the eastern part of the Ukraine, which is, in his view, historically, that's been Russia. I mean, that's part of Russia. And therefore, I want that back. I think that's right. I think it's about more than just the eastern part of Ukraine. It's about getting back to the Russian people, the Russian-speaking part of Ukraine back into Russia and making sure that Ukraine, I guess if that means that he's got to play a fairly destructive game

to make sure that the Ukraine doesn't move towards the EU or towards NATO, then he'll do that. And I suppose also maybe it's just a test. I mean, maybe he didn't really expect to gain anything with regard to NATO, but hey, you know, why not probe here a little bit? I mean, just see how they react and what, you know, maybe there will be some, it would create some fissures between NATO allies, between, you know, the Germans. who are tied very closely to Rush to via, you know, the natural gas that flows to Germany and the rest of NATO.

Maybe that's part of what he's thinking, too. That could well be. That could be. He played his hand very well in terms of restricting oil and gas, restricting, sorry, gas supplies to Europe, taking advantage of the winter season to do that. He also restricted wheat exports, Russian wheat exports in December, ostensibly to preserve domestic consumption, but actually that's not something that great for wheat prices either.

And certainly he's gained a lot of really good publicity. If you imagine that Putin has, all he's had to do is put 100,000 troops near the border with Ukraine, and every single major world leader has flown over to meet him as a result. You'll recall that meeting with Macron on the big white table. I guess that's just simple. Right. What a picture.

The table was a football field it looked like. Putin was on one end and Macron was on the other. It was pretty bizarre. Yeah. And he's managed to show the world that he's prepared to align himself with China and that China is willing to have that and that they are willing to deepen the economic relationship. I don't know what that really means.

How meaningful that is in the long run, but at least it's a sign. Yep. I think at a minimum. Yeah, I think at a minimum he's now solidified Ukraine as a buffer state, right? We're not, the West is not going to embrace NATO or embrace Ukraine into, or bring Ukraine into NATO anytime soon, right, because of these tensions. So that alone might be enough, right? I just want to make sure that, or he just wants to make sure that Ukraine is in the middle

there as a buffer, doesn't want any troops on his borders. Because they were thinking, they were flirting with becoming part of NATO, I guess. Yeah. It's gone back and forth over the years. So I think that is really off the table now. Maybe not explicitly, but implicitly for the foreseeable future. Hey, let's talk about the scenarios then. So I guess this is kind of a, if you think about it, a tree of possibilities in the kind of the first branches, you know, invasion, no invasion, right?

So how do you think about that, Robben? how do you handicap that part of the probability tree? So I think, as I was saying earlier, I've become a bit more pessimistic about the prospects of some kind of incursion into the Ukraine over the last week, whereas a week ago I was much more even about it, thinking it's about 50-50. I now think it may be more like 45, 55,

or even 30-60 on a dark day. 40-60. Oh, sorry, like 40-60, getting all these probabilities. I get my head. So I kind of veer between these kinds of, this is sort of a boundary right now. It's a bit more negative around the possibility of no incursion.

But let's be clear that even not sending troops in doesn't mean that Putin's not going to interfere with the Ukraine. So I think the possibility that actually Putin takes his troops back from where they are now, that he completely leaves Donetska and Luganska alone and doesn't try to interfere with Ukrainian domestic politics and acquiesces to NATO's wishes to unfold to Ukraine, virtually zero. There's no way that's going to happen.

Yeah, right. Which means that when we talk about no incursion, what we mean, and this speaks to Chris's point, that he's going to continue to interfere with the Ukraine for some time to come. He's going to continue to want to weaken the Ukraine's sovereign structure, the relationship of provinces with the central government, weaken them, make sure that these provinces become more federalized, that they have greater freedom to align themselves with Russia if they wish, and he'll be willing to fight proxy wars or even encourage regime change in order to get it.

