Streetwise Professor

I have been adamant in my opinion that OPEC is a weak reed for non-OPEC producers like Russia to lean on, because cartel members face a prisoners’ dilemma that can make cheating a dominant strategy.   The market’s decidedly bearish reaction to various OPEC pronouncements suggests that most people who are putting their money where their mouths are share similar views.   Reuters reports that OPEC compliance–or lack thereof–has indeed been weighing on prices:

Members of the Organization of Petroleum Exporting Countries had pledged to lower output by 1.5 million barrels per day for November in order to prop up prices, but were only 66 percent compliant with the target last month, a Reuters survey showed on Tuesday.

OPEC’s decision to wait until later this month to take more supply off the market, combined with a steep sell-off in U.S. stocks, led to a drop of more than 9 percent in U.S. crude oil futures on Monday.

Benchmark U.S. stock indexes were up more than 3 percent on Tuesday as investors hunted for bargains amid optimism that the government will bail out the U.S. auto industry.

OPEC CUTS

OPEC members remained concerned about oversupply in the world oil market and may decide to cut output further at their next meeting in Algeria on December 17.

“We are concerned about the glut … I think there is an indication that we will have another cut,” Qatar Oil Minister Abdullah al-Attiya said.

Top oil exporter Saudi Arabia has highlighted $75 a barrel as a “fair price” for oil.

Meanwhile, sources said two OPEC members, the United Arab Emirates and Kuwait, will increase oil sales to many major Asian customers, sending mixed signals about OPEC output cuts.

This is especially ominous for oil sellers because (a) compliance usually is at its peak immediately following new agreements, and (b) even in a competitive market, some producers would cut output anyways in the face of sharply lower prices, so the two-thirds compliance overstates the extent to which anybody is taking one for the team.

There were recently reports that Russia would cooperate with OPEC in an attempt to stabilize prices, although Medvedev’s comments on the subject during his love-in with that looker Hugo Chavez were decidedly mealy-mouthed:

Major price swings aren’t in the interest of either oil- producing or consuming countries, Medvedev said yesterday in a Caracas ceremony where he and Venezuela President Hugo Chavez signed energy accords. He said Russia would “coordinate fundamentally with Venezuela” and other OPEC nations, without specifying how.

“We will be coordinating, but it doesn’t mean that we’ll be colluding.”

And just what does that mean, exactly?

Ironically, through its tax policy, Russia has already effectively cut world supplies:

November oil exports fell to their lowest level since 2004 as firms cut supplies because of high export duties while output headed for its first decline in a decade.

Falling shipments have become a major concern for the government since the budget depends heavily on oil-export revenues.

Energy Ministry data showed Tuesday that Russian oil exports via pipeline monopoly Transneft stood at 3.70 million barrels per day in November, down by 12 percent from 4.21 million bpd in October. Oil companies had threatened to cut November deliveries by as much as a quarter because they said exports were loss-making with an export duty at $287 per ton ($39 per barrel). The average price for Urals blend crude was about $55 per barrel.

The decrease in exports made the government change the scheme of calculating the oil export duty, which, starting from December, will be set monthly instead of once every two months.

The December oil-export duty calculated under the new scheme was set at $192.1 per ton, almost a $100-per-ton decrease from the November level, but oil firms have said it was still too high to make exports attractive.

Viktor Vekselberg, one of the major shareholders at BP’s Russian venture, TNK-BP, said last week that the new export duty would help oil firms survive but was not enough to encourage investment.

The Energy Ministry data also showed that Russia’s oil production fell by 0.4 percent to 9.82 million bpd in November from 9.86 million bpd in the previous month.

Oil output fell throughout the first half of the year, and analysts had expected that it would recover in the second half after a number of oil companies started new fields.

That cut of 500m bbl/day is about one-third of the promised OPEC cut, and (per the Reuters numbers) about one-half of the actual cut.   So, if unwittingly, Russia has done proportionally much more than OPEC to support prices.   (OPEC output is about 34 mm bbl/day, Russian output is about 10mm bbl/day, so the Russian reduction is about 5 percent, OPEC’s 3 percent.)

But–and here’s where the irony gets even thicker–due to the shrieks of the domestic oil producers, Russia is considering a cut   in export duties, which would result in higher exports, lower world prices, higher domestic (after-duty) prices, and likely lower government revenues.   Thus, Medvedev, Putin, and others are talking out of both sides of their mouths, simultaneously promising Chavez, OPEC, that they will “coordinate” to keep world prices high, and telling domestic producers that they will ease export duties.

