Less is mortgage
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Now that Putin has ordered Gazprom to do what was implicitly already company strategy by filling up its European storage once it completes doing so in Russia, the market's eased up a bit and prices have been talked down (slightly). Pressure points in national energy systems across Europe remain a huge concern. The impending closure of the Maghreb-Europe gas Pipeline providing Algerian production to southern Spain due to political tensions between the Moroccan and Algerian governments has led to panic in Madrid. 1/3 of the country's power needs are met by combined-cycle plants that utilize gas and Spain is relatively unconnected to other gas markets in Western Europe. This is just the latest example of the perils of failing to develop adequately resilient energy systems capable of managing shocks effectively. Peter Zeniewski of the IEA put out a great note last week covering the upsides of Europe's liberalization of gas markets. What stands out upon first reading are the relative savings that have been generated over the years by dropping oil indexation and building up a market where prices are dictated by competition between suppliers and supplies of natural gas on a spot basis:
European importers and consumers have collectively saved tens of billions of dollars since 2010 thr0ugh these regulatory changes, a fact obscured somewhat by the oil shock from 2014-2016. The forecasted losses this year are less than the net savings from 2019-2020. Every analyst and market participants struggles with recency bias and the assumption that what's just happened or is happening now best illuminates what will happen next. But it turns out that the scale of the economic hit from gas import bills isn't yet as large as we might expect on the basis of the old oil-indexed model. I had a thought about how to avoid similar crunches on a short-term that's not yet worked out but modeled somewhat on innovations we're seeing in Russia – European governments could use a 100% oil-indexed reference price with a 6 or 9-month lag as a benchmark during a crisis period like this such that any relative increase in spot prices for gas above the benchmark for wholesalers would be compensated at month's end by the government with provisional guarantees extending what would effectively be grants intended to cover shorter-term costs if need be to retailers to be returned out of future earnings over a long time horizon. The bigger structural problem, however, isn't the supply crunch. It's mobilizing more of those import savings into investments to improve resilience and energy efficiency.
Rosneft CEO Igor Sechin is warning that the failure to invest in traditional sources of energy could bring the last century, an epoch of low energy prices, to an end. Setting aside the ahistorical nonsense about energy costs or using a real-adjusted price for coal in the 1920s vs. the efficiency and technical capacity we possess today, Sechin's warnings that high prices slow economic growth are demonstrably true. Energy drives productivity and consumption in countless ways. European PMIs show a noticeable slowdown starting in July-August when prices and markets entered the supply and squeeze. The following is from OPEC's October report:
There's also truth in the likelihood of higher energy prices in the shorter-term because of supply volatility in various guises. But high prices have always driven fuel switching and investments into efficiency. The Ministry of Foreign Affairs and official spokesperson Maria Zakharova have criticized the EU's recent Arctic strategy document claiming its aim to prevent the further extraction of Arctic oil & gas threatens world energy markets. When Zakharova is doing the complaining, it doesn't really look like the Kremlin has much up its sleeve aside from trying to prevent demand destruction for natural gas by eventually offering more gas. The games talking hydrocarbons up or down goes on. 2021 isn't 2007. The reason prices are rising is precisely because there are newer options and ways of managing future energy mixes that weren't possible during the last commodities boom. Otherwise firms would be lining up more investments. Maybe Sechin should complain about OPEC+ cuts more if he really wants to hammer home the issue of supply shortfalls. His views on decarbonization are shared by the heads of oil majors like Exxon and traders like Trafigura, but what's unstated in this conversation is that they the industry has been free to invest into more supply over the last 5 years. They didn't because they all bet on shale never disciplining itself, struggles to get costs even lower, and most importantly the fact that future demand has looked uncertain for longer than just the COVID shock. Even with oil prices being low, conventional exploration and investments take long enough to materialize that you'd think more could have been underway. ESG isn't to blame for that. The industry's model as a reliable dividend cash cow died in 2015-2016 and they're still adjusting to a world where past bets didn't quite pan out.
What's going on?
If you can't actually get money into the hands of small and medium-sized businesses or else fail to stimulate demand enough to support them, you have to get creative policy-wise to meet national targets for SMEs' share of the economy and output. State-owned companies are supposed to foster SMEs by contracting them as suppliers but always seem to fall short. The Duma are now taking up a bill that is proposing a novel fix to that problem – allow state-owned companies to create small and medium-sized suppliers they can buy from at arm's length. State subsidiary SMEs won't receive any advantages competing for contracts over privately-held ones per the law, but the proposal creates a loophole for SOEs since they could spin off various subsidiaries to bid for contracts between sectors and, in many cases, self deal or supply other SOEs the parent firm has already contracted with. This proposal typifies the problem with economic governance. The Kremlin and government set policy targets and kick it to the Duma, regional governments, and large companies to sort out. But since no one wants to sacrifice their own share of the state-backed or sanctioned rents they rely upon, the end result are half-measures like this approach that end up expanding the potential power of SOEs. It risks being diversification on paper.
Efforts to allow SOEs to boost SMEs dovetails with a noticeable contraction in the creative sector (all privately held and mostly SMEs) over the last 5 years. Researchers from the Higher School of Economics have found that 25% of all creative businesses have closed in that time:
PR agencies, architects, the videogame industry, and more are bleeding jobs and businesses over time. Now the Duma's looking to give SOEs more space to claim and win business in other areas of the economy where SMEs continue to operate competitively with the caveat that many live and die by their ability to win state procurement contracts, and therefore are tied to federal and regional budget expenditures. Despite a 5-year effort to reform arbitral courts used to adjudicate arbitration suits between businesses, businesses don't trust the state much more. Where thousands of courts existed before and could be captured by business interests, now there are just 7. Businesses, especially large ones, still prefer to use foreign courts to resolve disputes. Marginal reform efforts can improve the formal environment for businesses in countless ways. Informal networks of influence and power still operate and tend to concentrate the more that these efforts take off. That Duma bill could boost the SME data to meet national targets. It's still going to hurt SMEs overall.
