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The New Super Sigh-cle

Commodity supercycles cost oil exporters, and Russia's no exception
The New Super Sigh-cle

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Navalny received 2 years and 8 months for what will effectively be hard labor in a penal colony. A reported 1,377 people were arrested at protests and events in the wake of the decision. It’s a dark day for Russia and the future of its politics, already playing out with the trial of Meduza editor Sergei Smirnov. Tatiana Stanovaya’s thread on the significance of the day is a good snapshot of where things stand, but this claim in particular still irks me:

This misses the underlying challenge that Navalny has posed, I think. The FSB cannot take problems like worsening standards of living, falling real incomes, and a lack of good jobs in stride because it can’t resolve them or make them go away. There is no doubt that this will inaugurate a new wave of repression that has no direct precedent since Putin first came to power. We’re in new territory. But to analyze the moment through the lens of prior eruptions of discontent and protests that were readily handled by the FSB and the state’s security apparatus seems illogical. It’s been 7 straight years of falling real incomes since the 2011-2012 cycle threatened the Kremlin’s political balance. As Alex Nice notes, the regime’s stable of ‘political technologies’ is exhausted. The simplest one is giving people a decent life with the hope of doing better. That’s vanished or else still vanishing. The divide now is not between ‘spin doctors’ and the security bloc. It’s between those who recognize that the underlying socioeconomic structure of the country that generates political relationships is no longer adequate and those who clearly are deciding policy now who see the tightening of repression at the expense of people’s livelihoods and wellbeing as the necessary response. Spin still matters, but matters less and less the longer the country’s stagnation drags on. Navalny’s gamble that they can’t arrest hundreds of thousands or millions of people is the real threat to the Kremlin. It doesn’t take a mass organized opposition movement so much as collective exhaustion and the rejection of the social contract that now governs Russian politics. That’s clearly happening, if in fits and starts.

Putin’s not going anywhere, at least for the foreseeable future. Nor is what is ultimately a repressive political system. But it has ceased to deliver enough benefit to enough people to sustain its legitimacy, and thus it’s the economy that’s the time bomb Navalny and his protest movement are counting on to make corruption, abuse, and mistreatment all the more salient. As Mark Galeotti notes, it’s convincing self-interested elites to join forces that will most likely bring about change. It’s hard to see who those elites actually are, but the pile of rents available to be distributed is shrinking over time as more and more industries, groups, and interests claim a piece of it thanks to the FSB et al’s obsession with securitizing every part of the economy. That’s a recipe for big fights ahead as profits decline and the relative value of control over different political and economic institutions changes in response to global trends.  Most worryingly, the system will collapse without Putin to manage it. Even security elites understand this. The question is when the threat of a chaotic vacuum and economic crisis become a big enough fear to create that class of ‘self-interested elites’ to take action. Leonid Volkov’s Facebook post has set the tone of what Navalny’s team hopes to foster next.

What’s going on?

  1. The agricultural sector’s facing declining profits thanks to the forces of nature and markets — a weaker incoming harvest, a 10-15% increase in input costs for production, and the export controls designed to keep domestic prices low are going to eat into earnings. The National Credit Ratings (NKR) finds that profits could fall as much as 30-50% year-on-year in the upcoming season. Higher fuel costs are another floating concern based on the flagging price control response out of Moscow. Much of this decline reflects the fact that 2020 was anomalous. Food prices kept rising during lockdowns and demand didn’t stop. Export prices per ton were up 33% year-on-year by December. Still, the agriculture sector is giving us a glimpse of how systemically inefficient the Kremlin’s current phase of economic policy has become and where it’s headed. Price interventions are going to hurt capital investments, and without those investments, the state is going to have to rely more on repressive means to fight off discontent. Russia’s competitive advantages on international markets are its natural resource (and agricultural) export capacities. They can’t be insulated from world markets if Moscow wants to reap the benefits.

