15 min read

Everything's fine

Putin and others are striking an absent note on the state of things
Everything's fine

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Igor Sechin and the folks at Rosneft had some fighting words coming out of SPIEF last week. Sechin’s main contention is that the under-investment into oil & gas output is going to undermine price and market stability, criticizing the IEA’s net zero model that shows all O&G investment must cease. Per Sechin, the industry needs $17 trillion between now and 2040 to maintain current output levels. Of course, there’s no reason to believe that we’ll be consuming the same amount of bill by 2040 and Sechin’s also left out how much the industry has changed since 2014-2015. Granted it’s just one outfit and it’s got its shortcomings, but Rystad estimated that as of 2020, breakeven prices for unsanctioned oil projects had fallen 35% since 2014. Breakeven prices for oil aren’t the same as the total project spend by any stretch, but if we apply that level of deflation to net oil & gas spending since 2015 from the IEA data, we can see that there’s a serious problem with Sechin’s implicit thesis about spending levels as a proxy. LHS is US$ blns and a also applied it to gas though that wasn’t what Rystad claimed just to get a visual of what cost deflation looks like:

Basically, if we take the declining breakeven cost as evidence of analogous overall cost deflation, oil spending levels in production terms have been, at minimum, constant since 2015. Production has actually grown since 2015 along with demand overall so there’ve been considerable aggregate efficiency gains to reduce the dependence on new finds to replace older ones annually. Sechin is, of course, correct that killing upstream output too quickly by using policy instruments to strangle oil & gas supply are, frankly, stupid approaches. In the past, cheap(er) oil was an impediment to fuel substitution, but now with the prospect of carbon taxation and various policy measures shifting demand, the cost of externalities, and the potential to massively invest into greener infrastructure, there’s actually less need to strangle supply. The warning from Sechin reveals their hand — they expect oil prices to rise and buy them space to avoid further diversification risks and want to sell the line that China and the “East” will determine future demand. That was true from 2000-2020. It’s not necessarily true anymore, especially as the OECD has come to be the marginal buyer of commodities with more aggressive stimulus — US Treasury Secretary Janet Yellen is calling on the G7 to use more stimulus, support measures, whatever it takes to foster more growth — and renewed interest in proactive industrial policy. Oil & gas production remain essential, but the investment arguments have to do a better job acknowledging the cost deflation we’ve seen the last 7 years and that the application of newer tech, better use of data, etc. will probably realize yet more cost deflation in the years ahead. Rystad offers a very imperfect proxy, but it's still telling.


What’s going on?

  1. I missed this Friday, but the current commodity cycle has dethroned oil & gas companies as Russia’s undisputed dividend leaders — metallurgical firms are now paying out the same volume of dividends. These movements of capital are big given the relative depth and development of Russia’s financial sector. Last year, shareholders received an estimated $36 billion in dividends in Moscow. ITI Capital’s forecasting a 7% return for 2021, beating out the nearest competitors in London and Italy by 3%. That’s a good deal for foreign investors looking to cash in the commodity cycle and for a bit more exposure to emerging markets including Russia. Russia’s public firms perform very, very well, no doubt aided by the creation of rents, state support, occasionally controlled input costs, labor’s weak bargaining power, and so on. The uneven environment for NOCs vs. IOCs on the oil & gas market are going to benefit Russian firms as well. The more investors fret firms like Exxon, Chevron, Shell, BP, and so on over the lower marginal returns for green investments into utilities and infrastructure vs. upstream exploration, the more interest — and scrutiny — the 10%+ returns for firms like Rosneft and Gazprom will receive. Backing off of OFZ issuances is one thing. Green geopolitics affecting investor perceptions of Russian securities is a different kind of challenge for Moscow in the longer term. This year, though, is looking good.

  2. The Rosstat and MinEkon data shows that demand and capital investment levels have nearly recovered to pre-COVID levels, a positive sign that things are ‘stabilizing’ across the economy. Behind the sunny numbers, however, lie a few glaring questions like “what’s up with real wages?” and "why would pre-COVID levels that led to 7 straight years of real income decline be seen as a positive?” The following data’s been seasonally adjusted:

    LHSBlack = # unemployed (mlns) Orange = # employed (mlns) RHS — Blue = real wages, (% growth for the period)

