China-Taiwan Ship Inspections, OPEC+, Russia/Ukraine Update

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China-Taiwan Ship Inspections

Taiwanese President Tsai Ing-wen met with U.S. Speaker of the House Kevin McCarthy as planned after speculation the meeting would be canceled to avoid inflaming U.S.-China tensions. China responded by announcing a three-day special joint patrol and inspection operation in the Taiwan Strait.

What makes this patrol different than previous Chinese moves in the Taiwan Strait is that the Fujian MSA (China’s Maritime Safety Administration) indicated it would conduct on-site inspections of cross-strait direct cargo ships and construction vessels to "ensure the safety of ships and ensure the orderly operation of key water projects." 

Taiwan's Maritime and Port Bureau issued a statement that also condemned China's announcement, but more importantly, it urged ship crews that if they encounter any requests by China's coast guard to conduct "boardings and inspections" they should immediately reject them and notify Taiwan's Coast Guard Administration for protection and to handle the matter.” Taiwan Defense Minister Chiu Kuo-cheng said that Taiwan had not seen any cases of China boarding Taiwanese ships to inspect them.

Our working thesis is that there will not be a fight between China and Taiwan anytime soon. While that scenario is possible, we thought it was more likely China could try to seize an uninhabited atoll or shoal disputed with the Philippines to test U.S. resolve to support its allies in the region, rather than pick a fight over Taiwan that China would likely not be able to win in any meaningful way due to the current state of its naval forces.

This development does not challenge that thesis – but it is a signpost along the way to alternate scenarios of even a minor skirmish in the Taiwan Strait and the attendant supply chain disruptions that would follow. The key question is whether China will attempt to inspect or board a Taiwanese ship. Military exercises and strongly worded statements are par for the course.

What makes us take this situation so seriously is China appears to be doing something new, and if China follows through on its threat, it then puts the ball in Taiwan and the U.S.’s court. Will Taiwan then follow through on its pledge to intervene? Will the U.S. come to Taiwan’s aid? The decision trees that come from a Chinese action would reverberate. In addition, one thing that concerns us is the overtones of the Black Sea Grain Initiative, which saw Russia claim the ability to board and inspect ships in the Black Sea. Russia went through the UN, in part because Ukraine is a country, but China’s move here is vaguely resemblant of that kind of move.

For now, our working thesis still holds. It does not appear to be in China’s interest right now to pick a fight with Taiwan. Even if China boarded a Taiwanese vessel, the most likely scenario is that the U.S. would not agree to come to Taiwan’s aid and Taiwan would chicken out without U.S. or even Japanese support. But the triggering of this signpost necessitated a quick reassessment of the situation and bears extremely close scrutiny going forward.

We take some solace from the relative lack of coverage in mainstream Chinese press about these developments – Taiwanese press was far more informative about China’s intentions, which suggests Beijing is brandishing a tough image without committing itself to a course of action.

OPEC+ Oil Cut

Saudi Arabia and other OPEC+ oil producers announced further oil output cuts of around 1.16 million barrels per day. Bloomberg reports China was surprised by the move and that “Chinese refiners are starting to mull spot purchases from suppliers including Latin America, the US and West Africa to make up for a shortfall should OSPs from Saudi Aramco and other producers become too expensive."

Because this is a voluntary move, Saudi Arabia can claim it was not lying when it said official OPEC quotas would not change this year. Oil prices surged ~7 percent on the news, but as of this writing are hanging out at $80 per barrel. As we noted last week – supply/demand fundamentals looked bearish for oil. This fits with that narrative, and the Saudi move should be seen as propping prices up from collapsing rather than as a clear path to $100+ barrel oil.

The China part of this surprised me. I would have thought Saudi-China would have had an arrangement here, but this suggests China got caught flat-footed. Perhaps Saudi Arabia is not happy about Russia becoming China’s top oil import choice due to the discount offered by the U.S./European price cap. It is difficult to decipher Saudi Arabia’s intentions. Perhaps it is as simple as wanting to maintain prices so they can spend on things like Vision 2030 and Lionel Messi, but by doing so they are actually supporting competitors in places like the U.S. and even risking their newfound coziness with Beijing.

EU LNG

The U.S. and EU Task Force on Energy Security met and published a joint statement. The most important sentence is tucked in the middle of the statement: “In the coming months, the Task Force will continue to work on keeping a high level of U.S. LNG supplies to Europe in 2023 of at least 50 bcm. This is necessary given the challenging supply situation and the need to ensure storage filling for the next winter 2023-24.” In the coming months -- will that translate into higher natural gas prices for U.S. consumers? Especially if Europe has a colder winter in 2023-24 (and it is due for one)?

