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MinFin de siècle

Cheap oil and budget needs are expanding MinFin's reach into oil politics
MinFin de siècle

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Foreign Minister Sergei Lavrov set off some diplomatic fireworks when he noted in an interview with Vladimir Solovyov that Moscow saw that “in certain areas, sanctions are being imposed, creating risks for our economy in the most sensitive spheres . . . we don’t want to isolate ourselves from life in the world, but we have to be prepared for it. If you want peace, prepare for war.” He added, “the idea’s always been that we don’t want this, we want to develop relations with the EU, but if the EU goes down this path, then yes, we’ll be ready.” Them’s fightin’ words, Seryozha.

The Kremlin’s insisting that his words were twisted by Western commentators, but the bigger point raised by Lavrov and the team at the generally defanged Ministry of Foreign Affairs remains that they now view the EU as an unreliable partner, the line taken since Borrell’s PR disaster of a visit to Moscow:

Some have taken this as proof that sanctions do actually work. At imposing some economic and political pain? Sure. At changing Russia’s behavior? Clearly not. What’s more interesting to me about Lavrov’s statement is the context of how Borrelll’s visit ended. From what I can tell, there’s little reason to believe that Nord Stream 2 is at serious risk, despite the exuberance of many, myself included, who just want a little more excitement when actually talking about otherwise boring and misrepresented pipeline politics. Steinmeier’s comments, though distasteful, don’t really matter much.

I don’t think Lavrov’s comments suggest that the Kremlin is that bothered about additional sanctions, though obviously there’s a huge amount of consternation if the EU goes after personal wealth and denies travel access and so on. I think the real story is that aside from getting Nord Stream 2 built, Moscow’s gamble on Trump’s presidency and its ability to cripple US policymaking and its ability to leverage its alliances and institutional heft geopolitically has been a spectacular, short-sighted, and self-defeating failure. Brussels and Washington are much further apart on China than they are on Russia, and the UK is clearly making a play to drag the rest of Europe along with it on that front. US NATO commitments to Europe under Trump actually increased on the whole, setting aside the episode over deployments in Germany that, frankly, had very little impact on European security but reminded the fiscally austere across the continent that in the false guns or butter dichotomy that has governed much of the political economy of the Eurozone and EU, the preference has long been to let someone else worry about the guns. Angela Merkel’s successor-in-waiting with the CDU Armin Laschet doesn’t believe Navalny has any bearing on Nord Stream 2 and hews closely to the long-running geoeconomic view in Berlin about Russia, but he’s not foolish enough to risk facing the music over US spending and defense commitments. Biden is far more able a diplomat than Trump, and support in the rest of Europe, particularly Eastern Europe, for US positions on many matters may not stop Germany from getting the energy deals it wants, but it does mean that there’s no real room for maneuver to change the arc of EU-Russia relations.

If we take for granted the thesis that Russian elites largely see the EU as a sideshow compared to NATO, then Moscow also fundamentally misjudged the moment with Trump. The biggest shocks to the system came from a shattered consensus on trade and the social contracts found in developed economies content to make use of globalized supply chains increasingly exposed to China, the United States’ premier geopolitical rival. NATO, as yet, has little bearing on China in security terms. But in an era where supply chains, R&D, technological adoption, and the next great industrial-green revolution are all front and center or taking shape, the EU does. And worst of all, Trump’s inchoate nationalism and unilateralism actually cemented the political space needed for Democrats in the US to actually take a harder line on re-shoring manufacturing and attempting to get security partners to align on trade (setting aside the role that the Left and the Right played in killing TPP and its EU cousin TTIP).

In this light, Lavrov’s comments reflect the grim reality that Moscow lacks the tools to force Europe apart from Washington or to meaningfully take part in the emergent economic Great Game between the leading powers and blocs. Once carbon emissions are on the table, imagine the faux outrage to come. Russia’s now facing the music. Autarky only works when you have strong partners to finance your autarky and advance your goals abroad.

What’s going on?

  1. According to six analysts interviewed by VTimes for an exclusive, Russia may face sugar shortages as soon as July-August because of its price control policy — prices are likely the lowest in the world at the same time that domestic sugar production (from beets mostly) is the lowest its been in 5 years and some output is exported within the EAEU to Kazakhstan. The underlying issue is that the price control agreement allows wholesalers and industrial consumers (think large bakers, for instance) to buy sugar at the low fixed prices, but sugar producers (all of whom signed onto the agreement) still had long-term priority contracts for end users. The price purchasing agreement for the wholesalers and industrials had no means of assuring said sugar used in production would end up reaching end users folded into those contracts. Kazakh importers with wholesale branches in Russia then realized they could buy sugar more cheaply there, then ship it back, further adding pressure as market participants quickly adjusted by refusing to buy sugar above a certain price (usually no more than 40 rubles/kilo) which is actually below the sum production cost. Apparently no one actually knows how much sugar is left in the country. The gamble now is that beet production will recover enough to cover any emergent deficit. VTimes calls the price control the “Venezuelization” of the economy, and based on this story, that’s not far off the mark.