Yamal LNG is expected to return dividends for Novatek for the first time this year since prior profits were used to service debt obligations. It's expected that Novatek will realize 40 billion rubles worth of dividends for shareholders from the project for Jan.-Sept. with that figure rising through the rest of the year. 4Q uncertainty about oil prices and natural gas demand affect further projects. Despite Novatek owning a 50% share of the project and receiving profits accordingly, it's important to remember that it only contracts something like 1/6 of the production for supply purposes. Its partners get the lion's share of the physical product for their own trading operations. That doesn't mean Novatek isn't seeing its 50% share of the profits per its equity stake, but it does mean that Novatek has a lot less control over how and with whom it negotiates for sales. The company may not increase its dividends, though. It might instead be using profits from Yamal to offset not spending from elsewhere as it builds Arctic LNG-2 and considers its capital allocation given CEO Leonid Mikhelson's concerns that demand may peak by 2030 and wipe out the business case for a host of long-term investments.
LNG doesn't offer the same kind of flexibility as a pipeline to ramp supplies up or down and involves different risks when taking the investment decision. LNG is a relatively liquid, global market that trades between regions whereas pipelines serve a fixed market or markets. No wonder Novatek isn't in the business of Gazprom-style hardball. To that end, Polish gas monopolist PGNiG is demanding that Gazprom revisit the pricing terms of a supply contract for 10 bcm signed in 1996 that expires on December 31, 2022. Why Gazprom would do so is a mystery given that Poland's supply diversification and pricing strategy has been a mix of EU market integration, a buildup of LNG capacity (which Novatek could, theoretically, jump on), and yet-to-be completed interconnector capacity to create a unified Baltic market much more focused on LNG volumes as a future driver of supply buying spot volumes of piped gas as needed. Strangely, the government in Warsaw doesn't seem willing to take into account the fact that the existing pipeline supply contract is still oil-indexed and therefore likely providing prices a fair bit lower than spot prices at the moment. The response from Russian analysts is straightforward: you wanted this market, now you got it. Buy the ticket, take the ride.
In another sign of the Duma's growing role managing economic policy, the Duma is now considering a law that would link mortgage interest rates to regional wage levels. Speaker Vyacheslav Volodin thinks a link with average wages would be a useful policy to consider as a means to afford Russians living in regions with lower wages and fewer high-wage jobs the opportunity to buy in their home region. His chief aim seems to be preventing regional labor deficits as a result of internal migration to Moscow, St. Petersburg, or European Russia if you live in Siberia and the Far East. Ideally, the differentiation of mortgage rates by average wages would be folded into the existing mortgage subsidy program that launched last year and will be active at least through the end of 2022. There's just one problem with taking this approach – it's likely to drive up property values in the regions they hope will retain more people. That means higher rents, more pressure to expand access to housing, and more constituents who don't want their homes to lose their value once they've bought them. Housing has become a focal point of Russian politics in a really interesting way, even if their intentions have more to do with managing population declines and the over-centralization of the economy more than helping people build up nest eggs in real estate.
On the wage and housing front, the Russian Federation of Independent Professional Unions (FNPR) has written to labor minister Anton Kotyakov requesting that the national minimum wage rise to 50% of the national median wage by 2030. As of now, minimum wage stands at 42% of the median wage. The FNPR is arguing that based on comparative indicators, minimum wage is usually more like 67% of the median wage in developing countries and 55% of the median wage in developed ones. Crucially, the union identifies the fact that minimum wages are much lower comparatively to those found in developed economies as a driver of stagnation because people can't afford to consume more. They get it! So imagine, if you will, that their proposed increases are adopted. Then mortgages would become more comparatively accessible since the state has decided that fixing or subsidizing rates is an appropriate form of economic stimulus. If they do, demand for homes to buy should go up, which then drives up demand for housing stock from renters while homeowners tend to take a more cautious view. I'm curious to see if other unions start making this argument. It'd be the foundation of a shift in attitudes as to how the regime manages stagnation and the material interests of the coalition of voters it has relied on since 2012. Let's see how MinEkonomiki rolls out what are akin to food debit cards for the poorest Russians worst affected by accelerating food price increases.
COVID Status Report
39,849 new cases and 1,163 deaths were reported today. As we can see, most regions haven't taken strong public measures with the non-working days about to take effect since they don't have to:
The Duma will reportedly debate the passage of a law that would mandate vaccinations as the government's attempts to get the pandemic under control while limiting the degree to which they shut down the economy get more desperate. That's a huge signal that the calculus in Moscow is changing quickly as death counts continue to break records and the national healthcare system reels from the influx of patients. Russians have canceled various trips planned to regions with much stricter measures in place, another hit to the tourism industry but one that will likely be offset by Russians deciding to be recklessly taking health risks in other regions, abroad, or else at home. At this point, it's hard to blame the regime. I do for failing to take adequate economic measures that would have made managing prior waves easier financially for most households and botching the vaccine rollout. I ultimately don't for the lack of trust the public has in information and the refusal to accept the gravity of the situation. Would more transparency around the data have helped? Definitely. But it's not like a lack of transparent data is the problem in the US, even if political polarization and atomization is a likelier driver there. According to Roman Shmakov from the Ministry of Health, mortality rates among pregnant women are three times higher this year than last year. If the regime can't sell saving pregnant women's lives to the public now, no idea what optics they'd turn to in order to get this sorted without resorting to government mandates that many people will hate.
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