So that's the no invasion scenario, which is not really that great in that outlook for the Ukraine. Let's stop there for just a second. So one question is, okay, I guess that's the most positive possible outcome here that, you know, Russia does not actually. invade. Certainly they're going to interfere and create havoc, but they're not going to invade. If that's the case, what does that mean in terms of, I think, the most, you know, the kind of the benchmark we're using to assess the economic consequences of what's going on there is oil prices. So oil prices, you know, if you look at Brent, which is kind of the globally traded price,

that's close to, well, last I looked was close to 95 bucks a barrel. That feels. like that's up $10, $15 a barrel on the Russian news. I mean, it was up anyway because of demand supply dynamics coming out of the pandemic. Demand picked up faster than supply. And there's a lot of things going on with OPEC and North American fracking. And therefore, prices were up. But the problems in Russia, Ukraine, have added 10, 15 bucks a barrel. So my question to you is, that sound about right. And does that come out of price, do you think, if we go down this, this more positive scenario of no invasion? I don't see that it comes down a whole lot if he simply backs his troops away, because there'll always be the fear of some renewed threat. Maybe some of it comes back down,

as he'll be some relief in the market, I guess, as he does this. So, yeah, I can see some of it coming back down. But overall, he's still going to be very connected with the Ukraine. He's still going to be very interested. But it's less oil that I worry about, to be honest, Mark. It's more European gas that I worry about. And here I think, you know, I struggle to see the stress go away at all, even if he steps back, because Russia has such a strained relationship with Ukraine when it comes to the supply of gas through the Ukraine into Europe.

And it's going to do whatever it can, I feel, to simply reduce that supply and deny the Ukraine transit fees from gas. So they're very keen to have Nord Stream come online. Now, Nord Stream will carry about 55 billion cubic meters, a year. That's Nord Stream 2. That will double the entire North Stream capacity. North Stream 1 has the same capacity. So there'll be an entire 110 billion cubic meters of gas that can flow outside of the Ukraine directly under the North Sea into Germany. Ukrainian gas, its capacity is currently about 45 billion

cubic meters. It carries much less because gas Trump simply refuses to supply the gas via the Ukraine. And I can't see that that pressure goes away that suddenly we'll have full flow of gas through the Ukraine, Europe gets what it needs, and maybe even North Stream comes on because Europe feels comfortable with North Stream operating. So I think those pressures remain. Maybe it takes North Stream some time to come online. It might be to the end of the year to get various regulatory approval, et cetera. And at that point, maybe we start to see gas prices starting to come down. But then we're also going into winter at that point. So if we go through a stressful summer. Europe simply will be going into the next winter in a fairly vulnerable position

without enough gas in storage. So I can see pressure on gas remaining for some time. And that's pretty bad from a Europe perspective and inflation in Europe. Yeah, it's a good point. So, you know, from a kind of a parochial U.S. perspective, I'm focused on oil, but because gas does, these natural gas markets are generally local markets. So with the price here of natural gas, It's elevated a little bit because of what's going on in Europe through liquefied natural gas demand, that kind of thing. But it's pretty much on the margin. Here, in much of the rest of the world, the economic fallout from what's going on in Russia, Ukraine is through oil prices. But in Europe, you're right.

It's mostly about natural gas because, correct me if I'm wrong, I think about a third of European gas comes from Russia. And just a level set for the listener, the main way of getting. natural gas from Russia to Europe is through the Nordstrom, I'm sorry, I just, well, there are four pipelines, Mark. Four pipelines. There are four principal pipelines that carry gas from Russia into Europe. And you're right, it's about a third of Europe's gas requirement. The rest comes from places like Norway, Algeria, some from LNG terminals, and a declining

part of it from domestic production in the Netherlands. Now, that's actually a bit of a problem, the domestic production of the Netherlands, because the Dutch shut down on production and it's on a steeply declining trend over the past few years because they've been experiencing earthquakes in the north of the country where these gas fuels are.

So that's meant that reliance on Russian gas has actually sort of increased over that period of time. But yes, there are four pipelines that bring gas into Europe. The one that I was talking about, the one through the Ukraine supplies a bunch of central European countries.

