12 min read

OPEC on the cheek

The new output deal stabilizes the market. The next part's where the fun starts
OPEC on the cheek

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A reminder that this will be the last week on Substack for OGs and OFZs. My reasoning and what to expect for pricing and paywalling going forward are broken down here. I’ll begin the move to Ghost at week’s end and will aim to be up and running again around August 16 after a much needed honeymoon in Chicago. If you want to get your first 3 months’ subscription discounted at Ghost, subscribe sometime this week for the monthly plan or else the annual plan, which will rollover whenever it’s renewed — I’m still working out the logistics for how those rollovers work but will provide all of the relevant promo codes, probably via Substack or else personal email (reach me at nbtrickett@gmail.com) before launching on Ghost.

For those curious, I recommend watching or reading Alexei Kudrin’s interview with Kommersant for its series on the 30th anniversary of the collapse of the USSR. He flags his relationship with Anatoly Chubais and becoming a part of that social circle of reformer economists in 1988-89 with the expectation that they’d reform the Soviet economy and not that of an independent Russia. He again makes clear that the liberal bloc of advisers, financiers, and economists who managed to retain some form of orbit around Putin and his Petersburg connections as they came into positions of authority during and after the 1998 financial crisis fundamentally saw the collapse of the USSR as a political consequence of various forces and choices responding to the economic stagnation of society. He also makes clear that the creation of reserve funds were primarily intended to be a currency management system and only secondarily a rainy day fund — this makes a lot more sense when you consider the unnecessarily stringent limits placed on spending money from the National Welfare Fund and related sources of accumulated foreign currency earnings. There’s a constant fear of imports displacing domestic production, but that runs into some clear policy contradictions because the suppression of domestic demand, intended to encourage price stability, undermined the diversification of the economy. That dynamic is only more acute now. It’s rather laughable to tout post-Crimea successes at the macro level — there are plenty of sector-specific success stories, though often via subsidy and trade restriction. Rosstat data messes the story up. In 2017, oil & gas accounted for 16.9% of GDP. In 2018, it was 21.1%. In 2019, it was 19.2%. In 2020, it fell closer to 15% in absolute GDP generated terms but it’s clear that dependency is not best described merely by the sectoral share of produced output, particularly since it plays such an important role sustaining key imports elsewhere by providing foreign currency earnings and liquidity. The ruble floats now so why sit on those liquid reserves? There are plenty of reasons, but it’s useful to see that the contemporary political logic of accumulation for the regime’s purposes has deep ideological roots in the preferred methods liberal economists opted for to manage oil wealth, and ultimately failed as the economy’s. complexity steadily declined post-98’ through the 2008-2010 crisis period and has been stagnant since if not fallen slightly more.

What’s going on?

  1. Evidence is piling up that the positive spin on the economy from MinEkonomiki is mostly playing with data to hide the truth. A new NielsenIQ survey shows improving optimism — a rating of 90 vs. 89 last time, but still a net negative rating since it’s under 100 — but that 71% of Russians are still saving on where they can. 68% are spending less outside the house, 67% are cutting back on clothing purchases, 61% on eating out, 54% on annual vacation, 46% on takeout and prepared foods, and 41% on electronics. In June, banks only accepted 36.9% of applications for consumer autoloans to buy cars, the lowest figure seen since April and May 2020. Creditworthiness seems to be falling again. Debts for utilities have declined slightly thanks to write-offs, but households owe a combined 1.3 trillion rubles ($17.45 billion) for unpaid utility bills, a 5.9% increase year-on-year. Bakers are warning that state subsidies are inadequate to hold bread prices down and price increases in the range of 7-12% are likely for retailers in August. MinSel’khoz thinks flour and other inputs will get cheaper, so that fear is made up. What’s likely happening is that producers are now using the specter of further price increases as political leverage to try and offset past losses in case prices don’t rise, or else adapt as they do seem to keep heading upwards. If real incomes are increasing, most households aren’t getting the memo and business costs aren’t falling yet. My question is how does the 29% of Russians not saving breakdown? Does it include pensioners who literally can’t spend less because they already don’t really go out or buy prepared food? More likely that group is primarily government officials who’ve rewarded their excellent stewardship of the nation with wage hikes and, ironically, the core constituency of better off service workers based in large cities who the regime stopped courting politically after 2011. I’d need to look more at the data to be sure, but that’s my intuitive sense. Worse is probably coming, with inequality and averages hiding the damage, but there may be some turnaround after August depending on how long the current COVID wave peaks in place.

