13 min read

Miller Time

Gazprom's not losing market share, but its a shell of its former power
Miller Time

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First, a heads up that Monday will be a Eurasia day (and I'm considering setting a more regular schedule for them, just trying to work out what would make the most sense).

The latest turn in the Navalny saga comes with word that Russian authorities are now looking at charging him so as to get a prison sentence of 13.5 years in total. It’s a total reversal from initially saying they wouldn’t arrest him and a massive shift from the usual tactic of detaining him for intermittent, shorter periods of time to try and suck the oxygen out of the protest movements he leads. The Moscow Times writeup on the nuances of Navalny’s power and popularity from Felix Light and Pjtor Sauer is great and worth a read. Still, I’m left wondering less about what impact Navalny has on the appearance of the regime’s legitimacy, per se, and more on whether or not the Russian economy can continue to generate enough rents for its political class and institutions to distribute in order to maintain the existing, tenuous social contract.

BOFIT notes that Russia now holds the 4th largest currency reserves in the world at $596 billion as of December, and the National Welfare Fund is back to 2009 levels in terms of its net dollar holdings. But both of those symbolize austerity policies,  the suppression of domestic demand, and refusal to distribute rents more broadly. It’s also not exactly a large source of structural power for the Russian economy (despite semi-frequent remarks to this effect) considering China’s currency manage balancing act:

Chinese banks accumulated nearly 66% of the equivalent of Russia’s net currency reserve holdings in foreign assets in about 8 months. Those are fundamentally different transactions and serve a different purpose. It’s just telling that Russia’s most significant financial interface with global markets is through its central bank and the state, both of which exert precious little pull abroad. The point here is that in terms of macroeconomic management, Russia’s funds are only useful insofar as they help keep debt issuance and foreign borrowing costs lower. Money ain’t worth nothin’. It’s just how you spend it. Yet despite the ostensible benefits large currency reserve accumulation provides, Russia hates issuing debt and borrowing abroad, save for its leading firms that earn in foreign currency, and it hates spending it. China exerts a gravitational pull that dwarfs anything Russia can do that ends up having a large impact on commodity demand and prices while Russia isn’t even doing much very effectively with the resources its accumulated. Stability is really important. It’s also overrated when it reproduces instability by worsening standards of living. The improvement of Russia’s current account headed into 2021 is a far more important stabilizer than the volume of savings its sitting on and letting go to waste, but it won’t last forever. You can’t insulate yourself from external shocks when external demand provides the resources used to generate stability, especially as those market and price controls slowly increase systemic economic risks from under-investment and constrained demand.

What’s going on?

  1. MinFin, MinEkonomiki, and the Federal Tax Service are lining up a bill to set out new requirements for non-public companies registering in Russia’s offshore Special Administration Regions (SARs). A wide range of tax cuts — down to 5% for profits, 10% for revenues and dividends, and a 5% profit tax rate for International holding companies. The catch? They have to invest at least 300 million rubles ($4 million) in infrastructure in the region they’re registered to, have an office space of more than 100 sq. meters, a staff of at least 15, and earn more than 90% of their revenues off of passive activity. This isn’t going to trigger a flood of investor interest into Russia’s offshore schema and the infrastructure gambit is stillborn. Everyone knows the state will end up owning whatever they invest into, so there’s little point. The real value will be for JVs and related corporate vehicles used for Russian firms’ upstream and/or downstream activity abroad as they try to register the companies in Russian territory to dodge sanctions risks. That could work in limited contexts where they can make the underlying venture a tiny fraction of what a holding company holds, thus meeting the passive activity requirements. Africa is used for the example in the article. Worth following, but not getting excited about.

  2. A shift in export flows of refined products from Russian refiners has created a huge winter problem: benzine costs are nearing historic highs this January. Russian refiners and oil firms are realizing higher prices for exports and therefore selling less domestically to maximize their profits. Net stocks are at a several low of 1.2 million tons now:

    Title: Dynamics of Exchange Prices for AI-92 (rubles/ton)

    MinEnergo has chided them asking they produce more for domestic consumption, but what appears to be happening regardless is that domestic wholesale prices from distributors are converging with foreign prices, thus lifting retail prices at filling stations. Basically, if you imagine a template for Russian economic policy for this stuff, the aim is generally to find some means of suppressing domestic prices to quash price inflation while retaining the flexibility to raise export earnings. In this case, MinFin effectively subsidizes refiners when margins are weak (as they are these days) as part of never-ending Oil Tax Maneuver. But the obsession with allowing for export earnings means that external prices for export also end up creating a dilemma for Russian firms when they diverge from domestic prices, so this pressure is inevitable. It’s terrible timing. The average domestic shipment travels around 1,000 km so this creates a small, but systemic inflation risk in the immediate term for goods. MinEnergo is chalking it up to rising demand from the easing of restrictions. It’s probably a bit of both, but more about the price differentials.