    So first off, real wages rose more during 3Q-4Q last year after the initial hit than they did in 1Q when the labor market was supposedly far too tight from the loss of millions of migrant laborers. Second, we’ve seen that demand levels are financed by consumer debt to a higher degree this year than at any point last year and, in some cases, at record levels of debt for the last decade. The two strongest areas of investment recovery have been intellectual property and machinery and equipment — the former doesn’t really tell us terribly much by itself but is a good sign that companies are going through a phase deploying new techniques, new equipment, etc. to adjust and the latter is consistent with recovery. But rising investment levels are expressed in monetary terms and when you factor in price inflation levels for lots of goods, it’s an imperfect measure. Sber and others are confident that demand reflects people running down what were record high savings. That makes sense. It also suggests that demand levels may not remain this high if key rate hikes and a tightening of loan subsidies and similar programs take effect sooner rather than later unless real incomes return to adequate growth. It’s good unemployment is declining again and things are more stable. It’s just never the whole story when the ministries tell you everything’s fine.

  3. Just Russia’s party platform for the upcoming Duma elections reveals a fascinating split and development in the ideas landscape for systemic parties, one I think remains marginal at best and a political tactic but interesting to track as the exhaustion of the current economic model imposes ever more pain. Just Russia is openly fighting for voters from the Communists and appealing to similar sensibilities about the catastrophe that was the Soviet collapse and a desire to build a more solid basis for a fair society moving back towards socialism. As part of that plan, they propose creating a universal basic income of 10,000 rubles a month paid for using resources rents to try and escape the resource-led middle income development trap leaving Russia ‘dependent on the West.’ What’s perhaps most novel to me, admittedly a supporter of UBI who doesn’t see it as a threat to other more traditional and equally important forms of welfare and social policies, is that their positioning actually apes the social support Putin has preferred to lean on ahead of September. 10,000 rubles a month is a decent chunk of change, but still falls below the monthly minimum wage, therefore still forcing people to find work. That’s probably unavoidable given the country’s fiscal politics. It’s just a curious development in the Russian context because it really can play the role of a right-wing spoiler policy that US and UK leftists like to claim because of the peculiarities of Russia’s political economy and political system. But if it were ever to become a more serious policy discussion — note that I highly doubt it’s much more than a stunt — it’d mark a significant change in thinking in Moscow as to how the regime can best maintain living standards. Just Russia similarly want to restore direct elections for all mayors. That seems more like a means of trying to create a space for local orgs and politicians to develop bases of power without as much control from Moscow, something that frankly seems inevitable if the center can’t generate new rents in the years ahead.

  4. Based on the chatter out of SPIEF and the latest macro indicators, Russia’s interbank markets are now expecting the Central Bank to more aggressively hike key rates ahead of the September Duma elections. Inflation’s finally reached the “pain threshold” needed to trigger serious consideration of more aggressive action. Putin’s remarks at SPIEF noted that experts (read: Anton Siluanov and budget hawks) hoped for inflation at about 5% for the year, suggesting that credit has to get a fair bit more expensive quickly since key rates can’t solve commodity price pressures. Export banks for buckwheat were extended till August 31 and TASS and the Financial Times are reporting that MinEkon and others are looking to further expand export bans or else use much steeper export duties, a move that economy minister Maxim Reshetnikov claims is intended to induce producers to invest into production (despite the obvious losses of earnings from abroad that would serve the same function). The planned end to mortgage subsidies, extended for now, is expected to quash demand in the regions for housing that’s already in short supply. Given the political pressure to get serious about price increases, it seems likelier now that a stiffer pull back on monetary policy instruments and subsidized credits, a key rate increase, and budget spending will have to happen over the next few months in some way to generate data they can present the public contradicting the price increases they’re continuing to see for basic goods and housing. The Kremlin’s political strategy has merits — 52% of the public want the state to crack down on businesses and exert more “control” over them, which reinforces the logic of these manual control interventions and rhetoric. Doing so is highly risky when demanding they invest without providing enough demand and threatening to increase the cost of borrowing.


