The COVID-19 pandemic exposed social inequalities in healthcare, the division of labor and wealth for those without property or money in financial markets. Russia’s war against the people of Ukraine has exposed our global reliance on oil and gas, as well as minerals and agriculture.  Where COVID lockdowns crushed demand in many sectors, Russia’s war has heightened our awareness of supply side issues, notably the interconnections among global supply chains as sanctions become broader and deeper, .  We quote from a recent report from EuroMaidan Press, an English language Ukrainian news outlet:

“Russia’s military offensive in Ukraine could affect global food supplies, worsen shipping snarls, and threaten the fragile recovery of the pandemic-hit travel industry, experts say.  A prolonged conflict is heightening worries about global food inflation and hunger, the UN agency International Fund for Agricultural Development (IFAD) said in a statement on Thursday.”  (EuroMaidan, sourced 3/9/22).

Called the “breadbasket to the world”, Ukraine and Russia account for 30% of the world’s exports of wheat, 19% of corn and 80% of sunflower oil.  Ukraine is the world’s largest exporter of sunflower oil.  Ukrainian wheat exports have supplied Egypt, Indonesia, Bangladesh, Turkey, Tunisia and Lebanon.  Egypt and Turkey import 70% of their supply of wheat.  The planting season in Ukraine can be forgotten this year and likely for some time forward, affecting supply and price of these important commodities. (However, we note that a wheat shipment from Ukraine, Russia and Romania is on its way to Egypt.)

Pressure to ramp up oil and gas production is likely to reverse attention and support for de-carbonization and investment in renewable energy in the face of the current emergency.  We offer a few more details and then take a ramble through parts of the municipal market.

  • Quoting from AP News: “Oxford Economics said evidence from wars ranging from the 1980-1988 Iran-Iraq war to the 1999 NATO bombing campaign against Serbia suggest that a staggering collapse of the Ukrainian economy of 50% to 60% is possible.”
  • Europe relies on Russia for nearly 40% of its natural gas and 25% of its oil. 
  • Russia and Ukraine combined produce 70% of the world’s neon, which is used in the production of semiconductors.  Russia and Ukraine also lead global production of nickel, copper, iron as well as palladium and platinum – which go into production of micro chips in EV’s and semiconductors.  Russia is the world’s second largest producer of titanium.
  • The price of nickel broke records last week, creating trading chaos and leading the London Metal Exchange to suspend trading.  This alloy is used to make stainless steel and EV batteries as well as a variety of other transportation infrastructure.  (See an interesting explainer on the use of nickel in transport here.)
  • The price of fertilizer, which relies on natural gas for production, has skyrocketed, affecting the cost of agricultural production.  According to Bloomberg, Russia and Belarus represent the second and third largest producers globally (China is fourth).  Brazil is the largest importer of fertilizer and exports soybeans, coffee, and sugar products. 

Concerning Supply Chains: 

Quoting from the IFAD statement:  “…the Black Sea plays a major role in the global food system, exporting at least 12 percent of the food calories traded in the world. Forty percent of wheat and corn exports from Ukraine go to the Middle East and Africa…millions have been pushed into poverty and hunger by the impact of extreme weather events and the fallout of the COVID-19 pandemic.  The continuation of this conflict, already a tragedy for those directly involved, will be catastrophic for the entire world….”

Professor Anna Nagurney, director of “The Virtual Center for Supernetworks” at the University of Massachusetts, Amherst, has produced an up-to-date page (here) discussing the impact of the Russia/Ukraine war as well as recent supply chain network issues.   Dr. Nagurney is also co-author of “Dynamics of Disasters – Impact, Risk, Resilience, and Solutions” (TOC here). 

Hong Kong, one of the busiest international container ports in the world, is suffering a new COVID lockdown, affecting supply chains globally.  The Hong Kong Maritime and Port Board reports that they connect to more than 600 destinations worldwide.

(For those who might have been waiting for delivery of a Porsche, or VW, Audi, Lamborghini or Bentley that was one of 4,000 vehicles that sank after catching fire in the Azores, consider that Ukraine produced the wire harness and spare parts for Porsche and the company has now idled its Leipzig plant in Germany.)

Transportation thoughts: 

COVID inspired many to move from the larger, cities to less dense locations.  Traffic has increased in those medium and smaller locations, but in dense large cities as well, as COVID fears (and now, rising crime) have reduced willingness to use public transit.  For those who cannot work from home, or are in the process of returning to office, more traffic now collides with higher gas prices.  We might see the return-to-office slow a bit in the face of the higher cost of the commute.  Forecasts about future utilization and valuation of commercial office space may need to be further tweaked.

