How Will Russia’s Invasion Of Ukraine Change The Risk Calculus?

Europe’s violent history had been in remission, but it returned with a vengeance this week when Russia invaded Ukraine. It’s been comforting to assume that decades of relative peace on the Continent and its near-periphery had become the new norm and that centuries of war had passed into history as a real and present danger. But the world has been reminded anew that the long arc of history isn’t easily dispatched.

The shock and awe of reading reports on Russia’s brutal and shameful invasion of Ukraine is reminiscent of the early days of the pandemic in 2020, when there was widespread astonishment that such things could still happen. So it goes when we limit our historical perspective to extend over a few decades rather than centuries. Let’s call it recency bias on a grand scale.

Having received yet another wake-up call that Europe’s tortured history won’t go quietly into the night, the challenge is intelligently reassessing what has changed and how the changes affect global risk factors, or not.

These are early days and it’s premature to assume that anyone has a clear understanding of what lies ahead. But in what might be considered a tentative first draft of pondering the near-term future, let’s consider three possible scenarios as a starting point.  

Scenario 1: 20% probability. The war winds down quickly and economic and market activity returns to something approximating “normal” conditions. This appears unlikely. I give it a 20% probability, which is arguably too generous. Russia’s invasion of Ukraine was planned far in advance. For several years, Putin has been building economic defenses and generally trying to sanction-proof the country, a sign that he’s prepared for the long game and committed to achieving his goals. The implication: Russia’s not likely to suddenly back down and allow Ukraine to remain independent.

While it appears naïve to assume otherwise, it’s not impossible that a surprisingly favorable turn of events could unfold. Perhaps Russia faces unusually stiff resistance in the days ahead from Ukraine forces, which in turn convinces Putin to take a softer line. One hint of such a scenario arrives via a report today from the AP that notes “the Kremlin says it will analyze the Ukrainian president’s offer to discuss a non-aligned status for his country, as a Russian military invasion pushes closer to Kyiv.”

This could be another round of misinformation from Moscow, of course, and so it’s premature to read too much into this. But war tends to unleash surprises on all fronts and so Russia’s overwhelming military power could run into resistance on some level, triggering blowback that’s changes Putin’s course.

Ditto for the growing array of sanctions that countries are placing on Russia.

But the odds for relatively good news are constrained by a simple fact: Moscow is intent creating a puppet regime in Kyiv and it has the means to do so. In turn, it would be astonishing if Putin, at this late date, stops or slows military operations that fall short of his goal.

Scenario 2: 70% probability. Relations between Russia and the West deteriorate significantly and economic trade and energy exports are severely disrupted, but this falls well short of total isolation. In this scenario, there’s a conspicuous degradation in Russia-Europe/US trade and a significant and a sustained rise in geopolitical tension that creates what might be considered as Cold War II. The probability for this outcome: 70%.

Given the events of the last two days, it’s hard to imagine how any significant repair of relations unfolds between Russia and the West for the foreseeable future. It seems likely that a considerable degree of severing of economic interaction is a high-probability scenario. But given Europe’s relatively high dependence on Russian gas and oil, there will be limits and setbacks to the severity of this breach.

The weak link is Europe’s biggest economy — Germany, which relies on Russia for more than 50% of natural gas imports and about one-quarter of crude oil imports. Germany, in short, will acutely feel the pain of reducing or eliminating Russian energy from its economy. Accordingly, Berlin’s actions serve as a kind of proxy for monitoring how Cold War II evolves.

Overall, I expect a shape-shifting gray area in this scenario that delivers a complicated web of partial sanctions that ebb and flow through time.

Scenario 3: 10% probability. Geopolitical Armageddon – a complete and near-absolute breakdown in relations between Russia and the West that’s comparable to the height of the Cold War era. This scenario can’t be discounted, but largely for reasons outlined in scenario 2 – Europe’s dependence on Russian energy – I see this as a low probability: 10%.

But the probability could rise if Russia’s invasion is unusually bloody and creates a deeper-than-expected backlash in Europe. Even then, it’s unclear how prepared the Continent is for an extended run of high energy prices that would be unleashed by a near-complete collapse of Russian energy exports. The economic pain for Europe would be extreme in this case and so it’s doubtful that there would be sufficient political support in Germany, France, etc. to pursue this extreme agenda.  

But there may be a joker in the deck: Russia unilaterally decides to cut off all energy exports to Europe, perhaps in retaliation for sanctions. I’m assuming that cooler heads will prevail in the Kremlin, but that may be assuming too much.

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