Russia faces the economic consequences of a plummeting oil price

One of the themes of this blog over the past year or so has been that the fall in the price of crude oil and other commodities is good overall for the world economy. Mostly the argument revolves around the fact that there are a lot more oil consumers than producers as we note that lower consumer inflation has pushed real wages higher in net consuming countries. However this begs a question for producers and squarely in that camp we find Vladimir Putin’s Russia which will note this morning’s news with dismay. From Marketwatch.

February Brent crude LCOH6, -1.59%  on London’s ICE Futures exchange fell 80 cents, or 2.7%, to $28.14 a barrel, but overnight fell to as low as $27.67 a barrel.

If we look back we see that it puts it some 43% lower than a year ago as the disinflationary burst for the world continues. However for reasons I shall explain below this is an example of deflation for Russia which comes combined with inflation in what is an example of how quite a lot can go wrong at once.

As an aside regular readers may recall when Brent Crude Oil pushed above WTI or West Texas Intermediate by over US $20 at one point and the justifications which followed. I wonder where they have gone as I see that Brent Crude is now lower by around 70 cents. Was this another sign of financialisation of commodity markets?

Also this reminds me to point out that Russian crude has a benchmark called Urals Crude which is trading some US $3 below the Brent benchmark so that Russia is only getting around US $25 right now. Back in the commodity boom days it too traded over giving Russia not that long ago an extra US $100 per barrel in the boom times.

The cost of the oil price fall to Russia

Back on the 23rd of November last year I looked at oil production.

Output from January to October averaged about 10.7 million barrels a day, a 1.3 percent increase over the same period in 2014, the data show. That’s in line with the Russian Energy Ministry’s full-year forecast for production of 533 million tons, or 10.7 million barrels a day.

Back then we thought that Russia had trouble with an oil price of US $44 per barrel,little did we know what would happen next! Back then I calculated that Russia was around US $680 million per day worse off compared to the past “tractor beam” price of US $108 well now it is more like US $890 million per day. A back of the envelope style calculation but you get the idea.

The Bank of Russia did its own calculation in its December Monetary Report.

In January-September 2015, the decline in prices for oil, oil products, gas, coal, iron ore and nickel led to a reduction in export earnings in these categories of commodities compared with the same period of the previous year by more than 110 billion US dollars,

The plunging Ruble

The currency markets responded to this change in Russian fortunes by marking the Russian Ruble sharply lower and this has carried on. Back on November 23rd I pointed out that the low 30s had been replaced by 66 which was quite a drop. Well the drumbeat has continued since as a lower oil price as Russia Today informs us.

The euro rose more than one ruble on the Moscow exchange, exceeding 85 rubles for first time since December 2014. The dollar reached nearly 79 rubles.

Thus we see that Russians will find everything from abroad to be more expensive and in fact much more expensive. This will impact on matters such as the Central London housing market and the concept of Chelski as I note that it takes 112 Rubles to buy a single UK Pound £.

Imported Inflation

A currency fall on this scale means that there will be imported inflation and this of course differentiates Russia from a world of zero or even negative inflation. From the Bank of Russia.

At the end of 2015, inflation will be roughly 13%. In 2016 Q1, inflation is estimated to be at 7.5–8.0%.

Since last summer 2014 when most of the rest of the world was seeing falling and then zeroish inflation prices in Russia have risen by 20 % or so. This is what has hit the ordinary Russian if we look at purely domestic terms and them going to the shops. The amount shoots higher whenever we look at foreign purchases or anything which is imported.

Economic growth

The falls in real wages of the order of 9 to 10% have had a clear impact on domestic consumption.

The annual rate of decline in household spending on final consumption was 8.7– 8.9% in Q3, according to estimates. In October, the contraction in consumer demand continued, as shown by the decline in retail trade turnover (to 11.7%).

These are Greece like numbers and we see something else familiar from that situation if we look at trade.

The weak ruble and low income of all economic agents meant that the high rate of decline in import quantities of goods and services persisted (roughly 30%).

This means that in a surprise to those who have not observed such a situation before we see this impact on economic growth and GDP (Gross Domestic Product).