Those on tighter budgets must make spending choices between filling the tank and purchasing other goods (sales taxes).   Just as we were celebrating return to leisure and hospitality venues, the price of gas may alter that decision-making.  Driving vacations as we approach summer have been considered safer from COVID transmission than flying or taking a train, but may now be reconsidered.  The cost of air travel is likely to continue to rise. 

Under pressure to transition to renewable and clean energy (in conjunction with the COVID collapse in demand) oil and gas companies reduced new investment in exploration, curtailing supplies around the world. Turning the switch back on will take time and it’s a complicated process among extraction, refining (plus the grade of crude produced), and distribution channels. 

Production of electric vehicles (EV) and charging stations are likely to slow down in the face of key shortages in the materials that produce EV.  Gas taxes may experience a resurgence along with increased carbon emissions.   

A few Thoughts on U.S. Higher Education:

While the number of international students coming to US colleges and universities to study fell dramatically due to COVID travel restrictions, recession in Europe and elsewhere is likely to impact international study in the US.  We suggest looking at IIE, the Institute for International Education, opendoorsdata.org for data on countries of origin and destination.  As many analysts of US higher education know, international students tend to pay full sticker price for tuition and have helped balance costs for local students. 

And on Public Pension funds:

Governor Newsom recently called for California state pensions to cut off money to Russia.  CalPERS reported to the governor that it controlled $420 million in public stocks and $345 million in illiquid real estate assets.  While mark-downs would be sizable, they represent less than .2% of CalPERS total investments.  (See details here and here.) Further, dealing with illiquid real estate assets (especially those in private equity funds) may take some time.  The financial impact of adjustments in the portfolio may not be known until beyond the end of the fiscal year, or Q2 calendar year 2022. 

Aside from assets, the COLA (cost of living adjustment) increases for public pension members in the US are likely to grow, given persistent inflation and higher prices for basic items reinforced by the war in Ukraine.

Elsewhere on the pension front, there is an interesting tension afoot between current sanctions and recent state legislation concerning “anti-BDS” (boycott, divest, sanction) investments.  Thirty-five states have laws, executive orders or resolutions that discourage boycotts – largely against Israel. (You can find a list of actions here.)  A few left-leaning members of congress (the “Squad”) have pointed out the contradiction between current sanctions against Russia and Israel’s occupied territories. In a different vein, the state of Texas passed SB13 last May that directed state investment funds to divest of companies that have cut ties with fossil fuel-based energy companies.  (This included the Texas Permanent School Fund, along with several state pension funds.).  HB17 applies to political subdivisions that discriminate against natural gas and coal.  (See discussion here.)

Finally:

The global chessboard is changing.  Daniel Yergin noted the 1,865-mile Eastern Siberia-Pacific Pipeline that began to flow natural gas in 2019 from Russia to China.  Yergin stated, “In 2005, just 5 percent of Russia’s oil exports went to China.  It rose to almost 30 percent, and Russia eclipsed Saudi Arabia as China’s number one supplier.  A financial backbone to the oil trade is provided by the $80 billion of prepayments that China has made to Rosneft for oil supplies to be delivered over the next twenty-five years.”  (Yergin, Daniel, The New Map: Energy, Climate, and the Clash of Nations. New York: Penguin Press, 2020).  We note that Saudi Arabia’s ARAMCO recently agreed to build a multi-billion dollar refinery and petrochemicals project in China.  As reported in The Wall Street Journal, despite their pledge to achieve net-zero carbon emissions by 2060, Saudi Arabia’s oil minister told an international conference “…that the developing world can’t be kept in poverty by developed nations eager for a cleaner climate.”

A flight to quality from increased volatility in equity markets will likely help municipal bonds.  Similar to the period entering COVID, state and local governments have significant fiscal reserves: an unexpected boost of sales and property tax revenues during COVID, and federal support to proceed with infrastructure improvements in transportation, water and broadband to name a few.

Only a few weeks ago, pundits were predicting seven Federal Reserve rate hikes to tamp down the impact of inflation.  In the current context, some are now estimating three to five hikes – much of which is already priced into markets.  If you’ve already put your municipal market volume estimates to bed, you might want to revisit over the next few months.  If the Federal Reserve does indeed, soften its approach to rate hikes, we may see more refundings than were imagined in January and increased infrastructure investment.  Taxable municipal issuance may bump up as international investors recognize the stable, safe municipal asset class.  What does seem clear in the tension between ESG and oil and gas advocates:  we are likely to see less emphasis on carbon reduction and increased investment in fossil fuels, fracking and pipelines.