Calming down on "rebuild Ukraine"

We have been packing and getting ready for a long-haul half-term holiday and the kids have been getting very excited. So much so that at times you have to tell them to calm down and not get carried away with their expectations of how amazing everything is going to be.

This note is my equivalent message to those who believe Trump is going to deliver an imminent Ukraine-Russia peace deal which is going to end the war sustainably, lead to consumers going out and spending a lot of their savings as they have been curtailing their consumption because of the war, see a collapse in European energy prices which drops straight through to European manufacturing profitability as they don’t have to pass any savings on to their customers, all sending Europe into a big economic boom. Some of the relentless buying of certain rebuild Ukraine baskets is also questionable given several of the names within don’t directly benefit in anyway. I should say this is coming from someone who was bullish on European cyclicals and the rebuild Ukraine opportunity in November (see my posts below), but I just see too many incorrect assumptions and misunderstanding out there now, and certain European equities have moved a lot in a short space of time. Let’s see what comes out over the weekend but tactically it feels like we might have a travel and arrive setup here as the facts get digested, which may in time present a better buying opportunity to play a broader manufacturing and European recovery.?

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Probability and timing of reaching a durable agreement are being overstated

The market has high expectations for a tangible agreement emerging out of this weekend’s Munich Security Conference given right now Trump can do no wrong, and both Zelensky and Putin have said they are willing to come to the table. Of course they are; neither side will want to be seen as being the one who refuses to bring peace and they both have their reasons for wanting to end the bloodshed. The willingness to negotiate may be sufficient to trigger a temporary ceasefire, but to me the two sides are very far apart in terms of finding an agreement which can prove long lasting.

The ”leaked Ukraine plan” now looks to have been Russian planted propaganda and does not represent what Ukraine would be willing to give up, while recent comments from US defense secretary Pete Hegseth make it clear that the US seems to be adopting a Russia first stance which will be hard for the Ukraine and Europe to agree on. He has said that Ukraine must abandon hope of recovering all its territory lost to Russia, there will be no Ukraine membership of NATO, no US troops in the Ukraine, and no US security guarantees to Western troops in Ukraine. Zelensky has made very clear (and it makes logical sense) that there is a bright red line whereby the Ukraine cannot stop fighting without credible security guarantees; is NATO without the US a credible security guarantee in the short-term? Without future US support, it is in the interest of Europe to weaken Russia as much as possible now and support Ukraine in its current fight, hence the Weimar+ Statement from a couple of nights ago which states that “we are ready to enhance our support for Ukraine”, “we share the goal to keep supporting Ukraine until a just, comprehensive and lasting peace is reached”, and “Our shared objectives should be to put Ukraine in a position of strength. Ukraine and Europe must be part of any negotiations.”

There is a perception that Ukraine is suffering devastating losses on the battlefield and is under pressure to agree to any sort of deal but actually the Russians are also sustaining a higher number of casualties (they lost 48,000 soldiers in January alone after losing 450,000 in 2024) as Ukraine ramps up production of drones which are proving effective; they manufactured over 1.5m in 2024 and are on track to make 2.5-3m this year according to local officials.

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Views that gas prices are set to collapse on the back of a Ukraine agreement look aggressive and miss the facts

European gas prices have broadly continued to rally recently, trading at around two-year highs, and have not collapsed - contrary to the bearish narrative that has re-emerged since we had leaks over the Ukraine peace deal. The reality is the market already knows that new global LNG supply ramps up from 2026 and will meaningfully loosen global gas balances, hence the curve trades in sharp backwardation.