  2. This is from Friday, but worth contextualizing with other news from last week. Producer price inflation has reached record levels not seen since 2000 — they’re up 35% year-on-year as of May. It’s even worse for Kazakhstan, Turkey, and Brazil, but slightly better in Ukraine:

    That inevitably leads to higher consumer prices with a lag time as firms eat losses in hopes of retaining customers and riding out the surge of rising prices. These figures dropped just as S&P decided to rate Russia’s sovereign credit rating as a BBB-, the last level for investment grade borrowers before reaching junk status. Finance minister Anton Siluanov says it’s proof that macro policy has been good despite the 3rd week in a row in which there’s very little demand on the primary market for OFZ issuances because, spoiler alert, banks don’t want to hold sovereign debt as a safe asset to back other lending when the economy’s not in great shape despite some positive indicators for wages due to labor market tightness. Inflation’s going to keep rising per Central Bank assumptions, though the rate of increase should moderate. There’s no evidence anywhere that fiscal policy is to blame for these problems and it’s now nudging the ratings agencies to push Russia closer to junk territory. It’d be delicious, if tragic, irony to see Russia’s sovereign rating take that hit as a result of its failure to spend.

  3. MinEkonomiki is open to using the WTO’s dispute settlement mechanism and an arbitration panel to resolve its issues with the European Commission’s carbon border adjustment mechanism (CBAM) proposals. It’s to be expected given the complexity of the instrument and EU’s approach trying to coax and coerce trade partners into what it considers to be an adequate level of alignment (not necessarily harmonization or equivalence of carbon standards per my understanding, but I’d need to look more closely at the latest). Unfortunately, Moscow has an uphill fight ahead of it. The EU and Russia have repeatedly gone to WTO arbitration panels since Crimea as a result of Russia’s unilateral counter-sanctions on EU food imports. In several cases, Russia has lost its appeals to appellate bodies and then failed to implement measures in the timeline nominally agreed with the EU. Worse, the WTO took a big hit when the Trump administration quashed the appellate body on December 10, 2019 in a bid to free up the United States’ ability to add and retract tariffs as it pleases. Russia’s banking on the power of multilateral institutions it has little interest in maintaining and explicitly politicized as a result of its “sovereign” turn regarding trade and industrial policy since 2013. What’s more, the introduction of decarbonization into the agenda this year has upended key assumptions about the national projects that had otherwise been intended to drive Russian economic growth pre-COVID. We can’t yet see the full outline of the effects but it’s starting to look like the EU’s climate agenda is ironically what’s brought much more firmly into the American camp on Russia foreign policy. Since decarbonization quickly became a priority for European firms already facing stricter regulatory pressures and carbon prices, they started to change their attitudes on the foreign policy implications as have European governments, even with the current backlash against the reality that energy prices will rise and affect those who are poorest. The question is whether the impasse is resolved amicably with rising investment levels and action or through disorder that threatens to further weaken growth between both the Eurozone/EU importing economies and in Russia itself.

  4. The attempts to fix domestic fertilizer are now having a negative effect on harvest planning — growers are warning they might not be able to buy enough fertilizer at current price levels in August-September, which will then lower agricultural yields next year. Though it was agreed there’d be a price freeze after a meeting between the government and largest producers on July 16 and that small(er)holder farmers are to receive a 5% discount on fertilizer, the ministries in Moscow still have to work out the details. The trouble is that even with prices frozen, firms will have to cut back on purchases. That could lead to yield declines by as much as 20-30% by next summer. Whereas fertilizer accounted for about 15% of production costs coming into the COVID crisis, the cost of fertilizer has doubled since last July — prices are up 30-70% since the beginning of the year for different types on the St. Petersburg Exchange. The overall lesson is that inflation control measures taken today aren’t working, and can end up worsening future inflation since “inflation” writ large is distributed between different sectors and political groups. When commodity prices rise, extractive firms initially benefit before they feedback into finished products. When wages rise, labor benefits unless/until consumer inflation wipes out gains. These rates of increase are happening differentially depending on sector and even among fertilizers. The following are avg. domestic prices in rubles/ton over the last year:

    Red = nitrogen minerals/chems Black = Potassium minerals/chems Grey = ammophos Blue = anything containing nitrogen, ammophos, and potassium Orange = anything containing nitrogen and phosphorus Light Blue = nitrophoska

    Investment is the solution. Fertilizer manufacturer has received 1.3 trillion rubles in investment since 2013, and is hoping for another 2 trillion through 2028. Domestic production has continually risen, reducing currency risks and similar cost concerns, but it’s not enough to ward off global price increases creating sectoral cost mismatches.