Germany Getting Serious About EU Spending

German Federal Finance Minister Lindner rejected the reform ideas of the EU Commission – and makes his own proposals.

• (1) “Highly indebted” countries must reduce debt-to-GDP by 1pp per year; others above 60% by 0.5pp. Under current rules, everyone would need to pretend that Italy could cut by ~4.25pp per year.

• (2) A deficit above 3% automatically triggers sanctions (probably; it’s a little unclear).

• (3) Something about reverting to existing rules if the new rules fail after four years; not totally clear.

• (4) The surprise: “special incentives” for spending on climate and digitization. This likely means some of this spending would not count toward deficit rules. The left’s been wanting this; I didn’t think it’d be Germany that would put it on the table. I’m suddenly taking it seriously, though it still has to survive the frugal gauntlet.

War Update

Andriy Sybiha, deputy head of Ukraine’s president’s office, gave an interview to the Financial Times in which he said Ukraine might be ready to discuss the future of Crimea with Moscow if Kyiv succeeds in achieving its strategic goals on the battlefield. The Ukrainian president’s envoy on Crimea was a little blunter: “Ukraine plans to give Russia a choice on how to leave Crimea. If they don’t agree to leave voluntarily, Ukraine will continue to liberate its land by military means.” I am not sure whether that qualifies as a sign that Ukraine is open to negotiations over Crimea.

In an hourlong interview ahead of a European diplomatic mission to Beijing, China’s ambassador to the European Union said that critics had misinterpreted his country’s relationship with Russia, and suggested their ties may not be as limitless as their leaders once declared. Highlights: (1) “‘No limit’ is nothing but rhetoric,” but there’s no change in position. The war’s causes are more complicated than the West says (like that justifies it), and Xi has been too busy to call Zelenskyy. (2) China has not and will not give Russia weapons for use in Ukraine. (3) Confirmation that China is trying hard to revive the EU-China investment agreement (CAI). I will be modestly surprised if CAI gets a mention in any subsequent EU or joint statements because I think it has very little chance of surviving EU scrutiny and reviving it would only humiliate Macron. If I’m wrong, all hell could break loose.

According to ISW: “Putin dismissed Colonel-General Nikolai Grechushkin from his post as Deputy Head of the Ministry of Emergency Situations on April 5. ISW has also previously reported on recent investigations into and arrests of Russian Rosgvardia leadership, including Rosgvardia’s naval department head and Deputy Commander of Rosgvardia’s Central District. Rosgvardia was notably created using personnel and resources from a variety of Russian security and military services, including the Ministry of Emergency Situations (EMERCOM). The Kremlin may be attempting to oust a slate of Rosgvardia and EMERCOM officials that have fallen out of Putin’s favor in an effort to crack down on Russian domestic security control.” Economic pressure has not led to any apparent decline in Putin’s power – but here is an interesting blip that perhaps not all is well.

Middle East Update

• The Biden administration reportedly discussed with its European and Israeli partners in recent weeks a proposal for an interim agreement with Iran that would include some sanctions relief in exchange for Tehran freezing parts of its nuclear program. I’ve been fooled one too many times on thinking the U.S. would actually try to work with Iran, but maybe Saudi Arabia’s moves are finally creating the impetus necessary to do so? Probably not, but we need to look at this with fresh eyes and no memory of getting this wrong last year.

• Saudi Arabia is warning countries like Egypt, Lebanon, and Pakistan that financial aid will no longer be as easily forthcoming from the Kingdom. I need to revise my net assessment on Saudi Arabia from the bottom-up. The idea this article raises — as KSA as a sort of Islamic, MENA-focused IMF, made me stop in my tracks. Also, what happens to countries like Egypt, Pakistan, and Lebanon if KSA is actually serious about not bankrolling them anymore? Note also that Saudi Arabia has apparently bought Turkish allegiance… for now.

That's all for this month's Geopolitical Updates. A reminder that if you're enjoying these, you can sign up for Jacob's weekly version over at Cognitive Investments here.

And, a note from our last Research publication "Finding Relative Value in Emerging Markets", pension funds have now surpassed 2009 levels of unfunded liabilities... go read the piece to find out more.

As always, we'll see you out there...