We now have a most interesting constellation now. About three weeks ago I commented on the likely implications or developments following the Venezuela intervention and the likely implications and knock on effects on the shadow fleet and the second order implications for Iran, China and Russia and broader implications for geopolitical postures of both the US and China.
The US is amassing firepower in the Middle East. At the same time there are long planned exercises in Saudi Arabia until well into February. This exercise includes a main new entrant: Pakistan, which since signing a mutual defense agreement with Saudi Arabia following the Pakistan/India clash and the Israeli bombing of Qatar, is sending its most modern Western made jets (hint to India?). There is also a notable absence: the UAE. Among the participating nations in the exercise are pretty much all air forces associated with the major national signatories to the IMEC corridor, with Germany being a notable exception.
Geostrategically the IMEC is positioned as a counterbalance to the Belt-and-Road and that is why Pakistan’s participation in the exercise seems significant to me, given that in a direct confrontation last year, though we do not know the details, a Chinese jets shot down a French made Rafale jet(s) (the Ukrainians nevertheless placed a big order).
The UAE meanwhile hosts the Russia and Ukraine talks which are set to continue. Territory seems to be the big question. The Saudi Foreign Minister, while on visit in Poland, has issued a statement highlighting the importance of the Saudi and UAE relations, as tensions between the UAE and KSA have ebbed and flowed. The UAE has been enjoying a big economic ride on the backs of capital flows into the Emirates over the past 3-4 years owing to the war in Ukraine, but has aggravated regional players in other terrains.
The economic implications of proper sanction enforcement on the shadow fleet are most immediate for Russia as well as Iran and downstream for China as I highlighted in the other piece. The Russian shadow fleet is quickly reflagging to become “proper” Russian, ending the offshore professional service enabled hide-and-seek. India and China have been the main beneficiaries off Russian discounted crude and India is now full of “hot money” ready to deploy. An offramp for India may evolve further trade with Russia, but in value-added terms. So where can this money flow?
Making of the India Middle East Economic Corridor Geopolitically, a lot of things are stacking up when it comes to IMEC. We have a new bilateral investment treaty between India and Israel, a deepened trade relationship between UAE and India also backed by a new Bilateral Investment Treaty. Ongoing negotiations of a trade agreement between the UAE and Europe, a near concluded trade agreement between the GCC and the UK. A logical next step would be further economic integration of the GCC.
At the same time, we have improved relationship between the UK and the EU. Further trade agreements between India and the UK have been signed and the negotiations seem concluded for the EU and India agreement as well. Other agreements vis-a-vis South East Asia are also developing, this means there is ample geopolitical space now to breath economic life into these links (it should not be difficult thanks to excess profits having been earned in some sectors in recent years).
The main concern is naturally how the posture vis-a-vis Iran continues to develop. I think its unanimously clear that the world is not in a good state if Iran acquires nuclear weapons. If we take the logic of the production network at heart, the last few years can be thought of as showcasing a “rolling up” of the production network bottom up to create sharp localisation incentives that may reduce structurally hydrocarbon demand through investments in resilience and ongoing market shaping to create demand envelopes for associated digital assets.
This roll up involves a combination of temporary shocks that are followed by policy announced longer-term shocks around existing value chains involving instruments such as the CBAM to permanently change the terms of trade and market access. The Ukraine war can be seen as the stimulus here.
Regarding Iran, the main beneficiary of Iranian crude oil is China; the same with Venezuelan crude. This means any more expensive crude access to China may help improve Chinese trade balance through a multitude of mechanisms. A few days ago I was most concerned about whether the pivot in attention may be an invitation for China to move on Taiwan after the Americans provided a “demo” of regime change in Venezuela. Though, it appears that one of the aircraft carriers is in dry dock and the encirclement posture or exercise vis-a-vis Taiwan has ebbed. It may also be that the continued upheaval around the Chinese military leadership may have helped here. Nevertheless, I was and continue to be most concerned.
Turning to the economics. As the cost of imports of crude increases, this will help the Chinese anticipate expanded instruments like carbon pricing or CBAM, though the reserves will likely take much of the short term sting out. The medium term adjustment may be seen as helping with involution as I suggested before. How so? A strategic response will be for China to replace part of its ICE fleet. The biggest risk I see is that this fleet will find a long second life in Africa, baking in years of hydrocarbon demand. The exact calculus in terms of embodied carbon vis-a-vis lifecycle emissions of new EVs needs to be done, but I feel that it is imperative to be very careful here given the already broken 1.5 degree global heating this year. Elevated used steel prices and scarcity may reduce that risk somewhat.
Why could the IMEC turn into a greening vector? Again, I want to be an optimist. Life is not nice if one only sees the darkness. My hope is that folks will come around to the conclusion that the “best” way to keep the Arctic out of play geostrategically is to ensure that the Arctic waters continues to remain difficult to navigate, preferably frozen. I think the insecurity of the US is due to a combination of stretched resources and having a navy that is built for warm water environments with ship hulls that may not be that suitable for icy waters and the threat of hypersonic rocket capabilities, necessitating an air defense build up (which could be pan-European). The European polity may have been shaken up by the issued threats to finally think European defense in a pan-European setting (not that they didn’t want to think it that way, but previous attempts I can remember were undermined by both the UK and the US), rather than following narrow national interests.
So why is the IMEC a potential greening vector? First of all, it stretches countries from India to Europe and the US, with vast potential for production of green hydrogen or urea scheduled in the Middle East as greening partners. These investments are starting to take off in particular in Saudi Arabia. There are other elements around custom facilitation and trade in digital assets that is a part of it which may contribute to facilitating trade in ecosystem services and negative emissions.
Opposition to the IMEC may have come in particular from Egypt that may fear for its revenues from the Suez Canal. Yet, a closer look at climate change implications of rising sea levels highlights that fighting climate change is existential for Egypt and its food production in the Nile delta. Similar arguments can be made along the corridor and they obviously apply also to much of Europe, the UK, Iraq and others. So I have a hard time seeing that there is not a way to structure a trade that aligns interests.
The main geopolitical benefit of a pivot along IMEC for the parties involved is that, moving some of the physical manufacturing that is presently concentrated in China into wider South East Asia and India in particular, and using the hinge of the Middle East. A regular northern sea route passage would be a notable transport cost advantage for Chinese exporters, as economic activity pivots towards south east Asia, in addition to the “simple” benefits of protecting much land and real estate all over Asia by virtue of preventing sea level rises.
Why is it a catch 22 for China?
This puts China in a strange but hopefully ambivalent position. Strategically, China may wish to aggravate climate change for a strategic advantage here to maintain its dominant economic position as a manufacturing power house (hence the rapid deployment of AI and robotics) that may be perceived as under threat if there are major pivots away from it. This could bake in more climate change from the side of China. But then, on the other hand, China stands to benefit massively from having invested in being the global green transformation power house with a huge opening in the soft power context being seen, as potentially other players, as the responsible superpower as the US backs away.
I see most of the ramifications around any US intervention around Iran to further enable China to socialize the RMB and it will continue to benefit from improved market access for its EVs with more and more countries importing the vehicles. It continues to be in pole position vis-a-vis battery technology and will most likely reap the benefits and have to deal with the puzzles of AI deployment and a waning labor-use across society much earlier than Europe and much of the rest of the world.
This is left for another post.