Dear Reader:
Here at Wealth Daily, we take no joy in predicting wars. But to get global markets, you have to understand the relationship between peace, conflict, and money.
Two years ago, the "frozen" conflict between Georgia and its Russian-backed breakaway regions wasn’t even a blip in most western news outlets. But that’s when our international editor Sam Hopkins brought the region to your attention as a potential flashpoint with major geopolitical and economic significance.
As Sam said back in 2006, Georgia is a major transit point for Caspian Sea oil and gas—through pipelines that bypass Russia. "The Oil War No One Sees Coming" lays out a case that is still obscure in much of today’s coverage even though there is now heavy fighting in the Caucasus.
I urge you to read that excellent piece of research and forecasting if you want to really grasp what’s going on. And today, Sam’s picking up with the newest facts and how your money is affected.
Good investing,
Brian Hicks, Publisher
Understanding the War in Georgia
From Chechnya to Kosovo to South Ossetia and Abkhazia, it’s difficult to sort out Russia’s stance on independence movements. High in the Caucasus Mountains, a patchwork of ethnic enclaves confounds the former Soviet republics of Russia, Georgia, Armenia and Azerbaijan.
Joseph Stalin, himself a Georgian, knew the area’s complexity well. That’s why he started as the Soviet Union’s Commissar of Nationality Affairs, wrangling disparate peoples into Moscow’s communist corral.
Today’s Russia is capitalist, but Prime Minister (until recently President) Vladimir Putin pines for the days when Moscow’s power extended solidly into the "near abroad," from Finland all the way to the Pacific.
So the Russian Federation has taken the autonomous Georgian regions of Abkhazia and South Ossetia under its wing, sending in military peacekeepers to prevent Georgian government incursions while issuing Russian passports to local residents.
This sponsorship understandably irks Georgian leaders, who are close with the Bush administration. Russia’s support for Abkhazia and South Ossetia also seems to run counter to Russia’s backing of Serbia over the issue of Kosovo, a majority Albanian section of former Yugoslavia that recently declared its independence.
Further complicating things, Russia fought hard through the 90s to assert its control in Chechnya, a Caucasian part of Russia with a militant independence movement.
No matter what would seem to make sense, hypotheses are now out the window and Russia is at war with Georgia.
Down to Business in the Caucasus
Though there have been battles in the Caucasus since time immemorial, modern economic conditions change the spoils of war and the methods by which they are gained.
Georgian government websites have reportedly been targeted by Russian hackers in the past few days, a real show of force that can be equal in economic damage to a blockade in the Information Age.
In other recent regional squabbles, most of which have transpired without a volley of mortars, Russia has used its substantial oil and gas reserves as leverage to get former Soviet republics and satellite states to capitulate.
Ukraine found its gas supply cut by Moscow when it refused a price increase in 2006, and European states to the west cried foul since the drop in pressure to Ukraine also threatened supplies in NATO countries.
The energy equation is different when it comes to Georgia, though, which may be why we’ve seen Russia ban imports of Georgian mineral water and wine, as well as employing cyberwarfare, to inflict financial wounds.
Georgia is a key player in moving oil and gas from the Caspian Sea basin westward to the Mediterranean. The country has gained the support of the United States in the form of military consultation (we have a couple hundred troops on the ground there now even as Russia and Georgia are fighting), and with engineering expertise to move natural resources safely.
The $4 billion Baku-Tbilisi-Ceyhan pipeline, named for the capitals of Azerbaijan and Georgia and a Turkish province, passes within 100 miles of the South Ossetian capital of Tskhinvali.
image: BP
Carrying a million barrels a day, the BTC pipeline is separated from the Russian-backed region (which Monday is said to be totally under Russian control) by over 10,000 Georgian soldiers. It has also been buried underground for most of that stretch to prevent attacks by saboteurs.
The U.S. Department of Energy says there are two energy priorities for Caucasus countries: to diversify their energy supplies and to cash in on transit revenues.
Energy diversification and profit are indeed the top motivators for many policy moves these days, from Eastern Europe all the way to the United States. Russia, for its part, has moved to re-nationalize companies such as Yukos and projects led by BP while using energy leverage in neighboring states like Ukraine as mentioned above.
Russia opposes the BTC pipeline, which was purposefully built to skirt Russia’s transit routes. Moscow’s opposition to a trans-Caucasus route puts them at odds not only with Georgia but also with Azerbaijan and Turkey, the other BTC hosts.
As you can see in the BTC map above, Armenia would have provided a more direct path from the Caspian to the Mediterranean, but Armenia is tighter with Russia and has frosty relations with Azerbaijan over a majority-Armenian territory deep inside Azerbaijan.
Economic Fallout to Come
When I first started covering international energy issues and how tension in the Caucasus could affect supply, oil cost less than half what it does today.
That means the stakes are ever-higher, and what seems to be a matter of autonomy and ethnic affinity has become more economic.
Russia is also under scrutiny for moves outside the energy arena. Investors in NYSE-listed Mechel Steel (NYSE:MTE), previously worth over $15 billion, got spooked by comments that seemed to threaten top shareholder Igor Zyuzin. Putin also hinted that the government’s anti-monopoly service and state prosecutor should get involved in accusations that Mechel is selling materials abroad at a discount to the Russian price.
Mechel’s stock price swiftly dropped, and so did the Moscow Stock Exchange benchmark index.
The Georgia affair may not do Russian stocks any favors either, but then again Israel’s leading share index actually rose during its 2006 war with Lebanese terrorist group Hizbullah.
So far this summer, it seems that Putin’s comments on Mechel did more to harm investor confidence than the developments in Georgia, with the most precipitous decline coming in late July after the PM’s menacing words.
Since Russia invaded South Ossetia over the weekend, seized a base inside Georgia near South Ossetia, and now has paratroopers in Abkhazia, the Market Vector Russia ETF Trust (NYSE:RSX) is down by 6%, compared to a nearly 27% decline in the past 3 months together.
No Georgian stocks are available in the U.S., but the European Bank for Reconstruction and Development is already revising its growth estimates for the country.
"The frozen conflict in South Ossetia has always been a worry for foreign investors in Georgia and if that is ultimately removed as a result of this, it could become more appealing," analyst Michael Davey told Reuters. "If there is a final conclusion then the slowdown may not be that pronounced … but there will be one."
If you own any Russian stocks, watch them closely. Energy shares should be held, but be wary of Putin’s new aggressive language towards Mechel as well as the hit the market could take with continued fighting in the Caucasus.
Regards,
Sam Hopkins
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