9 min read

Oh Gee Unit

Oh Gee Unit

Top of the Pops

As I'm in the teeth of one project and have to start doing some of the leg work for another later this week, I've decided to make all of this week's newsletters free/public and will be doing a slightly different version each day i.e. less analytic writing and more rundowns of top headlines and 'hot take' writing. As a result, they'll be a little different in structure than usual and quicker to write.

First things first – US president Joe Biden is miffed that Russia and Saudi Arabia aren't ramping up output to stabilize oil prices and it looks like the administration has reached out to counterparts in China, Japan, India, and in other importers to form a united front demanding OPEC+ take action. When pressed on why he was appealing to raise output, NPR caught the two quotes I think are most relevant: ""On the surface it seems like an irony, but the truth of the matter is ... everyone knows that idea that we're going to be able to move to renewable energy overnight ... it's just not rational" and "It has profound impact on working class families just to get back and forth to work." The issue at the moment is the scale of inventory draws – crude oil being taken out of storage to be refined for consumption – relative to the available supply coming onto the market each day via spot trades and longer-term supply contracts:

Russian output was up 7.5% from September 2020 to a little over 10.7 million barrels a day in September, which leaves a bit of room for output gains back towards 2019 levels. However, based on MinEnergo's past forecasts, the state of capex in the sector, and the lack of large new greenfield projects, I don't think they'll quite hit the 11.25 million barrel a day mark from 2019. The oil industry globally is sitting on a huge influx of cash because of its successes reducing costs after 2014 and the much lower spend currently on exploration and new projects:

These companies can't convert that cash flow into production rapidly unless it's using shale drilling or else massively ramping up production from oil fields that have been intentionally under-tapped i.e. lots of capped wells that aren't a geological risk that be 'turned on' again. Biden's direct attacks on OPEC+ p0licy at the G-20 summit are a big deal because they highlight the need for state intervention onto markets in order to manage price and output levels during the energy transition. Intervention need not mean nationalization, though I count myself among those who think in the American case it's politically unfeasible but likelier to enter the conversation when demand actually declines. Negotiating price and output levels in a coordinated fashion can be enough. OPEC+ draws its power from controlling such a large share of output and it's only Saudi Arabia within OPEC+ that has globally significant capacity to vary production levels and plans to increase its potential spare capacity to 3+ million barrels a day in the next 6 years. Buyers have more long-term power on the oil market because they can make choices about what fuels they consume, how they structure domestic consumption, negotiate agreements amongst each other, tax consumption to discourage it, and so on. Even if the G-20 push comes up short, the lesson here is that when it comes down to high prices and energy crises, the US and China today share far more in common than the US and Soviet Union ever did. This is also why I get quite frustrated by the climate alarmism you often see on lefty, more academic Twitter about the push to increase OPEC+ output:

The premise is that increasing oil output today undermines the energy transition and achieving net zero since we ought to be levying carbon taxes and making oil consumption more expensive. Take the example of the United States, the biggest oil consumer on the planet and also an outlier when it comes to oil's share of transport energy needs relative to Europe in particular and also unrepresentative of oil's share of power and heating generation relative to emerging/transitioning market contexts:

About 34% of oil consumption last year in the US was industrial and/or residential, commercial, and electric power. Making oil more expensive by restraining supply now when you've ostensibly won the hard fought battle to stimulate the US economy enough to boost it above pre-COVID growth trends is self-defeating because it'll feedback into industrial costs for a wide variety of products quickly, worsen inflationary panics even if they are more often than not political moral panics, and make it more expensive to make things that are green and can be deployed. Supply-side controls are likelier to create shortages and hinder growth and tech adoption/investment until enough of the new infrastructure, rail investments, electric vehicles, and other aspects of cutting transport demand have been rolled out in the US. Europe faces a different path, but has lost time because of the obstinant refusal to commit to nuclear in Germany as a foundation upon which to manage declining natural gas demand in a more intelligent fashion. If you want the energy transition to happen as quickly as possible, you want energy to be as cheap as possible so that once states have sunk the money into emissions reduction, greening and reshoring supply chains, etc., the political costs of curtailing supply or investment shortfalls are much lower. Focus instead on minimization of methane emissions, congestion pricing, and other more locally rooted policy measures at municipal, state, and regional levels to find ways to reduce ICE car dependence and improve public transit first and foremost.