  2. As I’ve argued here, it looks like forecasts from the National Ratings Agency (NRA) are calling for months of inflationary pressure ahead, but on macroeconomic grounds rather than real economy woes. The Central Bank and others are basically set on the thesis that inflationary pressures happening now are mostly temporary or one-offs, while the NRA posits that the recovery in oil prices is a pro-inflationary pressure for 2021:

    Green/Lhs = average monthly ruble exchange vs. US$ Navy(ish)/Rhs = Brent crude (US$/bbl)

    January’s annualized inflation figures came in around 5.2%, a nudge higher than the end of the year data in 2020 which saw that figure nearer to 4.9%. Turns out higher oil prices might buoy the current inflationary pulse through the end of 2Q per these forecasts. I’m personally a little skeptical about the end of 2Q timeline for the simple reason that oil price recovery without too significant strengthening of the ruble by policy design and political risk premium on top of the lack of income support means there’s little chance consumers import more goods, but firms could buy more. Yet firm investment levels are relatively unresponsive to ruble fluctuations if their sector’s business cycle is heavily led by federal spending that isn’t rising yet. So if you do take the monetarist view, the CBR has to hike the rate to kill inflation, but doing so amid real CPI inflation due to structural factors would basically worsen the real inflation experienced i.e. wage deflation would most likely outpace falls in cost. The surge in private farming production at dachas last year shouldn’t be taken just as evidence of lockdowns — this is slightly limited given that a smaller share of the population could actually work from home since fewer work in services — but also a reflection of inflation on store-bought goods that picked up as the pandemic went on. But unless they go to market in large volumes, they won’t influence pricing as much. As expected, the CBR has held the key rate at 4.25%, higher inflation be damned.

  3. A floating proposal from MinPromTorg not yet acknowledged by the government to raise utilization fees by 25% for cars and 200-400% for special equipment (think graders, bulldozers, and the like) is bound to significantly raise costs for anyone buying. The increased fee — effectively a straight tax on imported equipment — is intended to try and recoup part of the cost of industrial subsidies to domestic manufacturers trying to replace imported equipment. But domestic manufacturers only account for 15-25% of the market as is and the proposal risks a massive price inflation spike. As many as 80% of consumers would see price increases. There’s no logic to the policy proposal identified by Vedomosti. The policy would further increase the price of production for consumer staples, including sugar, and be most noticeable for energy-intensive economic activity using these machines. MinPromTorg is adamant that for the key strategic sectors, Russian production already accounts for 50% of all output and these recycling fees wouldn’t affect the costs for Russian producers — one wonders how exactly since a shortage of domestic production would end up bidding up costs as well. The knock-on effects are considerable. This is not a great sign for the fall. No one’s actually guiding economic policy.

  4. MinTrans is now working through the logistics of rolling out full biometric border control systems at Domodedovo and Sheremetyevo airports, thus updating them in a manner closer to what you see at Heathrow and similar hubs elsewhere. Domodedovo already has e-gates in place and the tech’s there for passengers registering their luggage. Sheremetyevo has to do most of the catching up. What’s more interesting is that MinTrans has to create a new legal basis to allow technology to be implemented that would reject passengers from flights or entry into the country if their passports or tickets are flagged when they go through the new system. The public worry is about the security of biometric data and compliance with RosTelekom regulations. 75% of international airports are investing in this tech, and regulations have to keep pace. It’s hard to imagine, though, that there won’t be an attempt to align data collection capabilities at key international hubs in Russia — namely Moscow — with the extensive capabilities already in place on the Moscow metro to track individuals using facial recognition. The story is outwardly innocent and too much is often made of security efforts in Russia. But with the clear siege mentality now gripping the presidential administration and much of the government ahead of the September elections, I would assume that’s the topic getting kicked around without any public mention.

COVID Status Report

There were 15,089 new cases in the last 24 hours and a reported 507 deaths. Moscow appears to have leveled off some in terms of its decline, whereas its the regions where the improvement in the official data is seen:

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

Doctors are urging people to maintain their mask-wearing for at least a few days after getting vaccinated, which leads one to wonder what the actual medical guidance around the vaccine is since western equivalents typically see 1-2 weeks in which you aren’t yet immune. Evgeniy Timakov, an infectious disease specialist, is warning that there may well be another wave in April based on changes in behavior, shifts in underlying immunity to the strains that are circulating, and good, old-fashioned pessimism. The sense I get is that the limited reach of the vaccination program works in winter time when people are taking precautions and playing it safe, but that once it warms up, if there aren’t enough people vaccinated, the rush to ease measures clearly affecting regional and local decision-making will prolong the process of getting the virus under control. Regional hospitals are starting to close more of their COVID-specific capacity as caseloads fall. Another surge in cases would not only be a public health disaster, but politically fraught. The more Russians are infected, the more they take COVID seriously, the greater the possibility they decide to blame the powers that be for getting it wrong.