As a result, the positive contribution of net exports to GDP growth increased. According to estimates, this trend in net export dynamics will remain in 2015 Q4.

This impact will be temporary and flatters the current situation as it will fade away over time as some import demand will remain and be inelastic. However in spite of this positive influence it was a grim 2015 and 2016 whilst better is none too bright either.

the estimated overall GDP growth for 2015 was revised upwards to the upper bound of the range defined by the Bank of Russia in the previous Monetary Policy Report, i.e. to -(3.7–3.9%). In 2016 Q1, the annual rate of GDP decline will continue to slow to -(1–2%).

Some care is needed with reporting these numbers as they are of course in Russian Rubles as we note the impact of this. What I mean is that these are bad enough but of course if we were to price things in US Dollars the situation is much worse. This is how people tweet and write about Russian GDP looking so bad in US Dollar terms as a falling GDP is combined with a plunging Ruble. Of course it is also true that Russian GDP will have taken a dive in most currencies but it is particularly bad against the US Dollar as we wonder if this is another front in the currency wars.

Asset prices

If we look at the central bankers favourite part of the economy we see trouble too. If we start with the stock market we see that it had a surprisingly stable 2015 but has fallen 9% in 2016 so far. As to house prices the Bank of Russia tells us this.

However, with subdued economic activity and, in particular, shrinking real disposable household income and falling investment demand, it is highly likely that monthly growth in housing prices will remain negative up to the end of 2015, and a decrease in prices will be recorded at the end of the year.

Comment

We do not know what will happen next to the oil price and care should be taken in using a marginal daily price to cover a country’s economic prospects. But there clearly has been a major shift lower in oil and commodity prices and that shift has hit the Russian economy very hard. From our point of view it is hard to imagine a place where imported good and services have doubled in price and some have done more than that. The economy itself will have the problems of money illusion too – as Ruble prices will adjust over time rather than immediately – which UK economic history shows does not help.

The forecasts stated above are based on a higher oil price than now so Russia faces the prospect of 2016 being another year of economic contraction. Also there are two other things which stand out in its economic situation. One is the problem of repaying debt in US Dollars with a depreciating Ruble. The other is having an interest-rate of 11% as much of the world has near zero and some of Russia’s neighbours have negative interest-rates. If we combine the two it must be awfully tempting to borrow in US Dollars, Euros and Yen mustn’t it?

 

 

 

 

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16 thoughts on “Russia faces the economic consequences of a plummeting oil price

  1. ‘However for reasons I shall explain below this is an example of deflation for Russia which comes combined with inflation in what is an example of how quite a lot can go wrong at once.’

    This is something that comes across frequently from both yourself and many of the commenters on here.That is, that the CB’s/guardians of the global economies all seem to only factor in one thing going wrong at any time which then leads to the amusing charades by various Heads of State going on record saying
    ‘noone could have foreseen this coming’ etc etc,when the doo doo starts hitting the fan.

    In this instance Russia is a classic case and a warning,if it were needed,that UK property prices don’t exist in splendid isolation.

    ‘As an aside regular readers may recall when Brent Crude Oil pushed above WTI or West Texas Intermediate by over US $20 at one point and the justifications which followed. I wonder where they have gone as I see that Brent Crude is now lower by around 70 cents. Was this another sign of financialisation of commodity markets’

    This has been the Paul Hodges thesis and when you look at his forecasting record over the last year and a half,he’s trounced Goldman Sachs.Where were they calling $30 WTI when it was over a $100?Yet all of a sudden,they’re calling $20 WTI.Whatever!!!!

    The reality is that sky high commodity prices were a natural consequence of QE.The consequent government spending splurge in commodity producing countries were a natural consequence of sky high commodity prices, as were various asset bubbles.

