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Decoupling: A Massive Strategic Headache

Decoupling joins Decarbonisation and Digitalisation on the Strategy Agenda

Russia’s unwinnable war in Ukraine grinds on, giving us Generation X’ers the same nightmares we had as teenagers when our teachers told us we faced inevitable obliteration from Soviet Russian nuclear weapons. Putin’s problem is not what happens if he loses – in that case, he is finished, eventually if not immediately. His problem is what happens if he wins. He will end up ruling over a devastated, unproductive wasteland which hasn’t joined NATO or the EU but a wasteland nonetheless. It hasn’t bothered him much in Chechnya where Grozny (from up-to-date satellite images) is still pockmarked with ruins. It may bother him more in very much larger Ukraine. Russia certainly won’t have the money to rebuild and colonize it successfully during what remains of Putin’s lifetime, unless China steps in to rebuild all the assets it had in Ukraine until its Russian partner shelled them.

Plenty of people, from armchair generals to real life military experts, have been predicting that Putin will use tactical nuclear weapons in accordance with his oxymoronic, or just moronic, ‘escalate to deescalate’ policy. But what would be the point of nuking territory you want to occupy, or even nuking western Ukraine if you still intend to occupy the lands east of the Dnieper? It would make more sense for the Ukrainians to retreat west of the Dnieper and leave behind the cities Russian artillery has reduced to rubble, to let Russia occupy scorched earth, caved-in coal mines, salted fields, poisoned wells, blown up railway junctions, mined roads, and a booby trap behind every standing door.

In the real world, bloody stalemate, siege warfare and a cease fire agreement ceding some territory to Russia remain the most likely outcome. Russia needs the land link to its naval base at Sebastopol, and it wants unfettered access to the dozens of military suppliers it has in the Donbas. If Russia faces North Korean style exclusion from most of the international community, its government, oligarchs, military and people will have to decide for themselves if that is a price worth paying. The exodus of young professionals from Russia suggests one answer. Another is that the US and its allies may decide not to engage with Russia any longer, but plenty of other countries around the world will do so.

At this point, the economic outcome remains unpredictable. Russia will probably be subject to sanctions for some years to come. Europe and the US will try to wean themselves off Russian oil and gas. They may advance plans for their energy transition while simultaneously increasing investment in nuclear and hydrocarbon energy. Jorgo Chatzimarkakis, CEO of Hydrogen Europe, said at H2 View’s Virtual Hydrogen Summit Europe last week, that the invasion of Ukraine will be “a real accelerator for hydrogen” and that hydrogen should be included in European gas reserve plans.

While the West decouples itself from Russia, China’s support for the Kremlin means that the West has started asking itself difficult questions about its relationship with China. While the online shrieking classes call for the English-speaking nations to withdraw from commercial relationships with China, their governments have to accept that the theory which stated that China would democratise as it grew rich is now dead, at least as long as Xi Jinping remains in power, and probably for longer.

It is not however for this reason that China is less of a draw for FDI than it was 20 years ago. FDI has been falling for years and that China relies less on foreign trade for GDP growth than it has for 20 years (about 37%). Manufacturers have been reshoring from China for years already – as organisations like the European Reshoring Monitor can demonstrate. In the last decade, Chinese manufacturing labour costs have risen twelve-fold, so that a textile plant worker now makes per month what they did per year. China’s labour cost advantage is slowly being eroded.

As China closes entire provinces due to Covid-19 infections and upsets global supply chains, and as container liner prices remain 10 to 12 times their long-term levels, the pressure to shorten supply chains to the major OECD consumer nations is only increasing.

Meanwhile, China's technology advantage is growing. It might take a decade for instance to relocate China’s semiconductor industry to the US or Europe. But politicians with a longer term view than the current electoral cycle might begin to take the first steps of that decade long march to reshoring strategic industries. Maybe the UK’s recent appointment of a shipbuilding tsar (not a good month to assume that title perhaps) and commitment of several hundred million pounds to maintaining technical capability is a sign of this.

The decoupling of democracies from authoritarian regimes is in any event already under way as ESG focused investors wave their scented cambric handkerchiefs at human rights abuses in overseas countries, even through many ESG matrices can be shown to allow investment in for instance big tobacco, arms manufacturers or oil and gas producers. We can expect the decoupling to continue.

The consequence of this is deglobalisation driven by a combination of foreign policy and investor appetite. It will engender a realignment of supply chains including those which cross oceans. It won’t happen in weeks or months. It will be measurable in years.

This will affect the shipping industry. Future supply chains may be shorter as reshoring or nearshoring of manufacturing develops. Corporations will have to adapt to either smaller markets or to duplicating supply chains for different markets. The long-term effect will be that the economies of scale that shipping has achieved in the current century will become obsolete. We won’t need so keep growing the Valemaxes and Newcastlemaxes if, as the NDRC in China vows, it replaces 10% of virgin steel production with recycled steel by 2030. We won’t need ever larger container ships if Asia-Europe and trans-Pacific trade growth is enjoying a pandemic related last hurrah of growth.

The energy transition will multiply the effect of deglobalisation. We already know that the hydrogen based fuel alternatives to fuel oil for ships have far less calories by volume than fuel oil. Ships will have to have two to four times more bunker space, or will have to refuel more often, or sail shorter distances – probably more slowly. Shorter supply chains can give naval architects some cause for relief.

Agricultural and energy supply chains will alter. China is standing by Russia because China wants Russia’s wheat, oil and gas. As the Arctic temperatures rise 30 Celsius above where they usually are at this time of year, Russia stands to gain from climate change as vast Siberian steppes become more viable for agriculture. The Chinese want the food security that Russia can offer. If the US stops planting 50 million acres a year with soy to export to China, it can plant wheat and maize for western consumers. The Great Grain Race from Australia to Europe might be a seasonal feature as it was in the days of the wind powered clippers. If the West doesn't buy oil and gas from Russia, and OPEC won't supply it with more, it can either produce more itself, or transition faster to hydrogen, or do both.

The point is, the biggest risk we face in shipping for the foreseeable future is geopolitics. We’ve enjoyed the globalised world that developed after the fall of the Berlin Wall, the liberalisation of the Asian economies and the accession of China to the WTO. Indeed, cheap, reliable and ever safer shipping enabled globalisation. But along with the environmental costs of shipping being priced into the cost of freight in future, the clash of values will have to be priced into predictions about how world trade and the ships that service it evolve. All in all, it’s a massive strategic headache.

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