Sechin says relax

Rosneft’s 4Q financials are in and lo and behold, Sechin can claim record profit figures for 4Q 2020 and the company apparently lowered its production costs down to an average of $2.60/bbl. If we take that as given, the company’s got nothing to worry about. Then again, selling off shares of low-hanging fruit and considering further sales of brownfield assets while shifting your production base to Vostok Oil doesn’t suggest this makes any sense as a long-term assumption. The bigger story, though, is that Rosneft has reduced its net financial debt to $9.9 billion. That’s nothing compared to historic highs for the company — Sechin loaded up on $60+ billion in debt to acquire TNK-BP back when the company closed its 2013 mega-deal with CNPC and the Chinese government. Dividends are looking better for this year as a result of all this, and BP might also be sighing in relief that they still have their stake.

Vostok Oil has apparently cost Rosneft $9.6 billion thus far for the acquisition of Taimyrneftegaz and the related blocs. What caught my eye from the Interfax release, however, is the price basis for revenues and cash flow generated by the project when it starts production in 2024-2025: internally the company apparently assumes prices will be around $51 a barrel from 2024 onward for its Vostok models. That does not suggest that they believed demand was coming back strong last year, or else that US shale drillers have been tamed by this latest crash in their operating assumptions going forward. There is no way Sechin expects to maintain profit margins without supreme confidence that he can maintain the numerous deals he’s cut with MinFin for tax exemptions and support. But it’s not quite the smooth sailing one might assume given the scalps he just rode into town with thanks to those financials.

Quietly last week, MinFin and Rosneft reached an agreement regarding the Priobsky cluster — an aging stalwart for Rosneft’s resource base — whereby the state offered up 460 billion rubles ($6.2 billion) for investment into production via exemptions and breaks while MinFin now has a legal mechanism to extract payment and manage the oilfield if Rosneft fails to meet its terms. The latter point is a massively underreported story from what I can glean as it’s gotten relatively little notice outside of trade-oriented publications. In effect, MinFin is expanding its reach into the economy by using its influence as the ministry responsible for maintaining the Kremlin’s fiscal fortress such that if Rosneft fails to maintain output and performance requirements after receiving billions in state support, it effectively can be forced to make business decisions per MinFin’s oversight on a periodic review basis. If Rosneft can be pushed to agree to these terms, the extractive sector is quite clearly going to have to cough up yet more for the budget. Rosneft has sold Priobsky as an economic engine that will generate 9.3 trillion rubles ($125.2 billion) over the next decade. If oil prices average closer to $51 a barrel over that time based on Rosneft’s Vostok financial models, this figure seems ridiculous. $51 a barrel was inadequate to significantly stimulate economic activity across the economy since the OPEC+ agreement first took effect in December 2016, and that’s before factoring in US$ inflation since foreword looking models have to make assumptions about $51 a barrel in real terms vs. nominal terms and the changing inflation regime in the United States makes it a more significant ‘discount’ on future earnings if $51 a barrel is nominally calculated.

MinFin’s agreement matches with the next stage of fiscal politics. VTimes has a great piece out today on how the population’s share of income dependent on social transfers has risen significantly since the Soviet period. The following is in % terms and, left to right, incomes from entrepreneurial activity, social transfers, and income from property:

MinFin needs to exercise more direct legal control over economic activity controlled by the state that is extractive, not in a physical sense, but rather in terms of generating tax receipts and foreign currency earnings for the regime. The effect of the increasing role of social transfers for the population’s income is itself a reflection of the effect of the exhaustion of the resource-led growth model, austerity, and expanded power of siloviki and large firms/rich businessmen to raid competitors on incomes. Rosneft has to whistle a happy tune about its production costs and investment plans to appease investors and play to its strengths, namely its political support. But its financial results are embedded into the political contract MinFin is increasingly responsible for maintaining.

The Ministry isn’t considering expanding profit taxes on the sector until 2024 at the earliest, per Kommersant. What that really means is that the extraction tax system in place that disincentivizes investment — and therefore the creation of the additional economic activity Rosneft is promising will come about at Priobsky — will remain in place and the switch to a system that more sustainably supports investment will likelier come about only when global demand is already entering permanent decline. There are no plans to further raise taxes on the oil sector for now, but that’s also partially contingent on the oil price and fiscal needs that might come about in order to guarantee electoral success in September this year since, so long as deficit fears remain, the Kremlin can’t afford to tax the population at a higher rate (or raise enough revenues) to finance spending meant to buy votes. The $51 a barrel forecast Rosneft used for Vostok is almost certainly an attempt to sell the project as viable even with a lower oil price environment, but it’s telling that they think it’s realistic for where prices will be in 2024-2025 given Sechin’s past comments about a lack of investment into production. Behind the bluster and MinFin’s assurances that the budget is now safe with lower oil prices, Russia Inc. is preparing for cheap oil for years to come, most likely to MinFin’s benefit when it comes time for the oilmen to negotiate for help.

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