    Mix in various failures in oversight,be they the rehypothecation of collateral in the shadow banking system/bonded warehouses of China or the various failures to accurately measure leverage in the accounts of most banks,and you have all the ingredients for a very nasty crisis indeed.Especially now that the commodity collateral has slumped in value.
    http://www.reuters.com/article/us-china-qingdao-warehouses-idUSKBN0EX15P20140623

    • Hi Dutch

      The deflation issue is a particular problem as the record of the last couple of year has laid bare. The media encouraged by official pronouncements has majored on the idea of it being bad and just around the corner. Whereas in fact they meant disinflation which for the oil consuming nations has been a benefit and a bonus. If you wanted to see the clearest example of deflation in recent times there is Greece where we note that it took a combination of policy errors and a refusal to accept the truth to put it there. Oh and some of those listened to now are responsible for the errors…

      Ironically QE was also partly responsible for the end of the oil price boom via the way it financed the shale boom. It would indeed be an irony if it ended up as a disinflationary force!

  2. Also,o/t Shaun but as an example of a thread that would suit a forum,Fridays post was a pearler.

    Be nice to watch that one develop over time.

  3. Well I suppose if necessary the CB’s can always go for QE squared

    Forbin

    Ps : doesnt look like economics to me , more politics

    • Hi Forbin

      The irony as I have just replied to Dutch is that shale oil and gas was financed by QE money in yet another example of the law of unintended consequences. But as to more QE well I dont see the Bank of Japan being happy with the Yen at 117 and Mario Draghi will perhaps be wishing that he had fulfilled the hints and promises he made before the last meeting.

      Meanwhile in other news I note that it has been a troubled day for the Italian banks. Remind me again who used to be their supervisor?!

  4. Hi Shaun
    Main differences between Brent and WTI are ‘constraints’ on WTI. Brent has no physical transport constraints, WTI does. Brent is therefore used more widely as the basis for financial contracts, and as you say, this leads to greater volatility.
    You may have picked up the latest ‘advise’ from the Dallas Fed to banks to not force bankrupcy on frackers by removing the need for mark to market pricing on bad loans.
    Russia is pulling back on oil production because it can’t afford new capital investment in its fields. this could off-set new volumes from Iran. Maybe the Saudis will win this war? If so expect an overshoot to $80 later this year. However inside Russia, the populace are being asked to reduce their standard of living to support the homeland, something they usually do without much rancour. No budget cuts in ‘defence’ spending planned.

    • Well spotted JW, last week I forecasted we’d have some feedback when the US Gov favoured their own oil producing capacity. It would appear we have very quickly approached a Gvot subsidy to protect national interests. I am sure that the US people could afford to pay national producers $50/bl regardless of the world price level. Lets see how this develops.
      Paul

  5. Hello Shaun

    As the LTO oil is on life support and if they go down then thats the next Banking crisis

    how long can KSA and Russia continue drawing down funds ?

    All of OPEC is hurting

    and maybe the plan is to replaced US LTO with Iran crude but it aint certain that their fields are not damaged – will another 2 -3 million BoE per day do it? or just a million – its a gamble

    I beiliev that oil will recover , it taking about 18 months for LTO fo fall back and given the amountof cash pumped in I can see a lots of pain for 2016

    In theory lower oil prices should bounce the economies of the West up but this time the debt load is much much higher than before

    Kool eh ?

    Forbin

  6. At current prices, the UK’s North Sea fields are losing money. Yet Britain hasn’t yet had a financial crisis. There were predictions of rUK currency plummeting without oil income from Scotland.

    Oil income is unreliable, and makes GDP/tax revenue planning difficult, just look at the problems Venezuala is having.

    • Hi ExpatInBG

      The UK is less of an oil producer than it was and is a net consumer these days although somewhat ironically I think George Osborne’s tax changes are along the lines of “I chose a bad time to give up smoking” from the film Airplane.

      “Mining & quarrying output increased by 10.5% between November 2014 and November 2015 and contributed 1.3 percentage points to total production. The sub-sector with the largest contribution was the extraction of crude petroleum & natural gas, which increased by 16.5% and contributed 1.5 percentage points to total production ”

      As to the UK Pound £ well maybe the lower oil price has had an effect but the recent weak economic figures is more likely the main player. I guess Scotland is relieved it did not vote for independence.

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