How much of a disaster for the economy of Russia is the oil price fall?

The economic feature of the latter part of 2014 has been the fall in the price of oil and indeed commodities in general. For the world economy as a whole this will provide an economic boost but there is also a transfer of income and indeed wealth taking place as well. This is from commodity and oil producers to consumers of these products. At the forefront of those suffering is the Russian Federation which lest we forget depends heavily on its oil and gas exports. According to the US Energy Information Authority the situation is as shown below and the emphasis is mine.

Russia is a major exporter of crude oil, petroleum products, and natural gas. Sales of these fuels accounted for 68% of Russia’s total export revenues in 2013, based on data from Russia’s Federal Customs Service. Russia received almost four times as much revenue from exports of crude oil and petroleum products as from natural gas.

If we start to calculate the mathematics of the impact on Russian trade then the word is ouch! In 2013 the (Brent Crude) oil price averaged US $108.64 which as an aside nicely fits Forbin’s rule back then that it was revolving around US $108. However the month of October saw the oil price average US $87 per barrel which already was showing a 20% drop. Now of course the oil price is more like US $72 per barrel meaning that Russian exports of oil have fallen in value by 34% currently. Should that persist for any length of time it will be like exploding a torpedo in Russia’s export performance especially as gas prices will be lower too.

Russian government finances will be hit too

According to the EIA it was not only exports which were dependent on oil revenues.

Oil and natural gas activities make up a large portion of Russia’s federal budget. According to the Ministry of Finance, 50% of Russia’s federal budget revenue in 2013 came from mineral extraction taxes and export customs duties on oil and natural gas.

Looking forwards those taxes will be applied to companies that have a lot less revenue and any percentage taxes will be on lower sums. Although there are two nuances to this. Firstly the fall in the value of the Rouble will boost government revenues but as the subsequent inflation ravages the system each Rouble will buy less. So things may look okay for a while but in a “surprise” will then turn much worse.

Russia’s government bond market seems to have got the message as the worldwide trend to lower bond yields has passed its borders by if a benchmark ten-year yield of 10.67% is any guide.

What about economic growth?

The European Union autumn economic forecast told us this just under a month ago.

Moreover, since the Russian economy remains
highly dependent on oil-related income, a stronger
decrease in oil or gas prices could further add to
the pressures.

I think we can safely say that has now happened, and of course it comes on the back of this which I discussed on the 3rd of November.

On 31 October 2014 the Bank of Russia Board of Directors decided to raise the Bank of Russia key rate to 9.5 percent per annum.

I thought that this alone would send the Russian economy spiralling into contraction territory. Actually the Russian government seems to have been catching up with this line of thought.

@jsblokland Breaking!>Russia’s government expects economy to shrink 0.8% in 2015!

It was only eighteen months ago that forecasters were predicting 4% annual economic growth in Russia in 2015 so there has been quite a turn-around. Frankly if oil prices stay at the current levels it could turn out to be -4%.

What about the Rouble?

It saw something of a collapse yesterday and of course this came on the back of previous falls. At such times exact prices are hard to find but the Financial Times has reported it thus.

At one point the rouble hit a record low of 53.86 per dollar – a move of 6.5 per cent, according to Reuters data – though it later pared some of its losses.

There has been a rally since which has pretty  much tracked the oil price and it now takes 51.7 Roubles to buy a US Dollar. Back on the 3rd of November I reported it thus.

it is facing a currency which was at 34 to the US Dollar at the beginning of July and is now at 43.3 for a fall of 27%.

So since July it has dropped by more than 50% against the US Dollar. No wonder President Vladimir Putin has been on the news wires regularly to say that Russia will abandon the US Dollar! The catch is that others would have to accept Roubles.

Inflation, Inflation,Inflation

The other side of the collapse in the value of the Rouble is a considerable upwards push to the rate of inflation. Russia can cushion itself with its fuel and energy prices should it so choose but anything that is required from abroad is getting more and more expensive. Thus Russia has decoupled itself from the world trend towards disinflation. According to its central bank the state of play is as follows.

given the inflation of 8.6% p.a.

On this subject Bank of Russia Governor Nabiullina is quite outspoken.

As a matter of fact, inflation is a tax on the poor. According to opinion polls, the rapid price growth remains the key problem for the population.

Also with inflation set to move into double-digits there has to be doubt about the feasibility of the inflation target.

The Bank of Russia acts step by step focusing on the smooth slowing of inflation down to 4% in the course of the next three years.

Oh and if you think that Russian inflation is going higher then get set for higher interest-rates too.

That is why the deposit rate and, therefore, lending rate cannot be lower than inflation.

There is a danger of a downwards spiral here as we note that one has already been in play.

