Living near a rocket-manufacturing plant in Dnipro, in eastern Ukraine, holds certain advantages for Anastasia Kvitka, 33. There are none of the planned electricity outages that have plagued much of Ukraine since Russia began lobbing missiles and drones at the country’s power grid. That makes it easier for her to write marketing copy for Bordio, a Latvian software company that has several employees in Ukraine.
But when an explosion rocked Kvitka’s home recently, she assumed it was a Russian attempt to target the factory. “The house trembled. I thought that the windows would fly out,” she says.
Feb. 24 will mark one year since Russian President Vladimir Putin ordered a full-scale invasion of Ukraine, unleashing a military campaign of stunning brutality that has probably killed hundreds of thousands and destroyed much of Ukraine’s infrastructure, and shows few signs of ending. Ukrainians have displayed remarkable resilience, and the West has shown surprising cohesion in the face of Russia’s irredentist assault. Yet, financial markets mostly have registered apathy, remaining far more attuned to central banks’ fight against global inflation.
As the war enters its second year, however, the economic consequences could become more pronounced. The conflict already has knocked about a percentage point off global gross domestic product, estimates Dana Peterson, chief economist at the Conference Board. The U.S. Federal Reserve has repeatedly warned that the war’s uncertainty is complicating its economic outlook. And supply-chain disruptions, especially in the energy market, have encouraged a broader move in the U.S. and Europe toward political management of the economy.
It might be tempting for investors to write off the war as a distant tragedy unlikely to tank the markets. But with high-tech weapons pouring into Ukraine from the West, and Putin committing hundreds of thousands of fresh troops, the conflict is entering a critical phase. At a minimum, the fallout will further depress economic growth. It will surely complicate business and policy decisions. And more-extreme developments are plausible.
There are three ways the war could evolve this year. Scenario No. 1, many analysts’ base case, is that neither side will be able to gain a decisive military advantage and the fighting will persist indefinitely, with no significant change in territorial control.
Daleep Singh, President Joe Biden’s top international economics adviser through mid-2022 and now chief economist at PGIM Fixed Income, sees two other alternatives: The war might escalate beyond recognition—or Putin’s regime in Russia might collapse.
Singh considers scenario No. 1—grinding warfare—probable, and the outcome that “the market has largely priced in.” But scenarios Nos. 2 and 3, he says, “likely cover 15% to 25% of the probability distribution, and those risks aren’t fully discounted in market pricing.”
Unlike the stock and bond markets, the energy market has been whipsawed by the West’s effort to punish Russia for its invasion of Ukraine, and Russia’s response. Russia announced earlier this month that it would cut oil production by 500,000 barrels a day, potentially tilting the scales toward higher oil prices. Brent crude, the international benchmark, recently was trading in the mid-$80s a barrel. Russia’s Urals blend has been trading below the $60-a-barrel price cap set by the U.S., the European Union, and other advanced economies in the Group of Seven. Russian oil and gas revenue fell by 46% in January compared with the year before, the Russian Finance Ministry said in early February, hinting at the economic toll.
The energy market has been under pressure since Russia’s invasion of Ukraine. Above, an oil storage facility in Nakhodka, Russia.
Alamy
Nor does the energy war seem to be ending. A part of the cap that targets Russia’s diesel exports went into effect at the beginning of this month. It is too soon to tell how the restrictions will affect Europe’s diesel-reliant heavy industries.
The G-7 will decide in March whether to lower the crude-oil cap. Doing so would raise the prospect of more enforcement and put further pressure on prices. “If we looked back and found that it was having no impact on the Russian economy, then we would certainly revisit the level,” says a senior Biden administration official who requested anonymity. “You probably will see frictions and hiccups along the way as you see global trade paths emerge.”
Those hiccups challenge even the most seasoned forecasters. “I’ve been counting barrels for 32 years, and predicting the next few months in oil prices is as hard as it has ever been,” says Bob McNally, president of energy consulting firm Rapidan.
A case could be made for $50 oil later this year, or $150, “and neither one of them will be crazy,” McNally says.
Much of the war’s potential economic impact lies in second-order geopolitical shifts that are much harder to price than a barrel of oil. In January, the Bulletin of the Atomic Scientists moved its famous Doomsday Clock, which incorporates predictions about the imminence of nuclear war, as close to “midnight” as it has ever been, citing the war in Ukraine and other factors. Putin frequently reminds the world of his nuclear arsenal.
Still, some analysts believe that the risks of nuclear war have receded modestly since the February invasion. Biden made clear that nuclear use would threaten Putin’s rule, even as Putin established that he sees a personal threat in the supply of Western weapons that could strike inside Russian territory. Would Putin press the button? Nothing is stopping him, but “the more time is passing by, the less is the risk,” says Polina Sinovets, director of the Odessa Center for Nonproliferation.
The risks might change if Putin somehow were to exit the scene. When the Russian military faltered last year, Putin began to rely heavily on the Wagner Group, a private military company, which raised questions about his control of the state. Wagner leader Yevgeny Prigozhin is thought to harbor political ambitions, although he has denied this.
The potential collapse of Putin’s leadership is just one of many imponderables that could reshape the war and upend the global world order. Singh, the former Biden adviser, described a taxonomy of risk. “The worst kinds of scenarios are those that have little or no historical precedent, that involve nuclear powers, that trigger the use of the most potent forms of economic statecraft that aren’t easily counteracted with fiscal or monetary policy, and that occur with little or no warning,” he says.
A refinery in Moscow.
Maxim Shipenko/epa-efe/Shutterstock
Iran’s active support of Russia, and China’s passive support, could also amplify geopolitical risks, although the war in Ukraine and the Covid pandemic have prompted many Western governments to step up their risk management. Japan, for example, has been watching events closely, and has gradually been abandoning its post–World War II pacifism. “If one of the consequences of the Ukraine tragedy is that there is a new seriousness about deterrence in the Indo-Pacific and the balance of power, it might lower the risk of conflict there,” says Vance Serchuk, executive director of the KKR Global Institute, a think tank attached to the private-equity firm.
A war involving China probably would be far more damaging to the global economy than the Ukraine conflict.
Meanwhile, in rethinking their energy supplies, the U.S. and Europe are moving toward greater industrial management of their economies—a strategy that could yield mixed results. After several decades of globalization and freewheeling economic growth, governments are reconsidering, for example, whether the absolute lowest gas price is worth a national-security risk.
“Is industrial policy going to be able to make us safe and solve some of these geopolitical vulnerabilities?” asks Serchuk. “The track record is pretty mixed. Is it capable of producing good results? Absolutely. Is it also capable of producing inefficiencies? Yes.”
As politicians, soldiers, and citizens gird for the battles ahead, Kvitka, the Ukrainian who works remotely for an EU company, plugs on. She spoke with Barron’s via Zoom from a darkened home. The power was out, which meant the water was off, too. She manages her tasks so that she always has something to do when the internet goes down.
“No one in Ukraine can feel safe right now,” she says.
That is true for the rest of us, too.
Write to Matt Peterson at matt.peterson@dowjones.com
Credit: marketwatch.com