Hot Takes

I caught word on Twitter that the Polish government had announced plans to double the size of the military from 150,000 to 300,000, making it the largest force in NATO once that's realized on top of existing modernization efforts. The SU Congress is also looking at funding a command & control headquarters in Poland building on last year's enhanced defense agreement. Those convinced that Russia was entirely in the right in Ukraine or else that a nationalist Polish government will risk escalation will undoubtedly scream, but aside from helping the US adjust its force posture and reminding Paris that NATO may go on without it if it really wants to play that game, the surprise should be that it took 7 years after Russia's annexation of Crimea and de facto invasion of Donbas to trigger this response.

The industrial PMIs put out by IHS Markit show that manufacturing activity rose above 50 showing growth for the first time in 5 months:

It's a lot easier to expand activity when input prices are now falling as a result of energy shortages you aren't experiencing, in part because your price levels are more controlled and implicitly subsidized, and you're headed into the government procurement season. Good to see it rising since that lifts some household incomes too. Don't buy that it's a growth tailwind.

Quick Hits

Highly suggest you read this quick Moscow Times piece from Nikita Ponomarenko on the foundations of growth for solar in Russia. My only addendum is that it's all about rents. The state will find ways to make sure that rent distribution is prioritized over the speed of adoption, and they want that sweet hydrocarbon-based trade surplus providing transfers to other industrial investments that can be exported.

The oil revenue windfall has opened up space to tweak the tax code to help the oil sector. Deputies from the Ministry of Finance are in their own working groups and communicating with the Duma over the inclusion of West Siberian oil fields in an adjustment for the additional income tax levied on firms above severance and export duties on crude. The idea is to transition to an income-based taxation system eventually (likely after 2024) to replace the current tax regime, probably reducing oil's share of tax revenues but freeing up the sector to invest more. If they can't find new fields to exploit at the right price level, it's the only realistic option to maintain output.

Net debts owed to banks by construction firms for projects in motion are expected to double in 2022 to a whopping 4 trillion rubles ($56.4 billion). Worth following the borrowing trends as construction firms raid each other for labor due to shortages and the property market is going through a speculative bubble whereby apartments that don't exist yet are being sold and resold for profit.

Russian wheat prices have shot up to post-2012 record highs trading at $325 a ton for export. The regionalized nature of Russian wheat production means it'll take a little time for the export price realized in southern European regions to spread elsewhere, but that suggests another round of food price inflation incoming. The pricing pressure isn't just about shortfalls for harvests including in Russia, but demand pressure: Egypt – a world-leading importer – had state-firm GASC buy 180,000 tons of wheat at $327-329 a ton. $350 a ton is in sight now.

Consumption has passed pre-COVID levels, but real wages are stuck at levels seen in February and pensions have decreased in real value thanks to inflation. Not only did consumption start seeing a downtick in September as Russians moved into savings mode, but it turns out that transfers from the state helped some replenish their bank deposits. In turn, those deposits fueled a run on real estate as a preferred repository for savings. The better off got better off and the rest are frozen in place. Still good to see that stronger consumption explains the sustained growth boost through August.

Exports of Russian agricultural equipment set a record for Jan.-Sept. hitting 16.3 billion rubles. That beats last year's total. But let's not kid ourselves. High prices for agriculture did a lot of the lifting, as have supply chain interruptions such that western competitors who would be plan A couldn't meet demand. Not a bad way to get a foot in the door for Russian manufacturers abroad, but as long as it's mostly CIS countries buying these imports, there's a relatively low ceiling on how large that market becomes.

Rostelekom is lobbying MinTsifry to raise consumer costs for access to and services on cell networks as a result of cost inflation. Prices haven't been adjusted in over 2 years and providing cell service is becoming a loss-making venture with higher material and labor costs at fixed rates. Rostelekom wants a 6.5% tariff adjustment.

COVID Status Report

40,402 new cases and 1,155 deaths were reported today. A snapshot of the top 10 regions by infection rate show a decent spread with St. Petersburg and Moscow at the 2 and 3 spots respectively:

Descending: Sevastopol', St. Petersburg, Moscow, Karelia, Smolenskaya Oblast', Pskovskaya Oblast', Komi, Nenetskiy Autonomous Okrug, Ulyanovskaya Oblast', Chukotskiy Autonomous Okrug

All a fair bit higher than figures seen during the last wave. As reported by Jake Cordell today, the September mortality data release shows that excess mortality figures had reached 723,000 people in total before the 4th wave hit in full:

We should expect to see excess mortality in October jump again, though probably not quite as high as Nov.-Dec. last year since testing coverage and QR code-type measures have likely made the official data a little bit more accurate for the caseload. The US has officially lost over 746,000 to COVID alone, and excess mortality obvious drives that figure higher. We're now at the point that over 0.5% of Russia's population has died during the pandemic that otherwise might not have, and that figure is going to keep climbing until vaccine takeup is mandated on a wider scale.

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