And that's the one that's, of course, been fairly, had a fair bit of spare capacity. And again, as you were saying, if the Russians want to shut that down, basically, and move it up to Nord Stream 2, which is the second pipeline that goes through the, kind of the North Sea into Europe, which is directly from Russia into Europe,

they want to use that instead of going through Ukraine. That's my sense of it. Of course, Russia hasn't said that. Yeah. It's important to note that that's not Russia's stated intention, but it would clearly be another lever, another bit of pressure to bring to bear on the Ukraine if North Stream 2 were to operate.

because that's 55 billion cubic meters of gas right there bypassing the Ukraine. And if you take the second pipeline that the second North European, or the third North European pipeline, if you take Nord Stream 1, Nord Stream 2, and then the third pipeline that runs from Belarus into Poland and Germany, then you would get in total about 160 billion cubic meters. That's almost sort of half of what Europe gets from, or more than half of what Europe gets from Russia in a year.

So at that point, there's huge, Russia is in a hugely strong position when it comes to negotiating with the Ukraine. The other point to make is that the gas firm's agreement with the Russian with the Ukrainian pipeline distributed and after gas runs out in 2024. So right now there's a long-term contract and a long-term commitment to supply a certain volume of gas through the Ukraine, but that's all up for grabs in 2024. So if you get Nord Stream 2 up and running before then, then I think. We're going back to that scenario, you've continued interference in the Ukraine.

That's a very powerful lever. Yeah. So 40% probability of no invasion, but regardless, there's still, it may be global oil prices come in a bit, but gas prices, natural gas prices going into Europe remain elevated. And of course, the uncertainty around the, the supplies will remain very, very high going forward. Let me think one other question about that before we move on to the other scenarios. It seems, you know, from a European perspective that this, this is a, this is a bad arrangement that they need to be working regardless of what happens. You know, even if Russian pulled all 130,000 troops off the border and went back to their barracks,

after all this, wouldn't you really be working pretty hard to get off of Russian gas? I mean, LNG seems the most likely way you would go. And by the way, I just saw a statistic. I think if you look at the share of natural gas coming into Europe, LNG is now the highest share. It's higher than Russian. It's more than a third. It's rising very quickly. But it feels like you would just go into hyperdrive on LNG,

local financial gas, and try to get that from Middle East, maybe from the U.S., I don't know, you know, that kind of thing. Is that part of the discussion? It must, you would think. It is. It certainly is.

And you're right. LNG supplies, since the start of this year, really ramped up. And there have been many, you know, the stories of vessels just queuing to get into deep sea, deep sea ports in France and its southern Europe to offload their stocks.

There's a, of course, a capacity constraint there. You can only offload so much, and then you've got capacity constraint at regasification plants because the liquefied natural gas has to be gasified again and then sent up through a pipeline. But that broad a story of why on earth is Europe not doing more to actually diversify away from Russia? I think this is also a typically European problem once again. So Europe has taken a bunch of measures over the last 10 years to improve its gas security and its gas efficiency in particular. So it all started out with having gas pipes flowing through Europe, carrying gas from Russia across European countries, but they only went in one direction or they largely went in one direction, which was to their destination.

So if you had, you couldn't do effective demand management as a result. So then gas interconnectors were improved to allow gas to flow back. And that improved energy efficiency. At the same time, deep sea port started to be built to increase the capacity for LNG. And all of that takes time. And also, I guess it occurs at a typically European pace because there are 27 member nations to deal with an agreement that has to be, you know, you've got to get a great agreement from all sides before you can do something big. So now I guess what this shows is that energy security simply is really top of the agenda.

And having a unified energy storage solution, for instance, is quite important. So there are gas storage facilities across Europe, but each country does its own thing. That's also not an optimal arrangement. You actually need Europe to be acting as one in buying and storing gas and agreeing to distribute it across countries. You've got to have greater ability to source LNG. That's not an overnight solution. In addition to having to build ports, lots of LNG supplied on long-term commitments, so actually diverting energy is not that straightforward.

You've got to scale up renewables. that's got to be part of the solution. So it is possible, for instance, to double the base of installation of solar PV. And you've got to do more effective demand side management and energy conservation measures. So a whole bunch of measures have to come together. Problem is that none of that's, of course, overnight.