What about foreign debt?

Russia itself only has a small amount of foreign debt but the situation according to the Financial Times is very different for its business sector.

According to the central bank, banks and other companies have $614bn in external debt, with $31bn of it due for redemption in December and another $98bn before the end of 2015.

It is not so easy paying that in depreciated Roubles is it?

This one is an intriguing conundrum as of course western banks would be hit hard by defaults in this area and we know that they are the “precious” which must not be harmed. So a change of tack would not be a complete surprise.

Comment

There are several factors to consider here. We firstly need to step back and look at the overall picture as financial markets are very volatile and both the price of oil and the value of the Rouble have dipped since I started writing this post! When we do so we see that even a central bank with considerable foreign currency reserves and a willingness to raise interest-rates considerably has found itself like King Canute and his failure to resist the tide or if you prefer King Lear railing against bad fortune on the blasted heath.

This leaves the Russian economy with several feet pressing on the brake pedal. Firstly we have the interest-rate rises, followed by rising inflation sending real wages negative, then falls in output and the trade balance driven by the energy sector and lastly weakening government finances. Against that we saw earlier in the trade numbers the small size of Russia’s manufacturing sector so even if it benefits from a lower Rouble the overall impact will be small. Let me hand you over to Britney Spears for a summary of all this.

Don’t you know that you’re toxic?

It’s getting late
To give you up
I took a sip
From my devil’s cup
Slowly
It’s taking over me

Toxic for Bulgaria?

If the South Stream pipeline project is now abandoned as Russian President Putin stated yesterday there will be considerable economic costs for Bulgaria too.

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10 thoughts on “How much of a disaster for the economy of Russia is the oil price fall?

  1. Thank you Shaun for another really interesting article.
    If I may ask one question:
    How much of the fall in the price of commodities affects the producer, and how much the commodities market?

    • Hi therrawbuzzin and thank you

      In a basic sense all of the fall affects the producer. But if they have hedged their position then some or perhaps all of the losses could be transferred to the commodities market. Selling futures would (depending on the price) shift it all and buying put options would (for a price) protect below a certain level.

      Of course a producer may only hedge some of their position or do so at different levels. But in recent times almost any sale of oil futures would have worked to their benefit.

  2. Hello Shaun,

    Aside the politcs of the Ukraininan adventure I suspect the Western Powers have abandoned the policy of equals here.

    As for the oil price drop in combination with economic sanctions I think the Russian people will see it as personel to them . The questions arise , if Putin is toppled , what makes our leaders , with their past record of being daft as a brush , sure that we wont get some one like a North Korean leader ?

    nothing from what I’ve seen, that worries me

    It has been reported that Russia now seeks further engagement with China , good luck with that as they haven’t been on good terms for a while , and the Chinese are getting bolder in international politics .

    Can Putin pull it off ? we’ll see , one thing is for sure with certain western sources likening him to Hilter ( they are wrong and stupid ) we may go from some sanctions to limited war straight to full scale conflict .

    I think China , despite their ambivalent attitude to Russia , will jump on the banwagon against the US and Europe ….. the economic impact will be sever .

    hmm, better check my pop corn stocks and get a new sofa …..

    Forbin

    • Hi Forbin

      Well our efforts to set up new leaders and governments in Iraq and Afghanistan have not exactly been a triumph have they? Perhaps we will show the same expertise with Russia…

      As well as the efforts with China Russia seems to be trying to get Turkey as an ally. Perhaps the gas/oil which was previously planned for the Bulgarian South Stream pipeline will now go via Turkey.

      The Rouble dropped like a stone again later in the day and is just shy of 54 to the US Dollar now.

    • Hi Dutch

      We can narrow much of that down. Here is the October state economic report for Western Australia.

      “The value of minerals and petroleum sales in Western Australia
      rose 20 % to $122 billion in 2013 -14”

      “In 2012-13 exports of goods and services accounted for 51% of GSP.
      In 2013-14 minerals and petroleum contributed 90% ($119billion) of
      the State’s merchandise exports. Western Australia contributed 48% of
      Australia’s merchandise exports in 2013-14, more than New South Wales, Victoria and Queensland combined…”

      .

  3. Hi Shaun,

    As Bill Browder of Hermitage Investment put it: “The rouble exchange rate is Putin’s real global rating”. We all know what happened to him and his lawyer when he went up against the endemic corruption. The policy of closing down or annexing foreign businesses on the Kremlin’s orders, plus the threat of further sanctions, having to tow the Putin line, makes IMO Russia uninvestable.

