Ukraine under fire: Where does Russia get its ‘endless’ supply of drones and missiles?

Russia has intensified drone and missile attacks on Ukraine, relying on a robust domestic production of upgraded Geran-2 drones, initially based on Iranian Shaheds. These easily manufactured, low-cost drones are designed to saturate Ukrainian air defenses, which are forced to expend expensive interceptors. This strategy raises concerns about Ukraine's defensive capacity, prompting calls for expanded interceptor technology and targeting of Russian production facilities. Western responses include fast-tracking their own drone development and considering sanctions on third countries facilitating component acquisition for Russia, though such measures carry economic implications for sanctioning nations, while Ukraine's President Zelenskyy continues to advocate for stricter oil sanctions.

Analysis

Russia has fundamentally shifted its aerial assault strategy on Ukraine towards a war of attrition, leveraging high-volume, low-cost domestically produced drones. By establishing licensed production and subsequently innovating on the Iranian Shahed design to create its own Geran-2 variant, Russia is now considered a leading expert in this class of unmanned system. This approach is designed to saturate and deplete Ukraine's more sophisticated and expensive Western-supplied air defense systems, creating a significant cost-asymmetry that an expert deems a "losing game" for Ukraine if it relies solely on defensive measures. The production of these drones appears resilient to current sanctions, as Russia successfully procures necessary components like satellite navigation systems and electronics from international markets, reportedly through third countries such as Malaysia and Kyrgyzstan. This highlights a critical weakness in the existing sanctions regime. In response, Western strategy is evolving, with the US Pentagon fast-tracking its own drone production, while policymakers face a difficult trade-off: imposing tougher secondary sanctions could disrupt global supply chains and increase costs for their own economies, a risk that tempers calls from Ukraine for more punitive measures, particularly on Russia's oil sector.

Key Decisions for Investors

• Investors should monitor defense sector companies, particularly those specializing in unmanned aerial systems (UAS), counter-drone technologies, and advanced air defense, as the conflict signals escalating investment and accelerated procurement in these areas by Western governments.
• It is prudent to assess portfolio exposure to supply chain disruptions and geopolitical risks, as the potential for broader secondary sanctions on countries enabling Russia could increase compliance burdens and operational costs for multinationals.
• Closely watch developments related to potential energy sanctions against Russia, as any meaningful restrictions on its oil exports could introduce significant volatility into global energy prices and affect investments across the energy sector.