  3. Sber is trying to acquire rights for 5 years to Disney’s film library to stream on its online platform Okko for the princely sum of $100 million. But since Sber doesn't have a TV channel, it wouldn’t be able to make the kind of use of the licensing agreement that Russian TV stations who’ve cut their own deals with Disney have, and it’s also over-paying for the content in question. Talks were interrupted in December when Duma deputy Anton Gorelkin introduced a bill limiting foreign ownership of online TV/movie platforms to 20% — Okko is 43.5% owned by non-residents. What’s more interesting here to my mind is that Sber is trying to use its relative size and massive bet on tech and tech services to ice out competitors by bidding up prices. Once Disney signs a deal above the market rate, other distributors might be try and do the same. It’s also an interesting space to see where Russian attempts to foster the domestic film and TV industries just fall terribly flat against leading content produced abroad. This isn’t an earth-shaking story for political economy, but it does suggest that SOEs trying to profit off of market opportunities to expand online platforms and the like are going to use their privileged access to credit, scale, and resources to outbid smaller, leaner private sector competitors where they can when it comes to who gets to import choice content. It also adds a degree, if I think often exaggerated, of political control for the state to the process.

  4. Data from YuKassa (part of Sber’s vaunted ‘ecosystem’) shows that during the COVID crisis, the number of self-employed Russians grew by a factor of 6.4 and earnings turnover for the self-employed rose by a factor of 10.6. There were 1.6 million payments being made daily through 120,000 Russian and foreign online platforms. Those working in retail for clothing and shoes saw the greatest gains — a 38-fold increase. Clients paid an average of 3,687 rubles ($49.22) per good online, a 250% increase over 2019. There’s more there. The number, though, are less the story than what a shift in working from home habits and greater flexibility for self-employment means politically. The more people are self-employed and in the formal sector, the more we might see the relative mobilization power of larger SOEs diminish in political seasons (depending on which types of jobs are being created). A lot also hinges on where the votes and jobs are i.e. the regime losing Moscow is fine, losing in Tyumen, Tomsk, Omsk, and so on much less so. It’s also just a bit harder for the state to control. In no way do I think this leads to a political crisis, but it will pose challenges for the models used to mobilize support at crucial junctures based on professions, office politics, unions, etc.

COVID Status Report

Daily cases hit 21,513 and the death toll fell slightly to 580. Declines for infection rates in Moscow look like they’re sticking and the R is getting under control steadily:

Black = Moscow Red = Russia Blue = Russia w/o Moscow

The scramble is now on for the regional governments to catch up to Moscow’s progress. What’s telling is just how disorderly the federal response vs. the local response has been, at least in terms of newer tracing measures. Duma Speaker Vyacheslav Volodin explicitly said that COVID passports weren't on the agenda for a Duma debate and vote just two days ago. But Bashkiria introduced a COVID passport scheme despite federal protests and Novosibirsk region is now considering it based on Bashkiria’s experience while other regional governors express doubts or refusals. Krasnodar krai is assuring the public that the UK variant hasn’t been discovered in circulation while it tries to get cases under control. It’s a total **** show. The federal government’s refusal to impose significant measures nationally for months is dragging out the infection rates, especially since it’s not really services driving most of Russia’s economic recovery so far and regional governments still face budget shortfalls from 2020. By kicking the can, regional governments now have a chance to basically vie for future favor and influence as they try and handle the infection rate. It doesn’t hurt the Kremlin at all, but it’s an interesting case where the refusal to act nationally has created more space for governors and local officials to build up local political support and legitimacy.

Everyone Knows When You’re Down and Out

Gazprom’s definitely happy about the recent spike in natural gas prices in Europe and the Asia-Pacific. Even if temporary, the company’s non-FSU contracts are expected to beat price levels for spot trades due to favorable terms. Fitch estimates that a third of Gazprom’s non-FSU exports are sold at spot rates, with the rest sold on oil-indexed contracts, hybrid contracts set to oil and gas prices, as well as gas forwards-linked contracts that are effectively a purchasing agreement with price triggers. Fitch’s outlook shows Gazprom is net cashflow negative for 2021-2022 based on price assumptions. Gazprom is going to survive this downturn, but I highly doubt it’s ever going to return to major profitability that creates new rents domestically without more policy support. Sanctions is part of it. Ironically, Gazprom’s project costs rise significantly when it works alone and without foreign partners and without bank loans. The latter, of course, is harder to come by internationally despite the fact that the company faces a lighter sanctions regime than Rosneft.

