Investment modeling attempts to take into account as many variables as possible, but almost never starts with a clean slate.
There is always a posit at the outset, and modeling either refutes it, supports it or straddles the fence. Modeling for equity returns generally presumes a more positive outcome and begrudgingly includes some “what ifs” to cover one’s behind. Very seldom, does a posit run the risk of total negation.
At the outset of the Russian invasion of Ukraine, the geopolitical calculation was that Russia, even if the near term victor, would be sated upon the absorbing of the land mass and that the Putin would be wholly unwilling to take on NATO in a ground war. As a result, the European response was to supply Ukraine with a variety of older, largely obsolete weaponry slated for the scrap heap, relying upon Ukraine to supply domestic lives for the meat grinder, a “mostly Ukrainian problem but a little bit our problem too“.
As the war moves into year 3, a shift in modeling may be required, and might have import for equity accounts on a global basis. The failure of Ukraine to recapture much territory in the summer 2023 counteroffensive was blamed on weather, on disparate weaponry, on lack of air support, on Elon Musk’s Starlink terminals, on lack of training, on generals in Ukraine used to Soviet era tactics. So, modeling morphed into calculations that Ukraine could ultimately transform into a Russian version of Vietnam, another Afghanistan, a massive capital expense with nothing to show for it. Another scenario recently floated is that of a partitioning of Ukraine. Again, not good for Ukraine, but that still keeps Russia off the doorstep of much of Europe.
Ominously, the failure of the Ukrainian counteroffensive was based upon a more fundamental problem, an intractable lack of artillery shells.
Recent Russian victories have revealed a significant shortfall in Europe’s abilities to supply munitions, leading to a potentially perilous reduction in the supply of Ukrainians prepared to die for their country. Nothing puts a halt to enlistment in a good cause faster than videos detailing entire trench defensive positions being blown to smithereens by multiple 1500 kg glide bombs, “Dresden sized”. Nothing puts more fear into the hearts of defenders than knowing the Russian military places no value whatsoever upon their own soldier’s lives in the goal to take an objective, with the end result that any Ukrainian soldier protecting that objective will also die.
An unspoken maxim of war is that voluntary enlistment only persists under an operating premise that more will survive combat than perish. When the equation factors in an assumption that more will die or be grievously injured than will survive unharmed, enlistment stops and is then replaced by compulsory service.
In my own province, more than 30,000 Ukrainian refugees have arrived, and of those, an estimated 8,000 are healthy men of military service age. That number of able bodied men represents an entire army division, and despite all the talk of patriotism for mother Ukraine, they fled. More service age men arrive monthly. Why would these men return to Ukraine, should it become more evident that their army is in peril? They are here, well away from Europe, because they have done the math of self-interest and have determined that there is about a 1 in 4 chance that by returning and serving, they will suffer a debilitating injury or death.
As to Russia, Putin was overconfident of an easy victory at the outset and had failed to prepare for a protracted war.
All Russia had was manpower and about 70 years of antique weapons; but 70 years of old weaponry is a lot of kit. The logistics systems of Russia were not coordinated, the munitions manufacturing was not up to speed, the army was largely conscripted and untrained. Now, the Russian economy has fully oriented itself for a war time footing. Further sanctions are meaningless as hard currency can be had via resource exports to friendly nations, who provide Russia with sanctioned equipment in exchange for resources.
By 2025, it is now estimated that the Russian munitions industry will be capable of supplying up to 2.8 million 152 mm artillery shells annually, the primary item lobbed upon defending positions.
2.8 million shells trained on the city of Kharkiv levels it to the ground, a city with a population of 1.4 million. Envision the bombing of Dresden in WW2, where 390 tonnes of explosives were dropped and multiply that explosive output by 170x. That output, when augmented by purchases from China, India, North Korea and other nations friendly to Russia, could represent a 10x multiple of the current productive capabilities of all of Europe. Russians will no longer need a basic training program for their soldiers because their primary job will be to shoot injured defenders not completely blown to bits by artillery and glide bombs. 2.8 million, 100 lb, high velocity bullets, will pretty much destroy anything that they are aimed at and the more Russia has, the more damage they will inflict.
