War in Ukraine: Thoughts on Longer-Term Implications

Everyone knows about the worldwide supply chain issues that started during the pandemic and were exacerbated by the huge rebound in demand for consumer products/goods. Despite recent news of retail sales slowing, supply chain disruption continues to pressure delivery, availability and pricing of goods. This, in turn, is contributing to the multi-decade highs in inflation. In addition, the war in Ukraine catapulted already rising energy prices into the stratosphere, further feeding the inflation beast. Finally, add in other commodity shortages, including the fears of global food shortages, and voila: a hat trick of bad news.

To consider the impacts of these three areas — energy/commodities, military reordering and supply chains — we begin by outlining some of the recent announcements that will impact the longer-term outlooks for these three areas.

Energy/commodities

Let’s start with energy and other critical commodities:

• President Biden announced strategic reserves will be released (1 million barrels/day) to support markets and mitigate the impact of higher fuel prices on the average American.
• Spain approved a “shock plan” to provide support to its economy and reduce impact of fuel prices and potential shortages. The package includes fuel price cuts and an increase in spending from the EU $800 billion recovery fund. It also includes subsidies to electricity-intensive industries and limits rent increases to 2 percent. Additionally, it offers $10 billion in state loans to companies to cover liquidity needs due to increases in energy-related costs.
• Germany announced the Nord Stream 2 natural gas pipeline is on hold. This project was to enhance energy distribution from Russia to Germany via a second pipeline to the existing undersea Nord Stream 1 pipeline that opened in 2011.
• In March, President Biden invoked the Defense Production Act, giving the U.S. government the ability to provide support for investment in the mining, processing and recycling of critical materials, such as lithium, nickel, cobalt, graphite and manganese. These minerals are used in the production of batteries for electric cars and clean-energy storage systems. This came on the heels of last year’s Executive Order directing a task force to assess vulnerabilities, procurement and strengthening of U.S. supply chains related to critical materials.

Thoughts on longer-term implications

Energy security and energy policy now look to top of mind for many countries. This, in turn, may lead to a faster implementation of renewables to counteract fossil fuel dependence. But this is a battleship that cannot turn on a dime. Watch how short-term changes interact with long-term goals (more nuclear for example?).

It’s clear that deglobalization of trade related to energy (and other important commodities, like minerals and food) has done an about-face. Trade ties are no longer viewed as providing mutually assured peace and have been replaced by a desire for energy, minerals and food independence and/or diversification.

Military reordering

In addition to energy security, we’ve seen military readiness and spending come front and center in our new world order:

• President Biden’s 2022/2023 budget proposal includes a 4 percent increase in defense.
• German Chancellor Scholtz announced a €100 billion allocation for defense in the 2022 budget presented to that country’s cabinet. The goal is to spend 2 percent of GDP on defense.
• Seven European countries have announced similar plans to increase defense spending, including Finland, Italy, Latvia, the Netherlands. Norway, Poland and Sweden.
• Finland and Sweden are discussing joining NATO.

Food security is yet another big issue relating to the war and its consequences. A large portion of global wheat, corn and barley supply comes from Ukraine. As a result, food prices have surged. An increase in world hunger could be the upshot.

Thoughts on longer-term implications

We have no crystal ball for the multi-faceted political ties of countries. However, the list of nations scaling up defense is impressive. In addition, President Putin’s calculation that NATO would not be a factor if Russia invaded the Ukraine now seems ill advised. Not only has NATO coalesced, but it also looks to be getting stronger.

Supply chain issues

Finally, the prognostications that supply chain issues would begin to abate in 2022 were not prescient. To be fair, the war added an unanticipated set of issues to the pandemic and post-pandemic problems. While the consumer demand for goods, which was turbo-charged during 2020 and 2021, is not over, we do see signs of services increasing and some goods decelerating. For example, in the March inflation data, airline ticket prices were up double digits (10.7 percent), while used cars were off (-3.8 percent) and some categories of apparel were down.

So, if demand for goods does subside in favor of services (as was the pre-pandemic state of the world), we may see some supply chain problems easing. However, there is undoubtedly a fundamental shift in how companies think about necessary materials and components. There are frequent discussions on CEO earnings calls of supply chain pressures and the inflationary knock-on effects. Clearly, some reshoring and/or diversification of suppliers will occur. This adds to the deglobalization theme you may read about. But beware, this Venn diagram of interconnectedness is not quickly undone.

Thoughts on longer-term implications

The war wore down the already pandemic-frayed globalization ties in supply chains, energy and commodities. In many ways, the economic ties of countries resulted in a laissez-faire attitude to potential conflicts, and, consequently, military spending dropped. Again, with no crystal ball on how this plays out in the long term, it is abundantly clear changes are afoot. Keep your eyes peeled for more announcements of reshoring and diversification of suppliers. This, coupled with the energy, food and critical commodities changes, will be worth looking out for. The Greatest Show on Earth was a 1950s movie (and the Ringling Brothers’ slogan). It is probably worth buying a ticket for, or better yet, in 2022 lingo, streaming. Let’s watch how this movie plays out.