So Russian gas dependency doesn't really go away that soon. It's also really interesting. One more thing I'll say about it, which is Russia's own perspective on this. So in 2020, Putin brought, in a Russia Energy Security Act, which sees Russian plans to diversify away from Europe out to 2035. So Putin really wants to sell more gas to Asia. But if he's going to do that, then, you know, Europe had better sit up and pay attention and work a lot harder to diversify

away from Putin. Yeah, makes sense. And I guess just as a quick sidebar, exacerbating all of this, of course, was Germany's decision back under Angela Merkel to mothball all the nuclear facilities for electricity. So they became very reliant on natural gas to power their electric utilities. And that's why almost half of the gas they consume comes from Russia because they're so dependent on it, just something to keep their mind. Absolutely. That was a big energy policy mistake. If I saw one, that was just such a knee-jerk reaction to Fukushima. Yeah, right, which was the Japanese facility that nailed by the earthquake and tsunami.

Okay, let's move on. So 40% probability, no invasion. We kind of talked about that. Now, let's go down the other part of the probability tree, and that is invasion. And kind of lay that out because there's different versions of this scenario. So give us a sense of that. So we've talked a little bit about it already, and we've mentioned the Donbass region and the possibility of invading there.

And I mentioned Donetskin-Lugan. So this again takes us back to 2014. So a little bit of history again, I guess, when Russia essentially supported separatists in two eastern provinces. And these eastern provinces declared themselves as quasi-autonomous states. And they've been basically fighting ever since with the Ukraine. Russia claims not to be supporting them, but of course it is. And a protocol was actually signed in 2015 called the Minsk Protocol that sought to bring all this to an end.

So to have a ceasefire there, to have these provinces actually federalized and set their own foreign policy. That protocol never came about. And my feeling is that a big win for Putin would be to actually get that protocol revived and to see these two provinces and eastern Ukraine be firmly in his hands. just as much as Crimea is in his hands right now. So I guess one of the paths down to invasion would be to say that actually, Putin is not going to achieve that through diplomatic means and therefore simply has to send troops into that part of Ukraine

and actually into the wider eastern part of Ukraine, which is called the Donbass region. That's actually a fairly big region, and it could be quite difficult for him to even hold on to that region for a long period of time, but it's certainly doable. And he may even then to send a message to the West and to the Ukrainian regime go beyond the Donvass region. So sort of extend a little bit further west.

And that would be one scenario. What kind of probability? Okay, now we're down the incursion, invasion probability part of the tree. And that has a 60% probability all in. And what percent of the total possible range of outcomes would be this, okay, I'm going to invade the eastern provinces, the Donbass region of Ukraine, and stop there or go a little bit further into the western part. But that's that scenario.

What kind of probability would you attach to that? That's my main incursion scenario. Okay. Everything else I see is in the tail. So I'd be putting upwards of 50 percent on that one. And that's 50 percent of any possibility. possibility. It's full.

I'd be putting somewhere between 50 to 53, 54% probability on that occurring. So if I put 40% on no invasion, and I'm putting up to 50% to 53% on this particular I'd come less likely. Okay.

So this is the most, in your view, likely scenario. Yes. That's what I would see is the most likely. This would almost, this would be your baseline then. It kind of is in terms of, in terms of his actions, yes.

Okay. Okay, interesting. Okay, very interesting. And, okay, so let's think about that for a second in terms of the economic implications. Or, first of all, it sounds like if he does that, there's going to be some reaction from the West, from Europe and the U.S. So in that scenario, what kind of response do you think we'd see here? So I think there's got to be some reaction. And from the U.S., I think there's got to be a fairly clear reaction. I'm less convinced about what Europe might do and how Europe might play along to anything that the US does.