Some think-tanks have done munitions math going into 2025 and the implications are sobering indeed.
Much of Europe failed to act upon the war. Instead of themselves re-arming, NATO nations largely raided existing stores of antique weaponry, hoping for a quick end to the conflict by combining harsh rhetoric with a variety of group photos involving resolute-looking heads of state. Ukraine was promised 1,000,000 artillery shells last year from Europe to defend themselves, but received just 300,000. That number is distressing, as it indicates a current productive capability a full 70% lower than internal estimates. Europe promised 1,000,000 million shells and the public assumed this equaled some percentage of productive capabilities; it did not. Almost 70% of that offer was to come from existing stockpiles and only 30% could actually be produced in a given year. It further turned out that net European production wasn’t even 300,000 shells annually. In fact, that number represented the annualized amount based upon the final quarter of 2023 production. Of the 300,000 shells actually received by Ukraine, many were decades old, perhaps 80% are useable. During the early stages of the Ukraine counteroffensive, artillery use was estimated at 45,000 shells weekly. All of Europe’s present, combined, artillery shell output, provides a bit more than 6 weeks of Ukraine’s annual need.
There has been almost no meaningful indications of Europe turning on enough munitions factories to match prior promises, let alone arm-up and represent an equivalent response to Russian military output.
According to EU top diplomat Josep Bosell in January 2024, European combined 155 mm artillery shell capability is annualizing at a rate of just 400,000 shells, with a hope that by the end of 2025, gross production capabilities may be 1.4 million shells per annum. This gross amount is roughly 1/2 that of assumed Russian productive capacity in 2025. Granted, Russia overstates things, but so too does Europe. Who knew that all of Europe could not produce more than 1100 shells daily? With a total of 44 countries in Europe, that output suggests total 155 mm artillery munition capacity of just 25 shells per day, per country. Europe intends to boost production sharply, but they have stated as much thrice, and so badly missed forecasts that the announcements were not worth making.
The most recent goals sound less than credible and more desperate. There is an incredible amount of “buck-passing” among the EU member nations, with each EU defense minister asking another national defense minister as to the status of increased munition production and receiving variations on the same answer” “nobody told us to make more ammo, I thought your country was doing it“. Then, they slap each other on the back fondly, assemble for the group photo, head off to the taxpayer funded lobster lunch with champagne glass in hand and promptly forget to build an artillery plant.
At the media debriefing in each EU state, post conference, the various defense ministers, when pressed on the status of the munitions shortage, truthfully declare: “I talked at great length with the defense minister of country X about the need for greater artillery production to assist Ukraine“; the viewing public takes that non-answer to mean another nation is resolving the problem. In European country X, the public briefing on the meeting produces the exact same talking points, but in reverse, leading that nations’ citizenry to assume another country is increasing artillery output.
The truth is, in the EU member shell game, too few countries are doing what needs to be done. Germany is planning to expand artillery output, and it will take years. Norway is already on it, but it takes years to tool up a facility. Those two nations alone cannot up their output sufficiently to meet even a fraction of the minimum requirements for munitions. Another 42 European nations remain, wringing their hands, doing virtually nothing. Nobody in Europe was producing the ammo required to mount a capable defense prior to the war, and they have yet to do so today. All of Europe is filled with hangers of aircraft possessing no missiles, warehouses of tanks with no shells and surface to air missile batteries, covered in tarps, with no SAMS to fire.
Yes, there is an abundance of small arms ammo to go around, but that requires armies get close and personal. Artillery is designed precisely to prevent that from happening.
