What Fate is Our Tomorrow Brewing (November 2014)

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a bit more than 6 minutes to read!

In the light of the recent RBCC RussiaTALK forum, which seems to have left many wondering whether these are good times for business in Russia, despite the effort that speakers put into convincing the audience that although “the times they’re a-changin’”, it’s not entirely for the worse, we at ISTORIYA have decided to put together a general economic and political overview of the current state of world affairs and make some predictions on, almost in the words of Pushkin’s Lensky, “what fate is our tomorrow brewing”, that is where the Russian economy is headed in the following few years or so.

Let’s begin with Europe, as it’s facing a new wave of separatism with the recent Scottish Referendum in the UK, Belgium overseeing a major conflict between the Flemish and the Waloon ethnicities and practically living without a government for the last few months, the Spanish Catalonia’s “underground” separation referendum this November, and peaking support for separatist movements in France’s Corsica and Italy’s Sicily. This likely marks the beginning of a US-anticipated transition from the so-called “Europe of individual states” to “Europe of cities and regions”, while there also exists a conflict between the pro-American Eastern European states and the, in the words of Donald Rumsfeld, “Old Europe”, which repeatedly began to take an independent stand in world affairs often contrary to that of the US (think involvement in recent conflicts in the Middle East). It is our opinion that these events will certainly have a major impact on investment risks and overall economic and political climate in Europe.
The EU’s stand on Russia sanctions also means the European states will have to be covering the natural gas provision payments of the Ukrainian state, as the national state-owned oil and gas company “Naftogaz of Ukraine” is currently in enormous debt and isn’t capable of covering even the pre-payments by itself.

Now, let’s proceed with oil prices, being a matter of uttermost importance to Russia as a major part of the country’s export profits come from oil. Oil prices have been on a steady decrease, down from $111 per Brent Crude barrel (it’s the closest in price and quality to Russia’s export oil) in July to somewhat $90 in October and falling. There are a few reasons for this steady fall.
Firstly, the so-called speculative part in oil prices has for quite a long time been rather significant, as from the beginning of 2008 the US Federal Reserve has been injecting the economy at both the national and international levels with dollar bills, with 3 programmes of so-called quantitative easing (QE) aimed at buying out “bad” bonds, floaters etc. from the market and replacing them with “free” dollar bills. However, investors seemed to prefer to invest this money into various kinds of financial derivatives instead of the “real” economy — with oil futures and call options being the top choice it really is no secret why the so-called “virtual” oil demand has been so high ever since. With the 3rd quantitative easing programme (QE3) recently shut down many are already looking to re-invest the money into other assets such as gold, precious metals etc., bringing down virtual oil demand and hence the world prices.

Secondly, there is now a steady decrease in world oil imports. China is one of the major oil consumers in today’s world, and with the recent “cooling down” of its’ economy (down from around 10% to somewhat 7.3% — 7.5% annual growth), China’s oil imports are also on decline. In addition to that, China has seemingly either stopped or, at the very least, significantly decreased oil buying amounts for its’ announced national grand oil reserve of 400 million oil barrels (almost 10% of total annual world oil produce). Also, the US are intensively replacing its’ oil imports with domestic shale oil extraction, further crippling overall oil demand.

Lastly, new oil export channels from the Middle East. Much to our surprise, Libya has recently begun exporting around 900 thousand oil barrels per day, while the Islamic State of Iraq and the Levant (ISIL) and Kurdish radicals established “partisan” (illegal) export channels going as low as $30 per barrel. Their export amounts are not that significant, but the mentioned price of $30 makes it a no-brainer for whoever’s buying, further bringing down the prices.
So, where’s the bottom line for this oil price fall? In our opinion, there are two primary restraining factors: Saudi Arabia, as it’s the largest global oil exporter, and the US shale oil extraction cut-off prices. The Saudi budget is balanced with prices of around $85 per Brent barrel in mind and going under would mean having to cut their vast social payment programmes, furthering the already growing civil unrest (as a consequence of destabilising regional events) — the present elite power struggle also doesn’t help this situation. This means that the Saudis will do anything it takes to keep global oil prices above the mentioned line. The so-called “shale boom” in the United States also revolves around rather highly priced oil, with net extraction costs peaking $85-90 per barrel – almost exactly the bottom line for the Saudi budget – therefore, in order to continue as intended with shale oil extraction the US will also have to take measures to keep the prices up.

Now, where does Russia stand in all of this? The current Russian budget is imposed with the oil price expectation of roughly $100 per Brent Crude barrel – that’s an annual expectation and even if the price fall continues, this year’s budget will still be in a surplus. However, it’s no secret that Russia’s spending has recently increased rather significantly due to sanctions and an increase in its’ military and technology spending, and there is a worry that this surplus simply might not be enough to cover the costs. As of today, four budget scenarios were prepared by the Russian Finances Ministry and the Ministry of Economics for the upcoming year of 2015: the high oil price scenario (around $100 per Brent Crude barrel), the “average“ scenario ($85), the low price scenario ($70), and the so-called “shock” budget scenario with Brent prices expectation of $60. Although the low price and “shock” scenarios would mean incredibly tough times for Russia, there is an overall notion that they are not to be expected due to the reasons already mentioned.

The sanctions, on the other hand, proved to be a much more difficult exercise, despite the Russian media claims that “they’re a mostly joke” (Russia 1, we’re looking at you right now). The first major problem is investment substitution, as a major part of Russian corporations both state and privately owned are heavily indebted in the West. This loan source has now become unavailable due to sanctions, while the debt remains enormous: around $433 billion private corporations, $214 billion banks and $60 billion state, totalling $721 billion in overall debt. Together with weakening of the Russian stock market this might result in a margin call, forcing Russian companies to sell off some of their assets to the West – there are currently on-going negotiations in regard to this, however if they are not successful Russia will have to be loaning up in China and certain Middle Eastern countries as well as covering the margin out of the first line reserve (valued roughly at $430 billion at the moment) for some of its’ strategically-important companies. The second major problem is technology import substitution, as Russia’s almost completely replaced a grand part of its’ technology industry with Western imports over the past 20 or so years, which as we know the recent sanctions limit to a significant extent. It is yet unknown how Russia is planning to go about this, as reviving the long abandoned industries will take years, while the anticipated partnership with China is not likely to yield significant results – China simply doesn’t have most of what’s needed itself.
Sanctions also served as a catalyst for the on-going conflict on the Russian political front between the so-called “liberals” group and the “national patriots” and the like, as the Russian public makes up its’ mind in regard to the Donbass conflict. There is much to be said on this topic and we’ll shortly be preparing a number of articles specifically about Russian politics but as for now we’ll confine ourselves to simply saying that the current situation is although uncertain, is relatively stable.

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