But it’s ultimately the question of what demand looks like that matters most. Even when the ‘natural gas as bridge fuel’ narrative was strong in Europe pre-COVID, underlying demand wasn't exactly roaring:

Net consumption never matched levels from 2009-2010, worsened of course by European austerity measures, energy policies, and global warming. China’s been the core hope for the future and there is certainly room to run for gas demand growth. Looking at the balance between the two markets is a useful reference to frame the structural challenge (and opportunity) Gazprom’s facing in the coming years:

China’s demand growth has more than offset the relative decline of European gas demand compared to 2009-2010 and the Power of Siberia pipeline — current capacity of 38 bcm, with work on a second branch via Mongolia likely underway soon — met just under 30% of 2019’s needs had it operated at full capacity for that year. But demand has kept rising in China, which means that Gazprom’s net market share — and exposure to LNG pricing — is worsening. Plans to potentially add 6 bcm of capacity to the current pipeline don’t change the problem. As I’ve noted (long ago) here, Gazprom has lost pricing power at every turn thanks to the combination of slack European demand, EU regulatory power and the threat of antitrust action, the optionality for contracts generated by even minimal volumes of natural gas shipped via the Southern Gas Corridor, and of course that old stalwart “Freedom Gas” from LNG trains in the US of A. China’s benefited from declining demand in South Korea and Japan generating contracts providing excess volumes that then had to be re-traded. All of this is old hat, but worth recalling.

What’s trickier for Gazprom now is what energy consumption broadly looks like since so much of the energy transition coincides with technological developments that should considerably increase net demand (at least at current efficiency levels) and create bottlenecks for power systems such as those experienced across Asia and even in the UK with colder weather. Using the same BP data through 2019, net primary energy consumption tells a more important story than net natural gas demand between the EU and China does:

Europe’s relative economic stagnation and energy efficiency improvements left primary energy consumption levels about 6.9% lower in 2019 than they were in 2000. In the US, primary energy consumption had only grown .005% in that time. For non-OECD excluding China, it was 69.9% while for China, it was 233.8%. Renewables are absolutely vital, but whenever surges of power capacity are needed as was the case in China 3-4Q, coal and natural gas can fill the gap way faster and more efficiently for consumers and utilities operators. There’s therefore an underlying contradiction whereby renewable power will reduce net demand for natural gas for primary energy consumption when power grids have adequate redundancies and natural gas or related stop-gaps available but demand will surge on a shorter-term basis to fill shortfalls. That seesaw was driven by household consumption in China, but China’s rise as an exporter is inseparable from its large rise in household energy demand since it was exporting industries that paved the way for wage growth as it did for a fair part of the Asia-Pacific. If re-shoring manufacturing is a serious part of post-COVID trade policies, the relocation of factories on developed markets will likely tip up net primary energy consumption in the shorter-run. So Gazprom’s not at risk of losing its market share. If anything, it could expand it in Europe in the coming years while doing so initially in China before seeing it fall in relative terms due to broader demand and import growth and aggressive, if possibly unrealistic, plans from PetroChina to hit 22 bcm of shale gas production domestically. The hollowing out of Gazprom’s market power is not that it loses its exports, but that prices will trend lower in the longer-term, only to then be interrupted by spikes of demand during cold snaps, off years, or other unforeseen events. In other words, the business becomes lower margin, the global market is increasingly integrated thanks to rising LNG production and cross-regional trade, the EU has defanged the company, and China doesn’t have to take prices from Gazprom either. Gazprom can credibly claim to continue to play an important role in European energy security due to supply bottlenecks. It just can’t exert much political leverage doing so because those bottlenecks aren’t frequent enough. Worse, other options are starting to reach commercial viability and competing SOEs are taking note. Rosnano’s launching a $320 million project in Murmansk to produce 12,000 tons of green hydrogen a year and sell it to the EU. Gazprom can still hand out construction contracts to friends, but it’s effectively lost or losing most of its vaunted status save that it generates huge volumes of tax receipts.

More broadly, though, it’s unclear how efficiency driven investment affects natural gas demand. Energy efficiency gains are a far greater threat to medium-term natural gas export earnings than the current craze around hydrogen. But net investment into energy efficiency has been lagging, especially since lower oil prices post-2014 didn’t encourage the automotive and industrial sector to sink more into R&D to cut costs. The following from the IEA tracks GDP changes with energy intensity improvements:

What’s worse news for Gazprom, however, is that if you look at the incoming Biden administration’s plans and where efficiency investment is taking place, there very well could be a slow and steady uptick in US LNG supplies post-crisis relative to US domestic consumption while China ramps up investment into efficiency to generate domestic economic activity, reduce its import bill, and foster competitive advantages for domestic firms that export related goods and services. The following from the IEA on building investments for renewable heat sources:

Marginal gains in the US lead to larger ones for LNG export volumes down the road, assuming Chinese demand underpins continued project investment. Moscow’s game of offering a dagger wrapped up in a gas supply contract has been dead for years, but now its claims about being a reliable energy security partner are also notably absent from it is own foreign policy comms strategy compared to recent years. Hydrogen and gas substitution are sexy. But it’s going to be slight shifts in efficiency and end use that put the final nail in the coffin of Russia’s energy influence as renewablse destroy the modeled returns on investment for legacy hydrocarbon industries and generate new rent-seeking opportunities for Russia’s tech-focused firms like Rosnano.

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