I had planned this week to discuss the major wars and conflicts underway around the world and how they have affected markets. However, President Donald Trump has just turned his mind to the war in Ukraine this week and that is likely to consume the global bandwidth, so it is worth addressing the Ukraine issue in some detail.
This was a war that the US president stated confidently he would be able to resolve within 24 hours. Allowing for some exaggeration by a showman politician to get people’s attention, this still seemed an excessively speedy resolution of a bloody conflict that had already caused some 198,000 deaths and 550,000 wounded on both sides. Nevertheless, the President appeared confident in his ability to end the war, despite some scepticism – veiled or otherwise.
His criticisms of Europe are not unfounded…
Now that he has turned his attention to Ukraine, it is important to understand that a number of criticisms do make sense and European governments need to listen to them since the Trump agenda is what is driving NATO at the moment and this agenda is likely to be much less tolerant of countries not meeting their share of the costs. The principal concern from the US is that Europe has been sheltering under the US defence umbrella – strategic and conventional – for too long and should take on more responsibility for its own defence rather than relying on America to come to Europe’s rescue after a crisis has emerged.
…and Europe has often been free riding on American military power
NATO has a stated target that each member nation should spend 2% of its GDP on defence. There are a number of issues with this. First of all, the 2% figure has often been honoured in the breach and large parts of NATO have not spent 2% of their GDP on defence, while some of the laggards include expenses such as military pensions in their 2% so they can claim to reach the target. The UK is a major player in NATO, along with France, but even London struggled in one recent year to conclusively meet the 2% target. The potential arrival of Donald Trump in the White House did prompt change and certainly concentrated minds. Three years ago, just 6 NATO members met their 2% commitment. Last year, 23 countries met that target – Trump looming on the horizon very rapidly concentrated NATO minds. The US spends around 3.5% of its GDP on defence, very large but still sharply down on the 6-6.5% it was spending during the Cold War when there was just one potential adversary sitting in Moscow. Now there are two that the US needs to guard against, and it is very clear that the US feels that Europe needs to pay its share of the costs of defending the continent to enable the US to meet its commitments elsewhere.
The numbers don’t tell the full story, but it is clear that defence is not cheap. Apart from the headline numbers, while much of the spending sounds good on paper, it is actually less valuable than it appears. For example, NATO “heavy lift” capacity is very reliant on US helicopters and troop-carrying aircraft, since the non-US element of NATO has much less equipment like this to enable the rapid deployment of NATO forces. Looking at artillery and armour, European governments readily admit that when they order new and updated equipment, one of the key ways of keeping costs down is to reduce the amount of ammunition bought along with the actual kit to use it with.
One lesson from the war in Ukraine is that a modern war in Europe is of much greater intensity than previously anticipated and historic forecasts of ammunition use will need to be revised – reducing or eliminating the ability to buy much lower quantities of ammunition as a cost-saving measure. I think I am right in saying that not too long ago the UK acquired some quite effective drones – clearly a weapon whose time has come – because of their battlefield performance. Once the MoD’s extra requirement for the drones had been specified by the Ministry, the drones were unable to take off with the weight they were now required to carry into battle once all the MoD requirements for a drone had been included. Defence is not cheap and the days of doing it both effectively and cheaply have probably long since passed.
Trump and Vance made their criticisms plain at the Munich Security Conference
Donald Trump, but more so his Vice-President JD Vance have been very clear in their criticism of European NATO partners – Trump called Vance’s recent broadside at Europe as “brilliant”. While many more countries now reach the 2% target, Vance in particular has turned his fire on Europe for failing to defend their own fundamental values which are ostensibly shared with the United States – a position that it is much harder to argue against or simply spend more on to resolve it. Instead, it speaks to a fundamentally different view of the situation, with Vance claiming that free speech was in retreat, religious liberties – particularly in the UK – were being lost and that Europe had thrown open its doors to people that it should not have allowed entry to since it posed a risk of extremism taking hold. It is significant I think that there was a lot less criticism of Russia and its war in Ukraine when Vance spoke.
Trump prompted alarm in Europe when the US President called Putin to discuss Ukraine
The White House announced on Wednesday 12th that Donald Trump had called Vladimir Putin and held a 90-minute phone call to discuss Ukraine and that the two men would subsequently meet for peace talks about the war in Ukraine. It is fair to say that this announcement sent shockwaves through any group with an interest in the conflict in Ukraine.
Conspicuously missing from the peace talks are…Ukraine itself (and Ukrainian President Zelenskyy) with Trump seemingly speaking for everyone on the pro-Ukraine side (apparently whether they like it or not). While Zelenskyy also seems to be missing from the cast of characters involved in these peace negotiations, he is the one person that most of those involved (except perhaps Donald Trump) believe actually speaks for Ukraine. The Trump administration insists that it is Europe’s responsibility to make sure Ukraine is secure rather than that of the United States. Emmanuel Macron of France – who appears to see things the same way – referred to this as Europe “carrying the burden of Ukraine” (and UK Prime Minister Keir Starmer has since offered to send British troops to Ukraine as peacekeepers to support any peace deal between Russia and Ukraine).
There is clearly some dissent within the European coalition that is backing Ukraine, with some countries critical of Donald Trump’s approach in seeking to meet Putin in the absence of any agreement about the way forward for Kiev since it hands a win to the Kremlin without securing anything for Ukraine in return.