COVID Status Report

24,633 new cases and 719 deaths were recorded in the last day. The regional case curve is flattening according to the official data so it looks like we’re close to peak figures or else have peaked, but I suspect a handy data intervention has taken place. Week-on-week case growth slumped to just 1.4% despite the absence of national lockdown measures and uneven regional policies — to be fair, there’s been considerable efforts taken to do things like prevent mass spreader events in general:

We’ll be uncovering the extent of the damage done by the pandemic for a long time because of the statistical chaos. Rosstat’s latest mortality release for 2020 shows that average lifespans in Chechnya, Lipetskaya oblast’ just north of Voronezh in the Black Earth region, and Dagestan fell 3.4-4% last year. In Chechnya, excess mortality hit 47% while people lived 3.77 years shorter on average. It’s difficult to believe that Russia has achieved an adequate 60% collective immunity through infections if only because we’ve seen that people infected with past variants who aren’t vaccinated are at significantly higher risk from new strains. That said, it is quite possible the caseload’s peaked in which case that’s the probably the best explanation.

Crisis Brides

OPEC+ appears to have sorted out a tentative agreement to resolve the impasse we’d seen the last few weeks. Starting in August, output will rise 400,000 barrels per day, the production baselines for the UAE, Saudi Arabia, Russia, Iraq, and Kuwait will be raised, and the original deal expiring in April 2022 will be extended to December 2022. Everyone saves face, the oil market kisses $100 a barrel goodbye, and US shale drillers can’t eat up some of the marginal gains later in the year thanks to excessive restraint. All told, the net adjustment upwards for baselines is worth 1.6 million barrels per day (LHS is mbpd):

The oil market has woken up to falling prices for Brent crude which are now hanging around $71 a barrel. Warnings about a rapidly tightening market are now probably going to give way to a more balanced perspective — since any shortfalls of supply can be readily met by OPEC+ for now, there’s no “real” supply squeeze. It’s a matter of maintaining a decent price band and avoiding another price collapse. OPEC’s July report flags the 800 pound gorilla in the room — China’s slowdown:

Russia’s current plan, per Aleksandr Novak, is to return to pre-COVID production levels by May 2022 by increasing production 100,000 barrels per day each month starting in August. That’s a net plus for Russian firms like Lukoil looking to sell down assets in Iraq and focus efforts closer to home as well as Rosneft, which always wants to push output as high as possible. Ironically, the positive push from a production rise for Rosneft’s Vostok Oil likely brings forward political conflict between firms. Transneft is expected to lose out on shipments of as much as 25 million tons of crude annually once Rosneft’s oil terminal supporting the project is completed. It’s expected to suck out 15-16 million tons of oil from the Vankor cluster and another 10 million from new output — Vankor volumes account for 3.4% of Transneft’s total crude shipments. Since tariff rates are tightly regulated and Transneft’s investment plans have historically been whittled down after grand announcements, marginal changes in earnings make a significant difference. What’s been a distributional fight between states over their share of the recovery pie will soon shift into domestic fights between firms trying to best position themselves for a market where output is more or less “normal.” The latest update from Minchenko Consulting for its “Politburo” reports on the regime’s insiders notes that Igor Sechin is the only figure from the inner circle with exclusive access to Putin. I’d hate to own anything he wants as production rises once more or else be pleading my case to save my own bottomline. Oil quality is also an issue. Tatneft and Lukoil were hit hardest by the removal of tax breaks for the extraction of high-viscosity oil to top up the budget. Vagit Alekperov has made clear he won’t invest into new production of that type unless they reinstate the tax breaks, which also probably explains why Lukoil has pivoted to focus on offshore developments in the Caspian and Gulf of Mexico — in Russia, offshore tax schema are more forgiving than onshore and Lukoil’s always focused on minimizing its tax burden unlike Rosneft and other SOEs in terms of its investment strategy.

We can also see from the latest OPEC report how the organizations view on the distribution of demand recovery is evolving and why that spells trouble for Russia:

In % terms, the US+Europe share of demand and China+Asia-Pacific share of demand are basically flat through 2021-2022 while it’s the “rest” led by India, the Middle East, Latin America, and smaller consumers in Africa and elsewhere not gaining yet either. Note that OPEC doesn’t use the same categories as BP so Asia-Pacific is really Japan-South Korea primarily. The point is that developed market recoveries are still pacing global growth and the net gains to demand it seems, which means that marginal shifts in road fuel use, public transit, and similar demand destroying activities and investments can begin to have a negative effect on cumulative demand within about 2-3 years’ time.  There’s little reason to believe developing markets are headed for a new wave of strengthening, oil-intensive growth even with the pathway dependencies on coal still in place. Vaccine nationalism and the numerous logistical hurdles facing mass vaccine production ramp ups will create a longer “trough” for recessionary effects from COVID due to higher mortality rates, higher infection rates, and the limited state capacity in many countries to address those shortfalls:

OPEC+ has decided on the best worst course of action available to it. Now the distributional fights will shift to the domestic side, where companies and individuals want more in a world stumbling into structural demand decline. The Ministry of Finance awaits at the ready to tell elites the state can only do so much to help. We’ll soon find out just how much value can be extracted in these conditions.

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