  2. The latest economic releases offering estimates that Russian GDP only contracted by 3.1% help tell the story I think explains the depth of the stagnation brought on by Russian policy. Kommersant stacked capital investments — any spending by businesses in pursuit of business goals/objectives — against real incomes:

    Title: Dynamics of capital investments vs. disposable incomes in Russia

    Blue = capital investments (% of GDP) Red = disposable incomes (2010 = 100)

    On an annual basis, businesses have been spending 2-2.5% of GDP less on business plans since 2014-2015 vs. 2012-2013. Investment levels for 2020 matched the lowest levels seen since 2007, when skyrocketing oil prices sustained real income growth without an investment expansion driven by diversification, but rather into extractive industries and importing sectors. The net decline in capital investment then corresponds to declining disposable incomes precisely because this last commodity cycle, and now looming commodity super-cycle, are different than 1999-2008 and the ability of externally generated oil rents to cover up structural deficiencies domestically evaporates in 2013. At the moment, state expenditure is equivalent to 40% of GDP. Unless they generate demand to support higher levels of capital investment, this year’s “recovery” won’t entail much recovering.

  3. The government has confirmed just over 214 billion rubles ($2.8 billion) of subsidies for Arctic projects. As usual, the conditionality of those subsidies is a game of Twister. For instance, up to 20% of the subsidies are provided without any expectation of repayment for investments into the “organization of new production” worth at least 300 million rubles ($3.94 million) that create new jobs and are covered by tax write-offs in the budget for up to 10 years. MinVostokRazvitiya gets first pass, and then the government commission on questions of Arctic Development make the final call on any project receiving support. Everyone’s swearing off money from the National Welfare Fund, instead promising that for every ruble of state support spent, 10 rubles of private investment will be ‘crowded in.’ The sum for support is insubstantial when you consider the elevated costs of operating in the Arctic and limited local labor force and infrastructure. On the whole, this doesn’t suggest the Arctic is a high priority, at least for 2021.

  4. A new natural gas bloc on the Gydan peninsula in the Yamal-Nenets autonomous oblast’ has been put up for auction on March 24. It’s expected to hold reserves estimated at 1.24 trillion cubic meters. What’s more interesting is that the auction terms state only companies that already have licensing rights on the Yamal and Gydan peninsulas can take part. That only leaves Novatek subsidiaries. This is unsurprising, but in recent years, Gazprom has tangled with Novatek by fighting for licenses and ownership of fields that could supply future LNG projects to make up for its own spectacular failures building out its own LNG portfolio beyond the Sakhalin plants it seized from Shell and Japanese partners. Novatek is locking in its supply for Arctic-2 and Arctic-3 expansions while it sorts out how much COVID will affect the demand outlook for LNG.

COVID Status Report

New cases came in at 16,474 with reported deaths at 526. Yesterday’s decline was notably steeper outside of Moscow than in it:

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

About a third of the nation’s cots are currently assigned for COVID patients and health minister Mikhail Murashko is arguing publicly that hospitals have to begin to shift more resources back to treating other conditions and for other needs rather than keeping too many cots “in expectation” of future COVID cases. It’s the clearest sign that Moscow is content to rely completely on the vaccine rollout to ensure public health while trying to improve mortality statistics for non-COVID conditions that have obviously taken a huge hit over the last year, boosted of course by the Lancet’s peer review of the efficacy of the Sputnik-V vaccine (91+%!). There’s also been a reported increase in fishing attempts on people since the vaccination campaign started, so we should expect more occasional nonsense as scam artists and corruption try to exploit the rollout by urging people to fork over money for foreign vaccines in exchange for state compensation that will never materialize.

Commodity Super Re-cycles

Countries heavily dependent on commodity exports face a bit of dilemma during boom times if large increase in prices for its main earnings generator — especially oil — feed into cost inflation across the broader economy. Take the Middle East for our most famous historical example. The years preceding the oil shock of 73’ had already seen prices rising, and the shock accelerated massive escalation of the salience of the region to the United States and Soviet Union’s respective foreign policies and security concerns. As oil prices rose, the Shah of Iran and the Saudi royal family jockeyed for ever more weapons systems that the US was happy to sell in hopes of maintaining market stability while it figured out what it could do to curb inflation amidst weakening output growth. The rise in oil prices allowed these states to buy more weapons, yes, but also US Treasuries, invest more into foreign banks, and to spend more profligately on domestic political initiatives. There was just one problem: rising oil prices generated rising cost inflation for construction materials and food imports. Iran in particular began to run insane deficits financing spending plans that made little to no economic sense and could only be sustained with continual price increases that reinforced this problem. Commodity super cycles do generate massive increases in revenues and export earnings. Russia benefited handsomely on that front from 1999 to 2008. Yet they also end up being ‘re-cycled’ into commodity exporters’ economies with often negative consequences.