Looser gas markets from 2026 and beyond means that to have a meaningful impact beyond already cautious market expectations, Russian gas will need to return to Europe already in 2025, and then be meaningful volumes in 2026 and beyond. There are plenty of stumbling blocks that make this far from certain – the routes to market are Nord Stream pipelines, transit volumes via Ukraine and Yamal imports via Poland. Politically it is hard to see Germany and Poland quickly changing their tune and be willing to effectively commit part of their economic future to being dependent on Russian gas flows, especially now that LNG is a more viable substitute in terms of volumes. Several German politicians have clearly stated that the idea of cosying back up and being dependent on Russian gas is far too dangerous. Then there are various legal obstacles and a long list of arbitration cases between Gazprom and former European counterparts in gas contracts to get through. Finally, and maybe most important on timing, there are various infrastructure constraints; for example Nord Stream 1 would need Gazprom to repair the pipeline while Nord Stream 2 would need to reconstitute the German subsidiary and get a license to operate as a Transmission System operator in German territorial waters. Realistically then if we get a lasting peace agreement and Ukraine is on board, the only incremental flows we will see anytime soon will be the ~15bcm via Ukraine, meaning gas prices are unlikely to collapse imminently and halve this year as some suggest.

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Power prices are already lower than when Russia invaded Ukraine

A fact that very few realise - German baseload power prices for the current year ahead are much lower than levels prior to Russia invading Ukraine, and this is not down to seasonality as we are comparing February 2022 to February today. If gas prices are not about to collapse and carbon markets are structurally tighter, then power prices are also not about to collapse.

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Consumer and Corporate sensitivity to a shift in gas prices overstated

There is no evidence which suggests there is pent up demand from European consumers waiting to splurge following a Ukraine-Russia peace agreement, especially if we only get a temporary ceasefire and no concrete agreement which pleases Ukraine and Europe. In the niche areas where this may be the case, it makes sense it would be service-related industries revolving around the Eastern European eco-system.

On the corporate side, many corporates have permanently changed their energy footprint so that they are less reliant on gas. For example, a recent report from Morgan Stanley Chemicals team shows that the estimated EBITDA sensitivity for a 10% move in European gas and power prices for BASF would only be +/- 2.5% as they have reduced their gas usage by 4.8 TWh following the closures of ammonia/caprolactam and TDI capacity.

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Steel is not an obvious net beneficiary

European steel stocks have rallied sharply on recent Ukraine peace hopes but there are credible arguments to suggest an ending of the war would be a net negative for the industry. Ukraine was previously one of the largest net exporters of steel in Europe, supplying 13-14mtpa into a ~125mt market. UBS research estimates that steel demand to rebuild the Ukraine could add 1.4-2.0mtpa to demand, however production would recover by ~5.4mtpa even adjusting for damaged plants, thus increasing net exports.

Then you have to consider Russian steel exports, which previously were over 10% of the European import market. If Europe removes sanctions on Russia, you conservatively could see an incremental supply increase into Europe of > 3%.

Cement is a local/regional product, very few European building materials companies have direct exposure

Rebuild in Ukraine will take several years but even if front loaded, will not suddenly tighten up European cement markets as it does not make sense to transport it over longer distances. In the listed European space, only CRH has significant cement capacity in Ukraine. The industry has already been using higher energy prices as a reason to increase prices; I think it would be very unlikely to see them capture the majority of the benefit from a sharp fall in power prices which would be front and center for all customers.

Finally, there are still plenty of question marks over the actual direct impact from rebuilding Ukraine such as the timeline and how much will be in Ukrainian territory. If the scale of reconstruction is ~$500bn as suggested by the World Bank, spread over ten years this would be under €30bn per annum which is only ~1.5% of European construction activity.

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Bernie’s weekend eats – Cah Chi, New Malden

If you like Korean BBQ and prefer low key casual restaurants, then do get excited about this one. I’ve gone and eaten at numerous Korean restaurants over the years in the New Malden area to try and find the best, and have finally settled on this as my regular. A family run establishment, the service is friendly, and the extensive menu offers plenty of choice to cater to different preferences. They have a good assortment of banchan (small side dishes) to fill the void of waiting for the main event, while I like the Pa Jeon (seafood and spring onion pancake), Jap Chae (glass vermicelli with beef and vegetables), and Korean fried chicken from the starters. When you are ready, they fire up the grill set in your table and come and cook whatever proteins you have chosen. I always have to order the beef LA Galbi (marinated beef short ribs), ox tongue, Iberico pork neck and tiger prawns but there are plenty other choices as well. We don’t normally have space for dessert but for those that do, they have green tea or black sesame ice cream, or a red bean bingsoo (milk based shaved ice dessert) which can be particularly when it’s warmer. ?