So for so many reasons, it's important for the US to stand up to any incursion into Donbass, including wanting to send the Chinese a clear message about international politics. So that's clear. It's less clear that the Europeans would at this point be completely unified in their response because we'd have to look at what exactly it is that the US does. Now, a number of options have been outlined. It might be worth just stepping through some of these. These include sanctioning individuals in the Russian government and or in Russian companies

and extending that are potentially to include even Putin himself. There could be sanctions levied on banks. Now, don't forget that these sanctions to some extent already exist. Russian banks, et cetera, have been sanctioned since 2014 in the Crimea crisis. So now we're talking about ramping up. those sanctions, there is the possibility of actually killing the Nord Stream 2 project. Now, we can talk about how that could be done and whether it would be feasible to do that, but there's certainly the possibility that exists of actually sanctioning Nord Stream 2 itself.

And I guess what else could America do? What else could the U.S. do? Those kind of become pretty big, pretty big sanctions, right? You could. as a big, potentially, a fairly big measure, exclude Russia from the international payment system, known as Swift, so that Russian companies seeking to do business and make payments, at least abroad, would not have access to a payment facilitation system. They'd have to really resort to fairly old-fashioned methods like sending faxes in order to get payments done, which would be very, very costly for them. Actually, it would be a big blow for Gastron, because Gastron, of course, wants European revenues and it wouldn't be able to clear its payments very easily.

Again, we can talk about how feasible all of that is, and that's where I struggle, because a lot of these measures involve getting the Europeans to buy into these sanctions. Swift is headquartered in Belgium. It's a cooperative. It's a neutral company. So to get the Europeans to agree to actually bar Russia from Swift, that's a big step. North Stream, too, is a big step. you'd likely see a certain amount of European discontent

in terms of agreeing to sanction Nord Stream itself. Don't forget that some Nord Stream activities have been sanctioned under US sanctions for several years, particularly the laying of pipelines, but I think we're talking about something bigger now. We're talking about actually blocking Nord Stream and ever allowing it to become operational. I think that would meet a fair amount of resistance.

I suppose if we come to sanctioning Russian banking system en masse, completely blocking them out of the international system, that's going to hurt the Russian people a lot. You could argue that that's not the desire of such sanctions, but you could equally argue that this time it has to be because of the nature of Putin's actions. So there are lots of challenges with these sanctions, but those are basically the types of sanctions that could be levied. And I think that some of the harshest sanctions probably won't be levied in this particular scenario, not because perhaps, I don't know, again, I don't really have a clear line of sight into the U.S. administration, but even if the U.S. administration wants to levy every single one of these

sanctions, I'm not sure the Europeans would buy into it. Right. So, you know, there would be saying, Chris, did you want to say something? Go ahead. I was just going to ask, so this scenario excludes any type of military response, at least not a direct one from the U.S. or Europe. Is that correct? Is that in your tail? It's a good question. I think we've constructed. at all our invasion scenarios, incursion stroke invasion scenarios, to exclude a military response from NATO because that, I think, would be really very much a complete game changer. This is already a game changer, particularly our tale scenario

where we do see a broader invasion of the Ukraine. That's already a game changer. For NATO to take the step forward and send its own planes, its own planes and infantry and cavalry, and I think that's something that could spark a lot of international ructions. Although there could be a range, there could be a range that it could be certainly just assistance to Ukrainian forces. Is that part of your scenario? I think that that's a military scenario.

That's already happening. So it's actually sending arms to you. Additional. And in fact, you can build that out further, if you like, because Russia has, of course, got so many frozen conflicts around the region and Georgia, Chechnya, etc. So you could easily see in a scenario like this. that over a longer period of time, Western allies actually starts to fight proxy wars of Russia in those regions. So I think it's very destabilizing for the geopolitics of the region as a whole. And we're not just limited, the scenario is not just limited to Putin sending troops in

and then facing sanctions. There is a slow burn, which is very geopolitically negative for the region. So in this scenario where Russia invades the Donbass region, there will be some sanctions. What kind of, obviously, hard to know how far the U.S. and the West will go, the Europeans will go. My read on what you're saying is they can't go all the way because there just won't be that kind of support from Europe. to do that. But, you know, maybe Nord Stream 2 will be put on ice for a little bit of time, at least some period of time. I'd be surprised if that wasn't the case. And President Biden said that was going to happen. So if that doesn't happen, I'd be surprised. The German chancellor didn't deny or say yes or no to that, but it sounds like that would happen. There would be sanctions

on individuals, no doubt about that. There would be. possibly be some restrictions on the use of international payment system, the SWIFS system, but that feels like a bridge. That might be a little bit too far under the scenario. Okay. So if that's kind of sort of the, did I miss anything, Chris? I just want to. Sorry.