Take food from the 2000s super-cycle:

Prices began to rise for most foodstuffs measured here by 2006 when oil prices really took off. The story’s worse for steel from that time period because of just how massive the industrial boom driven by China and a few other BRICS/developing economies was:

Unless you’re a market nut, you probably don’t recall that steel prices effectively doubled between early 2007 and early 2008 just before the Global Financial Crisis hit. These price increases were feeding into the Russian economy during the 2000s boom:

As we can see here, there’s a 5% spike in CPI between 2007 and 2008 and since the exchange rate was managed, if not fixed, to maintain ruble stability, the relative price level for consumers domestically kept rising as dollar earnings soared from higher oil prices. This dynamic ironically laid the groundwork for Russia’s post-crisis shift towards the securitization of the economy and attempt to insulate it from external shocks like global price inflation for basic foodstuffs because of Russia’s then considerable food import dependence or else the cost effects of rising construction input prices, higher steel prices, and more.

I spotted a story today on finanz.ru that mentions construction companies locking in rates for metal materials that are 10% lower than market prices by signing direct contracts between producers and consumers in place of clearing volumes through wholesaling middle-men. Apparently input prices for construction metals shot up as much as 50% between November and December depending on the region in Russia. No wonder Putin scrambled to order the government figure out a price control schema or approach for housing while the Central Bank lobbies to end mortgage subsidies and head off a financial bubble. As the global economy now shifts into a new commodity super-cycle, Russia’s going to have a much harder time managing input price inflation for the emerging input uses — EV supply chains, renewable energy, and so on — and where it doesn’t have to worry about price inflation — future steel demand should keep rising, but it’s conceivable that the demand profile changes — then it’ll have to worry about falling profit margins (obviously an issue for oil).

The larger point here is that this effect of ‘recycling’ in commodity exporters underpins the economic experiences that led Russia to shift tack post-2008 and now see it continually trying to erect a barrier between itself and the global economy in terms of pricing risks and growth. But whereas most developed economies would absorb price inflation for newer materials, ideally, by firms investing in cost-cutting via productivity gains, new managerial techniques, and new technologies, those options are severely hindered by Russian policymakers’ need to maintain employment levels and direct activity using the state budget. Basically, inflation is only the enemy when it runs out of control. Its negative effects on the poorest can be ameliorated with social policy and it should, in theory, help spur productivity gains and growth in a normal economy. That the Federal Reserve is now happy to accept higher inflation levels in relative terms than Russia’s Central Bank and that price controls became such a political hot potato last year suggest that in the rush to kill the inflationary pressures often linked to the structure of the Russian economy, policy is actually hindering productivity and the chance to move more of the labor force into SMEs where innovation, particularly for services, take place. 2020 proved a turning point for the new cycle because of underlying imbalances of supply for demand on metals and minerals and COVID’s impact on the energy transition and macro policy and a colder winter (JKM is LNG):

Oil lags behind the rest as they rally up with a weaker dollar and an incoming US stimulus bill to boost demand further. The problem this time is that past super cycles offered oil export-dependent economies enough space with the revenues raised to redistribute oil rents and absorb at least some of the impact. But now that Russia lacks the same sunny future for oil earnings and has shifted into an increasingly brittle posture concerning price variance and inflation for consumer, industrial, and construction inputs, it can’t as effectively recycle its way through this next boom. Even a large expansion of metals and minerals production in Russia — of limited value since too many deposits are less economical than those found elsewhere, particularly in they’re in Nowheresville in the Arctic —  won’t resolve the problem so long as Russia has to absorb production costs or subsidy costs to maintain export earnings so as to stabilize the ruble at the expense of the rational allocation of domestic capital. There are opportunities to be had for sure. But this next supercycle is going to create ‘recycling’ difficulties fundamentally different than previous ones in new ways with unintended consequences. Russians will feel that immediately in their pockets.

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