Page 11 - ISO April 2023
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        which was not a given at the start of the war—has prompted western
        nations to increase their support for Ukraine’s military and economy
        with total US support reaching around $113 billion (about 0.5% of US   Energy and defence trends are undergoing a
        GDP). However, we view the spring and summer as a potential   structural transformation driven by the longer-
        turning point in the war. Advances by both sides are expected to slow   term policy implications of the war.
        substantially, potentially settling into a frozen conflict on the nearly
        600-mile front in eastern Ukraine. Should this occur, the question for
        markets will be whether conditions support the start of a resolution   advanced technology prior to the invasion to include legacy and
        process. Recent headlines have indicated that western leaders are   mature sectors with high concentration risk. Oil, natural gas, and
        beginning to plan around a post-war scenario, and the key factors   energy infrastructure are likely to see persistent policy impacts
        that could form an off-ramp are twofold:            as the availability and expansion of these economic inputs is
                                                            more acutely seen as a core national security interest. This trend
        1. Will Ukraine and western allies see any move toward a peace
        settlement as durable and sustainable?              is likely to drive new investments into securing and diversifying
                                                            energy supplies with a focus on avoiding concentrations that
        2. Will Russian president Vladimir Putin assess that the costs of   could lead to future vulnerabilities, such as with critical minerals
        continuing the war outweigh the benefits?           for renewables technologies.

        Both of these factors support a period of heightened escalation   On defence, global military spending will be on a longer-term
        potential before any off-ramp becomes a clearer possibility.   growth trajectory as governments invest in military capabilities to
        Ukraine and the western coalition will look to increase the costs for   deter new  wars and conflicts  among  nations. The Biden
        Russia to deter similar action in the future, and Russia is likely to   administration’s recent National Security Strategy describes the
        challenge western unity and solidify control over currently   decade ahead as “a significant inflection point” that sees renewed
        occupied territory to increase its leverage in any settlement   tensions between global powers. From a US standpoint, investment
        negotiations. This generally positions the first half of this year as an   in defence will particularly be driven by the desire among
        ‘escalate to de-escalate’ setup—a military strategy term which can   policymakers to project a credible degree of capability for the US to
        be adopted to fit the trajectory of the conflict. We would expect   defend its security interests in multiple hotspots as this global
        market volatility at the beginning of any escalation, but any off-  competition increases. A recent expansion and escalation of
        ramp would be viewed as a market positive.          tensions with China will be a further tailwind for increased

        It is also important to consider less optimistic paths. The two   defence spending, in our view. A lesson learned from Russia’s
        more concerning possibilities include a protracted war that   invasion of Ukraine is that the threat of severe economic sanctions
        continues to place a drag on global economic growth and an   is  not  sufficient as a  means  of  deterrence,  which  will  place
        expansionary conflict that sees a direct confrontation between   renewed emphasis on military power as a critical national security
        NATO forces and Russia. A principal Russian goal would be to   consideration.
        degrade support for Ukraine among western allies. An
        environment of persistent inflation, mounting domestic fiscal   US-CHINA RELATIONSHIP
        challenges, and no end in sight to the conflict could weaken unity   Economic competition between the US and China is here to stay,
        among western allies and ease Russia’s path toward heightened   with the Biden administration taking a wide-reaching approach to
        regional power. A more escalatory path to the conflict involves a   its “competition, not conflict” China agenda. Bilateral relations
        decision by Russia’s policymakers that a war lost to NATO directly   deteriorated ahead of a long-awaited trip by Secretary of State
        is less damaging to the stability of the Putin regime than losing a   Anthony Blinken to China following the discovery of a Chinese-
        war to Ukraine. While this path may be unlikely at this stage, the   operated balloon in US airspace, which was postponed as bilateral
        range of possibilities related to the conflict warrant continued   tensions increased. The Chinese government additionally ratcheted
        caution given the level of uncertainty ahead.       up its criticism of US tech restrictions, describing the policies as
                                                            “containment, encirclement, and suppression.” These developments
        Even as markets look to a potential post-war scenario, we expect   point to the US and China entering a period of heightened tensions
        certain sector impacts to be longer lasting. Particularly, energy   and an increasingly combative tone in the bilateral relationship,
        and defence trends are undergoing a structural transformation   elevating the risk level around potential future flashpoints such
        driven by the longer-term policy implications of the war. For   as maritime accidents in the Taiwan Strait or South China Sea.
        energy,  part  of  the  war’s  impact  has  been  an  expansion  of
        national security  concerns around  economic  linkages  from

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