Yes, Ukraine is talking up goals on the purchase or assembly of 1 million first person drones, made entirely from Chinese parts, but those drones can only about drop a 1-5 pound explosive. Drone ordinance represents, in total, the rough equivalent of just 50,000 high capacity artillery shells and that is a kind assessment. Russia fires more than 50,000 artillery shells at Ukrainian positions weekly. Russia intends to purchase even more FPV drones from their staunch ally, China. Realistically any purchases made by Ukraine are fully negated by Russian purchases of the same equipment, from the same vendors, possibly at discounted prices.
Let us be realistic about Ukraine reports on FPV drone production; Ukraine is merely assembling Chinese components. What Russia and Ukraine possess in drone equipment is almost exclusively Chinese in origin. What happens in this conflict, should China decide to cut off or limit FPV drone components to Europe and Ukraine, declaring them to be in short supply, while greatly increasing volumes to Russia? China has already established a precedent for placing their thumb on the scale, favoring Russia vs Ukraine, with the Chinese decision to stop sending nitrocellulose to Europe in Q3, 2023. Nitrocellulose is the primary element needed to produce an artillery shell, and, wonder of wonders, is not even produced in Europe, but rather, is imported from China.
Russia has re-tooled its economy to a military footing, geared specifically for protracted and further engagement. Europe has not.
And now, as a consequence, Ukraine is running short of men and women with resolve, let alone limbs. The great bargain struck between Ukraine’s president Volodymyr Zelenskyy and Europe was that Europe and America would supply the munitions while Ukraine would supply the personnel. Europe said “OK”, rooted around in its attic for a bit, but then immediately offloaded the expectation for munitions delivery directly at the feet of the United States. The US is now, rightly, balking at doing far more than their share while once again letting NATO, non-NATO European countries and Canada off the hook. Without munitions, there won’t be enough Ukrainians left to fend off Russia and the next line of engagement becomes Moldova, Estonia, Latvia and Lithuania.
The recent setbacks in the Donbas should be evaluated carefully, because in a matter of days, what the western world was told to be a decade old bulwark of defense was revealed as a bit of a charade, with a defending armed forces that fled, leaving behind hundreds of wounded soldiers, abandoning considerable military kit in the haste, and having no secondary defensive positions to flee to. Russia has advanced quickly and there are signs of growing panic within Ukraine’s military.
What the Russian military has learned is that they know more about defense than the west.
NATO scoffed at trench warfare with artillery engagements claiming it to be archaic. But, the west was unprepared for 5 mile deep fortified fields that are triple mined, which renders speedy equipment inoperable. The west was unprepared for conventional artillery wars and now collectively is incapable of producing enough artillery to protect Ukrainian soldiers. The west was unprepared for drones that can take out an M1 tank simply by dropping a 5 pound bomb on the top hatch. The west places a value on human lives that Russia does not.
Europe has not yet woken up to these issues, but Russia fully understands them. Now, Russia has little interest in an armistice and partition of Ukraine, nor are they interested in a frozen conflict. Should Russia formally annex Transnistria (a break-away region of Moldova on the western border of Ukraine), it should be assumed that the Kremlin’s military complex feels confident in their ability to conquer Ukraine in its entirety and will then have a sizeable artillery advantage to direct against other European nations. Just what will Russia do with all that ammunition production, should they best the largest armed force in Europe, one now using an array of western weaponry?
Behind the scenes actions from Europe support the magnitude of the issue, with recent press in Europe talking up hopes from Germany to negotiate munitions buys from Bulgaria and India, two countries with distinctly pro-Russian leanings. It is shameful of Europe, cap in hand, to be reduced to trying to acquire ammunition from such vendors. Russia has most certainly taken notice of the deficiency, the miscalculation, the Kremlin will be emboldened. Russia has also realized that they can negate Ukrainian defender advantages by forcing them to retreat in a hurry, because no army shoots well when they flee. Ukraine has made their own miscalculations in failing to build out multiple lines of defense on contested fronts. Any Russian breakouts could result in larger encirclements of Ukraine positions and possible routs.