It's complex. Any other trade restriction? My understanding is Russia is a large expert of aluminum, palladium, other things that are critical for the auto industry. Do you see those as being sanctions or some type of trade restrictions as well? Let's take that one separately because that's another very complex political discussion. I think there could be other trade sanctions, particularly restrictions on imports and machinery, cars, and that kind of thing,

really to hurt Russia. So telecoms equipment, mobile phones, TV sets, cars, etc. These could all face sanctions entering Russia, which would then lead to You can imagine what would happen to Russia. You'd have a collapse of the ruble. You'd have inflation. You'd have a massive contraction and consumption and so on and so forth. I don't think in this scenario, though, I don't think they want to do sanctions that are going to be, you know, net detrimental to Western economies to the European economy.

They don't want to do that. That would be very difficult. Yeah, I suspect they won't want to go down that in this scenario. That would be surprised if they did that. Because it's like shooting your, you know, what is it? What's that phrase? Shooting yourself in the throat. Cutting off your nose despite your face, you know, kind of thing.

Yeah. I don't know. Is that a European phrase? It's definitely definitely a English phrase. Yeah, English phrase. There's something similar in one or two other European languages. Yeah. But let me ask on that scenario, what is the economic implications of that?

I mean, it doesn't feel like that's going to result in, significant turmoil in financial markets. Maybe briefly when it's all happening because there's the fog of what's happening and you don't know where it's going to all land, but not a prolonged period of financial turmoil, not a big impact on oil or gas prices. You know, they'll remain elevated because there's going to be a risk premium and they're kind of like what we talked about under the other, the snow invasion scenario, but it doesn't feel like this has big global macroeconomic implications.

Of its own, its impact is very largely. limited to Russia. I think what matters is what Putin does next. So as you said, maybe North Stream 2 doesn't even have to be officially sanctioned. Europeans can simply drag the heels for a couple of years, and that's enough to do that, where they try and figure out whether they should or shouldn't impose sanctions on North Stream 2 and kill the project. You impose sanctions in some Russian companies maybe even stop a few companies from using Swift, but let other companies continue to operate, put some sanctions on exports of manufacturers into Russia. This is largely a Russian problem. I think the question then becomes, what does Putin do next? And in order for

Putin to put pressure on the world, he's going to have to rely on the two levers, it's the only two levers he has oil and gas, and particularly gas into Europe. So I guess he would want to, he would want to foster a sense of divisiveness in Europe. And a clear way to do that would be to show who's in charge when it comes to gas supplies coming into Europe. So you could see that he would use that lever a bit, maybe not a whole lot, because that's clearly detrimental to him as well.

But you could see some innovation, some reduction in oil supply into Europe, some reduction in gas supply into Europe. Maybe not a whole lot. We saw some reduction in gas supply in January, for instance, and then a pickup in recent days, but if we go back to that kind of level coming out winter through the summer, that puts a fair bit of pressure on Europe when it comes to filling

up its reserves and boosting its storage ahead of next winter. So you can see that you'd have a bit more pressure on European gas prices in this scenario for a few quarters at least until the situation normalizes, potentially even a bit of a bit of elevated tension in Brent for a few quarters. But nothing serious, nothing that's going to cause financial markets to melt down. Okay. Okay. So just to summarize, the 50, 55 percent probability goes to this. Russia invades Dunbass region. There's some sanctions put on by the U.S. and Europe. Russia responds, but this is

kind of a temporary dislocation to energy markets and financial markets. And, you know, life goes on and, you know, tensions remain high, but they don't boil over. And the 40 percent probability is no invasion. So you were kind of at 90, 95%. So now the remaining part of the distribution of possible outcomes is kind of out there on the tail on the dark side, you know, maybe 5 to 10 percent kind of probabilities. How would you characterize that dark scenario? So I say that 5 percent in that tail, that's, again, it's a range of different things that could happen there. So the full 5 percent, if I look at it, you know, just coming out up to that 5 percent, that dark scenario is invasion on the eastern and northern France.