This is not an ideal state of affairs in my view
It would be fair to say that this is not an ideal state of affairs, certainly in my opinion. The US would end up negotiating with Russia on behalf of Ukraine and European NATO, with NATO peacekeeping troops on the ground in Ukraine, potentially serving as a tripwire in case hostilities resume again. The question I raised earlier is: are European security guarantees sufficient to deter Vladimir Putin’s forces? Were they US forces on the line I would say they would be entirely sufficient to deter Russia. With just European forces on the line, I think it is much less certain that Russia would be deterred and what we may be looking at is simply a pause in the fighting which would allow Russia (but also Ukraine and its allies) to rearm and resupply for an ongoing conflict. The risk of escalation is very high in this scenario, whether through accident or miscalculation.
Ukraine’s position has already been compromised by the US Secretary of Defense
I noted earlier that this is one of the outcomes that European leaders had been most concerned about – a temporary pause in the fighting and therefore a lifting of the pressure on Putin to try and make progress on the Ukraine situation. Instead, in the light of comments made by the US Defense Secretary Pete Hegseth that Ukraine will not join NATO and nor will the country return to the borders of 2014 or 2022, it seems that Ukraine has given away, or been forced to give away, two significant bargaining chips. I have also said before that if security guarantees are to be put in place to sooth Ukraine’s nerves – as seems likely – those security guarantees are going to need to be American security guarantees and not just European guarantees which are likely to end up down the road looking toothless as previous conflicts have clearly shown.
Sanctions on Russia remain in place as part of the western response to Russia’s invasion of Ukraine in 2022. Logically they should remain in place while any discussions or negotiations between the parties take place, although I suspect that there will be pressure from Trump et al for them to be loosened or actually removed well before all the issues are resolved. Similarly, the Euros 260 bn or so of frozen Russian assets held in Europe remain seized and last year generated Euros 4.4 bn of returns for Euroclear. Those are likely to return to Russia as part of an overall agreement rather than being used to rebuild Ukraine. Who will be left to pay for the reconstruction? Most likely Europe of course since the US has concerns elsewhere that it needs to deal with and plenty of criticism of Europe it would seem.
We could see markets improve if a Ukraine resolution is in sight… but what will be the longer-term prospects if Russian aggression is rewarded
These are probably positive influences for markets, although the devil will be in the detail and in western leaders’ belief that this perhaps marks the end of Russian claims on what we now regard as European territory. Only time will tell in that regard but, so far, what we have heard from Donald Trump and his colleagues is not completely reassuring as far as Europe’s territorial integrity or Europe’s willingness to defend that territory is concerned. There will undoubtedly be more information about these discussions that will come out over the next couple of weeks which will help us make a more informed judgment.
This article has been approved by Tideway Investment Partners LLP; however, the views and opinions expressed in the article are not necessarily the views and opinions of Tideway.
The content of this document is for information purposes only and should not be construed as financial advice. We always recommend that you seek professional regulated financial advice before investing.
About the Author
Stephen O’Sullivan was an ‘anchor’ client in the founding of Tideway and has been a client of James Baxter since 1999.
Stephen began his oil & gas career as an oil trader, economist and Asian corporate planner in the downstream and trading divisions of BP. He then spent several years with the upstream and gas divisions of Total, working with natural gas, NGLs, shipping, pipeline management and the Sullom Voe oil terminal. In 1989 he joined Coopers & Lybrand as a Senior Strategy Consultant in the oil & gas consulting team, working on the privatisation and restructuring of the energy sectors across emerging markets as well as on both sides of the nuclear sector. He lived and worked in China, Russia, Central Asia, Eastern Europe, Southern Africa and the Middle East in this period.
In 1995, he was appointed Head of Research and Oil & Gas Analyst at MC Securities in London – an Emerging Europe-focused investment bank, where his team was consistently number 1 ranked in EMEA oil & gas research. Following the sale of MC Securities to JP Morgan in 1998, he moved to Moscow as a Partner and Head of Research at United Financial Group, Russia’s leading independent investment bank, where he and his team were ranked the number 1 oil & gas research team and the number 1 Russia country team for nine years in a row.
After the sale of UFG to Deutsche Bank in 2005, Stephen became Head of EMEA and Latin American Research for Deutsche Bank where his research team was ranked the number 1 team across all the industry sectors, in both strategy and in economics, in country research for Russia & South Africa and across the entire EMEA region in 2006 and 2007. In 2007 he left Moscow and moved to Hong Kong as Head of Asian Research for Australia’s Macquarie Bank. In 2009 he joined Barclays Capital in Hong Kong to lead the build-out of the bank’s Asia ex-Japan equity research business.
Since 2013 he has been an investor in a range of businesses in technology, real estate and materials while living in Hong Kong. His major interests include China’s gas sector reform, China’s nuclear renaissance and the country’s global impact on energy markets. While based in Hong Kong he has also been a Senior Visiting Research Fellow at the Oxford Institute for Energy Studies, the world’s number 1 ranked energy think tank. At Oxford he published several major studies of the Chinese energy sector.
He is a contributing author to several international think tanks on global energy issues and has advised international law firms on the oil and gas sector globally.