The economic calculus for a nation converting entirely to a wartime economy only makes sense when the intent is to continue a war, expand territory, acquire an additional population to press into military service and to keep on going.
War, unfortunately, benefits from economies of scale. Russia doesn’t orient an entire economy to a wartime economy for just a 2-3 year engagement, involving a single country in Europe. And as Russia is already at war, has probed European capabilities and determined them to be deficient in key areas, why stop now? European and America’s combined 155 mm artillery shell capacity, by 2025 will still be less than the pro-forma forecast shell manufacturing capability of Russia. The munitions gap widens when one considers that Russian output can be readily augmented by suppliers in China, India and North Korea.
In the west, we dismiss and diminish the quality of Russian munitions. But, do we overstate our own capabilities? Ukrainian soldiers have commented that the accuracy and reliability of western munitions isn’t nearly as stated either. Furthermore, does a solder have the ability to differentiate a “degree” of death from artillery? When a 155 mm shell hits, the result is almost invariably death and as the general atop the Ukrainian armed forces recently noted: “quantity represents its own form of quality.” The American Abrams M1 tank, supposedly the most armored vehicle on the planet, can be rendered inoperable from a turret hatch hit by a $1,000 drone, made in China, with a $200 dollar explosive attached.
The failure of Europe to meaningfully address the munitions gulf has placed all Europe at risk and so long as that gap persists, there is absolutely no reason for Russia to discontinue expansion plans at a border between Ukraine and Poland.
NATO budgets are only increasing slightly, and of that amount it is overwhelmingly oriented toward payroll, pensions, medical benefits and retirement benefits for soldiers and bureaucrats. Another significant expense are the myriad of 400 page military studies and symposiums touting capabilities, with just a fraction of annual budgets actually going towards munitions. Russia, in contrast, will be spending a seriously disproportionate share of its GDP towards munitions, weapons and weapons factories. The Kremlin doesn’t need to concern itself with military payrolls, veteran pensions or medical benefits because most of their armed forces will die prior to the accrued expense turning current. Actuarially, Russia, despite its much smaller economy, relative to Europe, for now, may be in the drivers seat in this conflict. Time is very much of the essence and Europe has failed on its obligation for the most basic piece of kit in any war, munitions. Now, there may be a serious consequence.
Military doctrine assumes that an attacking force needs to be 4x-5x larger to win a head on battle against defenders. How does that calculation change when the attacking force also has a 7x-10x munitions advantage?
According to credible military sources in South Korea, North Korea has reportedly delivered in excess of 2 million 152 mm artillery shells, possibly as many as 3 million, to Russia since August, augmenting Russian domestic production. NK is reportedly operating artillery factories on a 24 hour basis to supply Russia needs, trading shells for food. The noted disparity in ordinance output between Russia and its allies to be used against Ukraine, vs Europe and its allies to be supplied to Ukraine, has swung momentum greatly in favor of the Russians.
Historical anecdotes on the outlook for defenders, when faced with an artillery mismatch, go back as far as the 1757 siege of Fort William Henry in New York. British Lieutenant Colonel George Monro was tasked with defending a strongly fortified position, with well armed and trained men, against the Marquis de Montcalm of France regulars and mercenary Huron Indians.
At the very outset of the hostilities, a small group of reinforcements made their way into the fort for an assessment of the situation. The fortress was imposing, constructed of 30 foot thick walls on all sides, 20 feet of wet clay fill poured between 5 foot diameter logs. The spongy clay would absorb cannon fire and was considered to be the reactive armor of its time. In fact, the builders bragged that the more cannon shot levelled against the fort, the faster the walls would transform to solid iron via absorption of the cannonballs into clay. But, the military planners did not anticipate that an attacking force would bring howitzers to battle, lobbing shells over the walls, rather than at the walls. When queried on the status of the British ability to defend against a larger French force, armed with massive howitzers, Colonel Monro reportedly offered up a blunt response: the French have bigger guns, and more of them. Once their artillery moves into range, they will pound us into dust.” A one-sided artillery battle resulted in a massacre of the British forces during the siege, followed on by an even greater massacre when the defeated survivors fled for the next frontier fort. Now, as was true then, fortifications and resolve are no substitute for munitions.