COVID Status Report

With the Ministry of Health now explaining that mortality rates in over half of Russia’s regions are at pre-COVID levels, the data was “boring” today (despite continued underreporting). Setting aside the COVID data, we can see that Russia’s export basket is performing better overall — and driving the recovery — thanks to the novel nature of the COVID shock with the timing of the commodity cycle and rising demand for metals & minerals:

Non-oil & gas export growth is basically down to higher commodity prices. Most stories about non-resource success are still resource stories at some point when you dig into Russian data and reporting. Foreign currency earnings are coming back into the economy and exporters are sustaining a fair bit of demand for goods and services. But it’s not necessarily consumers driving the import recovery. Imports are rising right in line with exports in USD terms. That’s bound to be closely linked to extractive industries and the prices of key imported goods and services, though it’s also a result of global supply bottlenecks pushing up the cost of imported components and materials for consumers as well. And this wave of pricey commodities will come with an extra helping of import substitution worsening the blow — Sergei Dankvert of Rossel’khoznadzor bemoaned the country’s complete dependence on imported eggs that don’t have any pathogenic microflora needed for the production of COVID vaccines and others. Imagine a new bill entering law to address this ‘problem’ indirectly increasing the cost of Sputnik shots in future years as the world adjusts to the possibility of annual COVID shots in the same manner as flu shots.


From one (not so) famous blogger to another

Putin’s appearance at SPIEF — full session linked here — and the surrounding commentary and policy talk/events paint a damning picture. Putin touted the broad recovery of the economy to pre-crisis levels, but acknowledged unemployment and lower real incomes remained a problem and that most of the challenges now facing the economy are structural. In his words, the decline in incomes aren’t a catastrophe. The focus instead was on ‘regional development’, the provision of 500 billion rubles’ ($6.87 billion) worth of credits at 3% for regional infrastructure, vague promises of support for small businesses in the form of additional credits, and targeted tax tweaks like exempting restaurants with turnover under 2 billion rubles from VAT. He similarly played good cop to Andrei Belousov’s bad cop telling metallurgical firms not to take Belousov’s inflammatory language too seriously since he may have crossed a line in tone, but is basically correct about the unintended effects of ‘super-profits’ across the real economy. Putin’s clearly been listening to guys like Igor Sechin who pretend that long-term supply contracts, in this case for metals & minerals, magically fix price stability issues and can ward off price inflation. Never mind that contracts can be torn up, renegotiated, or else indexed in such a manner that the supplier gets screwed during price squeezes. Kommersant noted perhaps the most troubling trend one could discern from all the SPIEF proceedings — virtually no one was seriously discussing big business investment, despite the pressing need to raise investment levels, but rather the relationship between business and the state. I differ from this rendering insofar as I think they’re the same question because of the demand deficit across the Russian economy and attempt to ‘mobilize’ capital as part of Mishustin’s Gorbachev-lite turn towards uskoreniye.

You get the sense that the state wants to have its cake and eat it too — ever since price regulation became an important ‘optic’ vector for policymaking, lots of performative and poorly implemented policy measures have been taken. Yet finance minister Anton Siluanov straight up shot down the direct visual of price regulation by making clear the state doesn’t set prices for producers to sell at. That’s of course strictly true, but essentially a lawyerly dodge. Export bans, pressure on wholesalers, and so on are still being used to prevent excessive price increases. Economy minister Maxim Reshetnikov is openly calling for more “shock absorber” restrictions on key foodstuffs suffering particularly acute price inflation. An interview he gave with RBK further stressed the overt renegotiation of state-business relations. He openly acknowledges the next 5-10 years present a “new reality” for economic policymaking and the economy, citing the usual laundry list of buzzwords but also linking that to higher inflation levels. In his account:

“It’ll take the real economy a long time to absorb the [expanded money supply] . . . the easing of monetary and budgetary policy that’s happened should have an end. In other words, the economy’s recovering quickly enough that it doesn’t need so much money.”

The aim of MinEkon, therefore, is to head off the worst of this monetarily induced inflation for consumers. He openly admits that the question of whether a tightening of monetary and fiscal policy will hamper recovery has no good answers, yet endorses raising taxes on windfall profits to help finance social programs. He’s basically endorsing soaking the best performing firms during the inflationary cycle to theoretically support higher social spending, yet no fiscal plans exist to provide a significant expansion of social support in the longer-run. What’s telling then is that Reshetnikov joins a broader chorus of voices suggesting that higher tax rates are intended to spur more business investment. Funnily enough, that makes a lot of sense on its face. Besides, firms that are able to claim more losses from spending are taxed at lower effective rates. It’s a rather hilarious about face on economic policy that selectively contradicts the consensus Kudrin has fostered, a consensus bolstered by the frequent business negotiations undertaken by Belousov and others in the past. Basically until the COVID crisis, the assumption was always that tax breaks would encourage investment. That’s failed spectacularly in the case of the various industrial zones and investment havens offering preferential rates that have largely failed to meaningfully stimulate investment levels. So now the state’s deciding collectively that raising taxes is the way to go. Sticks trump carrots. You won’t build? Fine, we’ll take more of your money. Putin even went so far as to chide Oleg Deripaska, floated by himself and his friends in recent weeks as a potential replacement for Boris Titov as the Kremlin’s new business ombudsman, for his Telegram criticisms of the Central Bank’s decision to hike the key rate to tame inflation. Per Putin, Deripaska is a “famous blogger,” which recalls the irritation at Obama’s assertion that Russia was a regional power once upon a time.

