The geopolitical crisis surrounding Russia and the Ukraine has been going on for months. The Russia crisis escalated after the tragic downing of Malaysian Airlines MH17, leading to heightened volatility in financial markets and concerns amongst investors. As a result, many companies with large exposure towards Russia have suffered heavily over this timeframe.
However, there are ample reasons to believe that the Ukraine-Russia crisis has reached its peak and will de-escalate in the coming months. If this scenario holds true, it might present investors with attractive buying opportunities.
In this first article, I will provide investors with an extensive analysis of why Ukraine is so important to Russia. This will provide speculators with the motives as to why Russia has allowed the current situation to escalate so heavily in the first place. In the second article, I will explain why I believe that tensions will de-escalate in the coming days/weeks/months. In the third article, I will provide an extensive list of ways of how investors could profit if these tensions do indeed decrease over the coming months.
Ukraine is vital to Russian energy exports.
In order to understand the current events surrounding Russia and Ukraine, we have to look at the reasons why this crisis happened in the first place. Most importantly, we have to understand why Russian President Vladimir Putin is willing to risk so much to retain his influence over the Ukraine.
Energy exports are the lifeblood of the Russian economy. Oil and gas exports accounted for over 30% of Russian GDP in 2011 (1), while providing half of the state’s budget revenues in 2012 (2). It is easy to understand that Russia would go through great lengths to protect its energy sector. So how does the Ukraine fit in in all of this? Ukraine is of vital importance for delivering Russian oil & gas to Europe. Many of Russia’s most important strategic gas and oil pipelines pass straight thru the Ukraine (Figure 1).
Figure 1: Russia strategic oil and gas pipelines.
Losing political influence over the Ukraine will simultaneously mean that Russia will no longer have control of these all-important pipelines. This would be a double-whammy for Russia. For one, it would complicate European oil and gas delivery for the Russians, by adding a new powerful strategic stakeholder; Ukraine. Due to Russia’s dependency on energy exports and the convenience of the pipelines located in the country, Ukraine could exert a large amount of pressure on the Russian Federation, for the betterment of its own political agenda. At the same time, losing control of these pipelines means that Russia will have a much harder time to influence Western European politics through its energy exports. Simply put, a politically independent Ukraine with its own priorities and agenda is not something Putin is waiting for.
NATO in Moscow’s backyard.
The other important reason for Russia’s commitment towards retaining influence in Ukraine is of geopolitical nature. NATO, short for “North Atlantic Treaty Organization”, is an intergovernmental military alliance of Western nations. Member states in this alliance agree to mutual defense in response to an attack by any external party. In short, it means that any military aggression against one member state constitutes an immediate declaration of war against the entire NATO. This alliance was formed in 1949 in order to counter any possible threat from the then mighty Soviet Union.
When the Soviet Union neared collapse in 1989, NATO struck a deal with former President Mikhail Gorbachev. In exchange for allowing a peaceful reunification of Germany, President Mikhail Gorbachev was rumored to have been promised that NATO would not expand "one inch to the east”(3).
With the advantage of hindsight, it is obvious that the West has not kept its end of the bargain (Figure 2). NATO has steadily expanded eastward over the past decades, with three large expansions since the German reunification. As of the last expansion in 2009, NATO encompasses most of Eastern Europe, with countries such as Poland, Czech Republic and the Baltic now being members.
Figure 2: NATO’s eastward expansion.
Understandably, Russia has felt increasingly threatened and boxed-in by NATO’s eastward trajectory. Currently, Ukraine is the last buffer between Russia and NATO and is therefore of vital importance to Moscow. If the Ukraine where to officially join the NATO alliance, it would be horrifying nightmare for the Kremlin. Firstly, it means that NATO would be in Moscow’s backyard. Russia would effectively be completely boxed in by NATO, which would effectively destroy the last shred of Russia’s strategic military influence in Eastern Europe. Secondly, Russia sees such a scenario as a threat to its very existence, as it would allow NATO to place military personnel and build strategic bases right across the border.
With this in mind, Russia is willing to go through great lengths to ensure that Ukraine does not become a member of the NATO alliance. With the ousting of the Pro-Russia Ukrainian President Viktor Yanukovych this year, Russia realized that, if they would not do anything, it would only be a matter of time before Ukraine becomes a NATO member. This, partly explains why Putin is so committed to retaining his influence in the Ukraine.
Local Russian politics.
Lastly, we should not forget that there is much at stake for Putin, both on a personal level and from a political angle. When President Putin took power in year 2000, the Russian Federation was in complete tatters. In years following the fall of the Soviet Union, Russia’s economy spiraled downward, culminating in the 1998 financial crisis. With its economy devastated and its military disorganized, Russia became a laughingstock on the international political arena. Russia’s international political insignificance reached its apex during the war in Kosovo.(4) At the time, Russia was allied with the Serbs and had not wanted NATO to launch a war against Serbia. Russian warnings where ignored and NATO subsequently launched a bombing campaign against the Serbs. When the air war failed to force Belgrade's capitulation, the Russians negotiated a settlement that allowed U.S. and other NATO troops to enter and administer Kosovo. As part of that settlement, Russian troops were promised a large part in peacekeeping in Kosovo. Adding insult to the injury, NATO never allowed Russians troops take up that role. In effect, the Kosovo War resulted in Russia’s international humiliation, which, together with the failing economy, led to the downfall of Russian President Boris Yeltsin.
President Putin has long been known to harbor strong nationalist feelings towards Russia and this can be seen in many of his previous speeches and political acts. Having witnessed Russia’s fall from grace first hand, Putin’s foremost mission was to restore Russia’s status as a significant international force and to repair the damaged sense of pride many Russian felt at that time. This nationalist modus operandi has formed the foundation of Putin’s political tenure. Over the years, the Russian President has actively promoted his image of being an “internationally strong man”, both locally and abroad. The most famous examples of this are the infamous “Putin macho” photographs(5) and his “hard-line” approach towards the West during the invasion of Georgia in 2008 and the Syrian Crisis. Lastly, preceding the Ukrainian crisis, Putin was facing increasing local opposition (Figure 3), with his approval rating falling to historically low levels.
Figure 3: Putin local approval rating.
This local political context has to be taken into account when analyzing the current situation. The loss of the Ukraine from Russia’s sphere of influence would have been seen as a huge political defeat for President Putin, Yet not the least because of its geographical vicinity and strategic importance. Given his local image as an “internationally strong man”, Putin took a “hard-line” approach towards the West once more. Putin’s “hard-line” stance in the Ukrainian crisis has caused his local approval rating to soar (Figure 3). This political environment partly explains Putin’s hostile attitude up till now.
As I have explained, the Ukraine is of enormous strategic importance to Russia, both from an economic perspective, due to the strategic gas and oil pipelines that lie in the country, and from a geopolitical angle, as the last buffer against NATO. This explains why Russia has been willing to risk so much in order to regain its influence in Ukraine. Russia’s hostile attitude has also been reinforced by the local political environment in which President Putin operates.
Yet even with the Ukraine being so strategically important, given the current economic and geopolitical realities facing Russia, it is highly unlikely that Putin will continue his current masochistic course. In Part 2 of this article series, I will explain the reasons why I believe that the worst of this crisis is behind us and why de-escalation is likely.
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Simon is the CEO and Editor-in-Chief of Foresight Investor. He has been following the markets passionately for over 7 years.