I very much doubt that a single major investment house or multitrillion asset fund manager is modeling in the possibility of Russia taking Ukraine and pressing their advantage to invade additional European countries.
Investors cannot fathom that Europe may once again be embroiled in a pan-European war. Yet, the Baltics are in the process of starting to mine their borders with Russia. Finland is encouraging Ukraine to acquire and use long range missiles to strike directly into Russia, and no fewer than 5 European nations have decided that they are OK with the notion, if not the action, of placing European soldiers directly into harms way; not their soldiers mind you, because the EU is all about passing the buck and avoiding individual responsibility, but European combatants nonetheless. There is growing unease in Europe at this time, the same sort of unease that may have preceded the Nazi invasion of Poland.
For the past 3 centuries, overwhelming firepower, more so than any strategic planning, won ground wars and this is not a naval war, nor an air war; it is a ground war.
European military planners, evidently, don’t exist. Not only does Europe lack the manufacturing capacity to produce enough shells to defend Ukraine, but, as it turns out, the EU does not even produce the necessary raw materials to create an explosive. It is madness to contract out the supply of nitrocellulose, a critical material required to conduct a war, exclusively to a staunch ally of the enemy combatant, only to express shock when nitrocellulose shipments end without explanation.
Russia has more men and overwhelming artillery firepower at present, or to paraphrase the late Colonel Monro “bigger guns and more of them“. Those in the capital modeling business should mull over the need for western boots on the ground in Ukraine, not to train Ukrainian soldiers, but to actually defend against the Russian invasion. Without munitions, we must model in European military deaths.
A considerable percentage of the population of Ukraine has left the country, many never to return, even when told that Ukraine sovereignty depends on it. My own nation is presently populated with the equivalent of an entire army of Ukrainian males of military age, claiming refugee status. The planetwide distribution, millions of able bodied Ukrainian men calling themselves refugees, all military age, creates a very real risk of blowback; “why should my country send in troops to assist Ukraine, when Ukraine permits strapping young men to head to Canada, to UK, to France, to Germany, to Poland, to far flung Fiji, and they wait out the war. Shouldn’t Ukrainian able bodied men repatriate themselves first to fight?” A fair question for which there is no satisfactory answer.
Absent European boots on the ground, a scenario does exist where Ukraine loses this war. There won’t be a building left standing in Ukraine should that come to pass, all destroyed by artillery, but the Kremlin no longer cares. I think that few have priced out a scenario for equity markets in 2024, should more Ukrainian ground be lost, to be followed by an announcement that European nations will be forced to commit soldiers to fend off the human waves of Russia. If Europe runs out of munitions, Russia will not stop and there are some pro-Russian nations in Europe that will switch sides at the drop of a hat, should Europe falter. In the face of life or death, self-interest has historically won out handily over collectivism. And lacking artillery, having sent everything in their stores, as Denmark has most recently done, exactly what will Europe fight with?
https://www.theguardian.com/world/video/2024/feb/19/denmark-sending-its-entire-artillery-to-ukraine-video
https://www.msn.com/en-ca/news/world/north-korean-factories-making-arms-for-russia-are-operating-at-full-capacity-south-korea-says/ar-BB1j1kqa?ocid=msedgntp&pc=LCTS&cvid=32c57b4a342b495884b53e8a2401ec9f&ei=14
https://www.defenseone.com/business/2023/11/race-make-artillery-shells-us-eu-see-different-results/392288/
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