    The Russian economy is basically dysfunctional where 110 close associates of Putin own 35% of the countries wealth. It makes the Western 1% look positively generous! Putin protects his wealth creating circle and they pledge their loyalty in return. They know, if they step out of line they will be crushed, with a long jail term. Much like the Western European countries in the middle ages to get on, you need the patronage of somebody higher up the hierarchy, think Kings, Earls and Lords etc., or if the Italy was totally controlled by the Mafia; from the very top to street level, without their protecting patronage if you run an attractive successful SME that somebody higher up wants, you will be made an offer you can’t refuse. If you resist then the apparatus of the state have plenty of ways of making you conform which is why there are allegedly over 1000 former business bosses in jail.

    Where Putin has spent the majority of the oil and gas wealth west of the Urals, especially in Moscow, to the east it is a different world. At least 25% of agricultural in inaccessible, due to infrastructure decay, if a wooden bridge across a wide river has collapsed, you can’t get your tractor to your fields, so you can’t farm it! The Siberian independence movement have a saying “We send you all our wealth and in return you send us stupid laws”, so there is much potential unrest to the east and the south.

    Where their economy makes and exports very little outside of the military equipment sector, this means that much stuff has to be imported including 25% of their food. Where they will be buying the imports predominately in US dollars, this is going to hurt. The slide in the rouble will protect them to a degree from the drop in the price of oil.

    Europe is diversifying their energy needs. In October Lithuania opened an LPG terminal which will supply over 90% of their gas and they are working with Latvia and Estonia on a joint second terminal so they are all totally independent of Russia for their gas. I suspect in about 5 years, Russia will be just another gas supplier in Western Europe, where they will have to supply at the right price on the right terms. Chinese gas deals won’t bail them out, where the Chinese have negotiated a tough price and with the cost of the infrastructure to get it there, they will be lucky to make a very small profit.

    The Russian invasion of Crimea means they have to subsidise it to the tune of over $4bn a year and they have raided the state pension fund to do this. Their invasion of the Donbas means they are having to pay their mercenaries, supply and replenish military equipment, fuel, ammunition and humanitarian aid which the mercenaries take and sell, so there are report of the vulnerable starving to death (repeat of Russian reaction to 1930 Maiden with the 1932/33 Holodomor?). There is also a considerable Russian army presence there and with an alleged 4000 or so Russian troops killed so far, there is the cost of buying off of their families to keep the figures quiet. If it becomes a frozen conflict then it will require major subsidies and rebuilding costs.

    These reports from Crimea will give you a taste of what happens when Russian style ‘enterprise’ and capitalism rolls into town!

    http://bigstory.ap.org/article/166097f662ec4e6e899b14c12e9a0c58/change-leadership-crimea-means-property-grab

    http://www.vice.com/read/how-the-invasion-of-ukraine-is-shaking-up-the-global-crime-scene-1106

    http://www.rferl.org/content/crimea-crime-criminals-as-agents-allies/26671923.html

    The view is that their economic problems have much to do with Putin and I think they are 12 months or so from a very hard landing. Oil prices, sanctions and a rouble in freefall are taking their toll on their currency reserves. I’ve seen various estimates for the amount they have burnt through in 2014 from $100bn to $250bn.

    • Hi Rods and thanks for the links.

      The currency intervention rose to a frenzy in October when US $27.7 billion and Euro 1.6 billion was spent according to the Bank of Russia. No wonder there was a change of tack! By contrast there was very little intervention in November but I wonder how much the Bank of Russia spent yesterday.

      Mind you there are some substantial losses here as late on today the Rouble dropped again and is now at just under 54 versus the US Dollar.

  4. Very much enjoyed your column and all the comments, Shaun. Serbia will also be hurt by the decision to abandon the South Stream pipeline. Construction on the Serbian segment of the pipeline began on November 24 in a village in South Bačka District, whose capital is Novi Sad, Serbia’s second city.
    http://www.gazprom.com/press/news/2013/november/article178376/
    The Serbian segment of the pipeline was supposed to contain a branch to Bosnia, so that Bosnians could be supplied with Russian gas.
    Serbian president Tomislav Nikolić (for some reason Tass chooses to transcribe his name as Nicolic), normally so deferential to Brussels, complained about the cancellation, saying: “The West and the East play ‘cat and mouse’ and Serbia suffers from this.“ Serbia is only a candidate country to join the EU, but it is already getting a taste of just how much attention Brussels is likely to pay to its economic interests once it is a member of the EU.
    http://itar-tass.com/en/economy/764820

  5. Maybe the people in Brussels can show some leadership (for a change) and start building some useful infrastructure in form of a gas pipe line capable of transporting Russian or Turkish or many others gas.

    Monopoly is always bad, but especially so when it’s owned by oligarchs. (Thanks Rods for the links and reminders of who we’re dealing with)

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