So the troop built up in the north, the border with Belarus on the east, there's a simultaneous incursion, Putin marches into Kiev, topples a regime. You've got tanks rolling down Kiev. And I think at this point, that's a very, very... Kiev, Kiev, we were on. Thank you, Keith. At this point, it's incredibly negative for Europe. We go back to those comments about Europe facing prospects of a war.

for the first time at 70 years and the re-emergence of those Cold War divisions. So I think Europe is in emergency mode at this point. So that of its own is a very negative scenario. And it invites the, I think it really opens the way to inviting a united European and American response in terms of sanctions against Russia. This is much more national security over energy security, but I guess that first scenario was more Europe puts its energy security first over national security. So I think you get very, very significant sanctions against Putin at this point,

including shutting gastroam out of Swift, shutting the entire system out of Swift, sanctioning, completely sanctioning Russian financial system, possibly even sanctioning Putin himself. And Russia just becomes a complete pariah state, which I guess, you know, given how the FX reserves that Putin has and the fact that he's been building what they call fortress Russia for the past few years, he may even be willing to countenance. but it's not going to be pleasant for Russia. I think what then matters is what Putin does next. And again, he comes back to his two leaders.

And I put very low probability on that, that he would actually then go out and really, really, really, shoot himself in foot by turning off the oil and gas taps or significantly reducing the oil and gas taps. But that's the scenario we've chosen to model as a dark scenario where Putin actually does that. not only does he invade Ukraine, both from the north and the east, not only is he then subject to very significant sanctions from the West,

but he then takes that additional step of wanting to hurt Europe in particular by significantly restricting oil and gas supply. And that, I think, is quite negative, because at this point we're facing, one, a geopolitical paradigm shift, be a loss of gas supply that actually you can't replace that easily, a significant reduction in oil that can't be rewroteed that easily. So this is all just very, very risk-off. It's a very risk-off environment.

Right. So that feels like that scenario, which broadly defines the tail of the distribution, it sounds like you're saying more like 5% than 10%, has lots of different shades of darkness, obviously. And the shade that we decided to actually, quantify through our modeling is way out on the tail. I mean, just kind of at the end of the distribution of possible outcomes in your mind. Is that a fair characterization?

That's a fair characterization. I think for Putin to restrict oil and gas to that degree, that it results in a huge pickup in European inflation, for instance, that would be very, very damaging for Putin, as much as it would be damaging. Chris, you kind of, I saw your face. So, you know, I'm always, I'm always in the tails. We're not talking World War III. We're not talking about, right?

No, we're not. Actual conflict, right? I could certainly paint a much darker scenario for you if you'd like. So you're stopping there. So just to quantify, right? Because I think clients are talking about, well, what if there is more of an armed conflict, right? We're talking comparisons to World War II, well, Sudatenland, et cetera, et cetera.

I think that's really good. We're not going to that degree with me. We're saying at worst in this very dark scenario, the Russians do take over Ukraine, but then the border stops there. There's no additional incursion. And certainly troops are massing along that border, and it's hostile, but we're not going beyond that in terms of an armed conflict. That's right.

And I think going back to some of the earlier comments, Chris, we'll still see proxy wars being fought. We'll still see arms being supplied to Ukrainian troops, and it's not going to be easy for Putin to hold to the Ukraine for a long period of time. So there's plenty of potential for conflict in that region. And of course, it's an incredibly dark geopolitical narrative for Eastern Europe and for Russia. But I think if we handicap that at about 3% probability, that's out in the tail, but not way out of the tail. I think you could go much further out into the tail with having full-blown conflict and NATO sending troops in, etc., etc.

