Can the Russian Economy Weather the Storms Ahead?
Poor Commodity Prices Hamper Russian Economic GrowthLow gas and oil prices continue to be a thorn in the side of the Russian economy. During the month of February, the Russian Reserve Fund declined by $8 billion from $85.09 billion to $77.05 billion as a budget deficit continues to plague the Russian economy. The Reserve Fund is used as a stopgap measure used to prop up any shortfalls that arise as a result of low commodities prices. The Russian ruble has depreciated markedly against the euro and the greenback, after staging a semi-recovery earlier in 2015. Owing to the austerity measures implemented by the government to make ends meet, several key sectors will face budget cuts. It should be pointed out that approximately 50% of all government revenues are generated by way of taxation on the gas and oil industries. The Russian Central Bank reported a month ago that its foreign currency reserves totalled $365 billion.
Expectations of Stabilizing Oil Prices
As of March 9, 2015 the price of WTI crude was trading a fraction under $50 per barrel while Brent crude oil – the international benchmark – was trading around $60 per barrel. According to analysts the 1 year forecast for oil is pegged at $57 per barrel. The Kuwaiti Oil Minister was recently quoted as saying that the oil price would stabilise between $50 and $60 per barrel in 2015. The current oil price is being bolstered by reduced production capacity in the US shale oil fields and by the ongoing conflicts in Libya, Iraq and Nigeria. Supply concerns emanating in Libya have helped to boost the price of oil. However the downside for oil can be found in decreased demand across the European Union, Australasia and emerging market economies. At the close of trade on Friday, 6 March the oil price dipped as the dollar rose, putting pressure on weaker currencies. The current price of oil is marginally above the record lows recorded at the start of the year – under $45 per barrel. This is especially notable given that under a year ago oil was trading over $115 per barrel.
Meanwhile, Saudi Arabia continues to hold its position vis-a-vis oil production. The Saudis recently announced that they would not cut production even if the price of oil were to drop to $20 per barrel. The consensus among key industry analysts is that Saudi Arabia is using its position of strength in OPEC to force US shale oil companies out of business by dropping prices so low that US oil producers have no option but to shut down operations. But it has been noted that several oilfields in eastern Saudi Arabia could still run at a profit if the price of oil drops to $10 per barrel. Another big problem is that of stockpiling oil supplies. There simply is no excess storage capacity available for all the oil that is being produced and not consumed. Estimates suggest that the United States has used up 70% of its oil storage capacity. Across the Atlantic in Europe, an estimated 90% of all oil storage capacity has been used up.
Russian Ruble Rises on the Back of €1.14 Trillion QE Program
In an effort to buoy investor sentiment, Russian economic analysts have been touting the recent semi-stabilization period in the Russian financial markets. The Moscow Times reported that the ruble strengthened as the oil price moved above $60 per barrel. As a result, the RUB/USD exchange rate dropped slightly below 60 for the time that the oil price was above $60 per barrel. The Russian ruble also gained marginally against the euro in thin volume trading. The ruble was further bolstered by reports that the conflagration in the Ukraine appears headed for a ceasefire. As Russian oil producers generate higher revenues from their exports, the hard currency gained by Russia helps to bolster the local currency. Another factor that has dramatically aided the Russian ruble is the European Central Bank’s quantitative easing programme. The bond buying program across Europe is designed to inject liquidity into the market to spur economic activity and stave off deflationary pressures. This bodes well for emerging market economies like Russia which could benefit from the increased liquidity.
According to the First Deputy Governor of the Russian Central Bank – Dmitri Tulin – the Russian ruble remains undervalued to the tune of 10%. The European Central Bank began its bond repurchases program on 9 March 2015 with cash injections of €60 billion per month. Both the MICEX index and the dollar-denominated RTS index spiked after these announcements were made. During February and into the first week of March, the ruble strengthened by approximately 12% against the USD. This was largely the result of increasing oil prices and greater optimism vis-a-vis the Ukraine crisis. Whether or not low oil prices will continue throughout 2015 is anyone's guess; suffice it to say the reduction in the number of operational rigs in US shale oil fields will cut supply and cause the price to rise. This bodes well for the Russian currency, especially after Russia was recently downgraded by international credit agencies this year.
A Strong Ruble and a High Oil Price or a Weak Oil Price and a Weak Ruble?
As it stands, the number of US shale oil rigs in operation is at its lowest level in four years. However, the US shale producing wells have switched their focus to high grading (expanding production in wells that can produce excess oil) and away from marginal producers of oil. Many industry analysts believe that it is more likely that the Russian ruble will approach 70 to the US dollar and the price of Brent crude oil will move towards $50 per barrel during 2015. Taking an optimistic perspective, the price of Brent crude oil would move to $80 per barrel and the ruble would strengthen to as low as 45 to the USD. Time will certainly tell.