Starker still is the official line that political repression has no negative effect on the investment climate. I do think observers, myself included, tend to overstate the effect of any given arrest or blowup on investment, but the claim beggars belief for the obvious reason that Russia is not China. It’s nowhere close to representing a huge growth consumer market, especially the longer that real incomes continue their downward trajectory and struggle in the new, higher-inflation macroeconomic regime we’re seeing emerge globally. The following uses the World Bank’s net savings as % of gross national income (savings+education expenditure - calculated energy depletion, pollution etc.) and GDP in PPP per capita terms using 2017 constant US$. Savings are LHS for ease, RHS is US$:

China’s got a massive ‘savings glut’ — a huge underconsumption problem because of its domestic imbalances — whereas Russia doesn’t. Further, we’d expect to see a larger relative rundown of Russians’ savings after the COVID crisis, though one differentially felt based on geography, income, and more. GDP in PPP terms in 2019 was only about 8% higher than it had been in 2008 in Russia, a figure that’ll be lower for 2020 of course. In China, the growth between 2008 and 2019 was more like 117%. In short, China’s repressive turn has far less of an impact on foreign businesses because of the huge volume of unrealized consumer demand that exists to be tapped. Russians don’t have that, and so long as demand is weak, the business case for foreign firms investing into unsanctioned sectors in Russia will strongly correlate to expectations that foreign firms either be able to export some of their production back into the EU or else into CIS markets. And that’s setting aside the complicating logics of decarbonization initiatives for western publicly-traded firms intended to appease investors on western financial markets.

Deripaska was wrong insofar as the Central Bank and Kremlin have to keep a close eye on how much money is being held in banks that faced a squeeze on liquidity needs for foreign currency during the oil downturn last year coming into 1-2Q this year. But only a big expansion of investment into production of core commodities needed domestically, lots more housing, and perhaps most importantly a far more rationally organized labor market less dependent on political favors intended to shore up support would be needed. In other words, the Kremlin needs to allow unemployment to be resolved by stimulus such that demand eventually pulls the supply side through to balance. But it took the orthodox supply-side approach and refused to do this, especially since it would entail surrendering political control over key sectors and political outcomes at a time when it needs to strengthen control over electoral outcomes. Now that tax breaks have failed, they’re talking up raising taxes in hopes firms prefer to put more of their money to use. But so long as the structure of the economy is tilted towards exporting sectors and growth domestic sectors largely benefiting from the fall in incomes and living standards — think innovation to cut retail costs using e-commerce, retail consolidation, or healthcare innovations using tech — that seems unlikely to work unless more money is given out to the public.

Kudrin is perhaps the lone “untouchable” voice calling for the state to reduce its role in the economy who really means it, rather than talking about privatization and more as a means to signaling to the richest and big businesses that they better open their wallets. But even Kudrin is still talking about tax breaks as a fix-all that won’t address persistently weak demand. The systemic liberals are incapable of proposing any ideas to fix anything because its their own orthodoxy that landed Russian macro where it is today and they rely far too heavily on creating institutional capacities and rights out of thin air rather than thinking of economic policy as a political instrument to alter the regime’s bases of support. The main options are to keep consolidating businesses, making it easier over time to corral businesses into informal agreements since property rights and protections ultimately are so often linked to pleasing the right political actors and reducing the space for SMEs to operate as a 2-speed recovery between big businesses and SMEs likely gathers pace. Putin went so far as to clarify that the Federal Anti-monopoly Service shouldn’t oversee any mergers or acquisitions worth less than 800 million rubles ($10.98 million). One imagines a lot of people are going to realize they can restructure their holdings in just the right way to acquire more without oversight at some point . . . Business is being told to know its place and act accordingly. We can take from that an obvious conclusion: the competent bureaucrats that used to run Russia’s economic institutions have been completely replaced with political technologists, and the best that over-hyped luminaries like Nabiullina can hope to do is abet the likes of Siluanov and countless others who are running the economy into the ground. After all, just a few days after that quip that no one had been arrested, Dmitry Gudkov fled to Ukraine fearing his arrest.


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