But honestly, to me, that feels like that's incredibly remote. Sure, sure. No, but I think it's important to quantify. Yeah, it's important. It's important to lay them out. Yes, I agree. And even under this scenario, then, trade is not restricted. It's not voluntarily restricted, right? They were still saying that gas, the Europeans would still be willing to purchase gas, other goods. Well, I think that, I mean, I based that on the entire history of the Soviet Union when even at the darkest hour of relations between the West and during the Cold War between the West and the Soviet. Union gas continued to flow into Europe. So I'd much rather characterize that scenario via Putin doing something negative on oil and gas rather than the West camping down on Russian oil and gas.

So what does that mean this scenario now kind of on the tail that we've kind of, I think, nicely put into relief. What does it mean for the economy, for the Russian economy, for the European economy, for the global economy? So the Russian economy is hit so badly in the first. scenario and it gets hit much worse than the second of course. It's the same it's the same leavers. The rubble plummetes inflation spikes consumption slows down consumer disposable incomes are really badly hit. And then similar sorts of things would happen in the

Ukraine as well. So we mustn't just think of Russia but spare a thought for Ukraine and what happens there with war on its soil. But when we come to when we come to Europe this is much worse for Europe because we'd actually see a significant pickup in inflation. So we modeled gas prices, European gas prices at about close to 180 euros per megawatt hour. That's roughly what we saw back in December when one of the big pipelines actually completely reduced supply for a few days. And European gas price futures spiked immediately to that kind of level. So if you see that those sorts of prices coming back, maybe it won't stabilize at 180.

Maybe it comes down to 150 after a brief spike. But nonetheless, if it stays there for a few quarters because Putin deliberately restricts gas supply considerably. That's very, very negative for European inflation and European growth. I mean, there's going to be a huge squeeze on disposable incomes. We'd be worried about corporate investment. We'd be worried about corporate profits and revenues. So it would be a very dark picture for Europe for some time to come. And that's also going to spill over to the global economy because we see elevated oil prices for a while. We're actually modelling Brent at $150 a battle for several quarters, so that's going to have a knock on effect on US and Asian inflation. And then we've got to

think about accommodative responses because this is clearly an emergency situation. So in Europe, you can see that fiscal policy and monetary policy will have to work together, but then it's clear as to how each will operate. Would fiscal policy choose to help households and help corporates or one and not the other? Would monetary policy adopt a wait-and-see approach because it's such a negative emergency situation, but then that may have some negative consequences for inflation expectations. Would the Fed do something different because it's less of a problem? Inflation will be, it'll be less of an emergency problem in the U.S. Yeah. Okay. All right. That's a pretty dark scenario. All righty. Well, a lot to think about,

and I'm sure between now and next week when we have the webinar, there'll be a lot of change in the moving parts that are changing pretty rapidly here. So we'll follow this very carefully and report back and make any changes to our forecast and scenarios that we think are important to do. Any last comments? Anything we missed in the conversation? I thought it was a very thorough kind of discussion of possible outcomes here. Do we miss anything?

Got a quick question. I've heard something around timing. I heard this statement from some military commanders that if there would, was to be an invasion of any type, it would occur within the next few weeks while the ground is still hard. And that because once you get into the spring and it becomes very muddy, troop movements become very difficult. Is that you give any credence to that or any way to that type of argument that if something's going to happen, it's going to happen soon, otherwise we'll be in a stalemate for a while? I've heard yet another date put out there, which was the 20th of this month after the closure of the Beijing Olympics, the Winter Olympics. the Putin would wait until then

to make sure that the world was at peace and people could enjoy the Winter Olympics before in fading. So it may be very, very, very soon. There's certainly a case to be made for doing it sooner rather than later. But I guess he's also got to think about the optimal European response.

The longer he has more time he has to play with, the more chance he has of driving a wedge between the US and Europe. So, you know, and I get the feeling that he's just, an incredibly strategic player to raise all these things up very carefully. All right. Okay.

All right. Well, thanks, Grav. That was very helpful in putting it, you know, and making it very clear, you know, how we're thinking about this. And again, we'll update our listeners and clients as we go along here. But thank you so much. And with that, I think we're going to call it a podcast. So thanks, everyone, for listening in.

And we'll talk to you soon.