I remember around ten years ago meeting an analyst who covered Russia. This seemed a very interesting opportunity to learn about the Russian economy and its relationship with the world. Yet his presentation consisted of chart after chart of the oil price super-imposed over some measure of the Russian economy; be it exports, the budget deficit or growth. The message was that pretty much everything was correlated to the oil price. If you understand and, even better, can forecast the oil price, then your job was largely done.
For me though, if there is one thing harder to predict than exchange rates, then it’s oil prices. And the price action seen over the past ten years perfectly reflects that. We were in the grip of the peak oil theory, under which supply was set to fall, whilst demand would outpace population growth as greater wealth lead to increased overall demand for cars, flights and other energy intensive wants. We are now in the midst of a secular change in oil market dynamics, disrupted by shale gas production, a growth in alternatives and a change in approach from OPEC.
But what does this mean for Russia and its oil dependent economy? There are three main points to note. The first is that Russia is a by-stander on nearly all these fronts. This applies to shale production and also renewables, where Russia has made some progress, but these look modest in comparison to the size of the economy. Instead, Russia continues to increase oil exports as the price hits new lows, largely because at the moment it has few alternatives, or at least that’s what it continues to believe.
The second point to understand is that Russia has not been hit as hard by the falling oil price as many believe. The decline in dollar oil prices has come at the same time that the Rouble has fallen, so the revenue received from exports has been a lot more stable, whilst oil exports have been expanding over the past year as a proportion of total exports. Rouble export revenues have declined at most 16% peak to trough over the past three years, which is modest compared to the oil price decline seen. But naturally the weaker Rouble is in itself a reflection of the weak state of the Russian economy, so it’s a double-edged sword.
But despite this, it’s still had a political impact, just because Russia’s oil revenues are such a major part of its government finances. If prices stay around current levels for the remainder of the year, then Russia is likely to face a budgetary crisis, with the current budget predicated on an average price of USD 50 per barrel. Unlike some others, it has not stashed away revenues from the good times in reserves for a rainy day. This places great pressure on the authorities to somehow make up the difference, but that’s hard to do when the economy is contracting and real wages are falling.
So for Russia, a recovery in the oil price to USD 50 p/b is a necessary, but not sufficient condition for the budgetary deterioration to at least stabilise. A price remaining in the USD 30s is bearable, but will likely see further taxes on oil companies, who have fared relatively well over the past year, all things considered. But a sustained move below USD 30 would put Russia’s finances on a very precarious footing, putting further pressure on the currency in a way that would not be welcome and possibly leading to higher interest rates as Russia tries to defend its currency.
Simon Smith, Chief Economist