Ummm, sorry to break it to you guys, but it’s one or the other–either keep the export duty high to reduce exports and help prop up the world price while screwing domestic producers, or cut it to help domestic producers and undercut fast friends like Chavez and Ahmadinejad (who are the most hawkish OPEC members) while putting further downward pressure on world prices.   “Both” is not an option.

Ain’t choices grand?   Let us know when you make up your minds.

One of the dangers that faces the Putin’s Russia is that the erosion of resource rents will dissolve the bonds that hold the natural state/cartel together.   This dissolution threatens the stability of the current government, and perhaps of the country.

I came across several articles today that make a similar point.   First, from RFE/RL:

Since Vladimir Putin ascended to power in 2000, petrodollars have been the key lubricant for Russia’s authoritarian regime of “managed democracy.” Easy money from energy exports has enabled the ruling elite to purchase the political loyalty of the country’s sprawling bureaucracy, to win at least the passive consent of a critical mass of the population, and to buy friends and intimidate enemies abroad.

It is far too soon, according to most analysts, to say that Russia is on the brink of serious political instability, or even close to it. And nobody is suggesting that Russia is on the verge of disintegration.

But with the regime’s essential lubricant slipping away, the system Putin built is beginning to show signs of strain. Newly emboldened regional leaders are clashing publicly with authorities in Moscow, marquee infrastructure projects — and the patronage that goes with them — are being scrapped, and the Kremlin is scrambling to amend the constitution to keep the current elite in power indefinitely.

“The potential damage that this fall in commodity prices could inflict is very great,” says David Satter, a senior fellow at the Hudson Institute and author of the book “Darkness at Dawn: The Rise of the Russian Criminal State.”

“Even though the leadership may be more capable of managing in a capitalist environment than the Communist leadership was, nonetheless, it is composed of people, because of the system that was created here, who have no hardcore loyalty to the system or the country, but are only pursuing their own individual personal well being.”

. . . .

Nevertheless, the economic downturn is beginning to cause rumblings of rebellion in the regions, where local elites showing signs of challenging the central authorities in Moscow for the first time in years.

A group of private oil companies in Tatarstan — which account for 20 percent of all oil produced in the region — is asking the government to temporarily exempt them from paying export duties and production taxes until crude prices recover. They are threatening to cease production as of December 1 if their request is denied.

Moscow Mayor Yury Luzhkov angered the Kremlin by calling on November 19 for the direct election of regional heads, which would give them more independence. Luzhkov received a stern rebuke from President Dmitry Medvedev and quickly backed off his comments.

Such insubordination, analysts say, could become increasingly frequent as the economic downturn dilutes the Kremlin’s authority.

“The oil regions are going to say, ‘We need to keep the income here. Why do we need to support these other regions that are parasites?'” says Marshall Goldman, professor emeritus in Russian Economics at Wellesley College and author of the book “Petrostate: Putin, Power, and the New Russia.”

It is therefore not surprising that with the economy in crisis, Russia’s rulers are spending a great deal of time worrying about politics, rushing to amend the country’s post-Soviet constitution for the first time since it was enacted in 1993.

. . . .

Since coming to power, Putin and his team have attempted to create a centralized, authoritarian, vertically integrated, and unitary executive that can manage a thorough and comprehensive modernization of Russia. In order to do this, however, the Kremlin built a vast network of patronage — similar to the Soviet nomenklatura system — in which key state posts, privileges, and favors were doled out to the loyal and obedient across Russia’s vast regions and republics.

But in an economic downturn, when there is less patronage to pass around, some analysts warn that Putin and his inner circle will have a harder time placating and co-opting Russia’s sprawling bureaucracy.

“The big question is are bribes elastic in a downward direction,” Satter says. “If there is less money to pay for corruption, are those people who are benefiting from the corruption going to be reasonable and accept smaller payments, or are they going to start fighting among themselves. All experience suggests it’s the latter and that could create enormous tension in the ruling elite…There was clan warfare even when the situation was favorable.”

The foregoing focuses on the reactions of the bureaucracy and the siloviki to the sharp decline in the booty available to be split among them.   A more problematic issue is the popular reaction to a sharp economic slowdown.   At least one analyst quoted in the article suggests that the passive tendencies in the Russian makeup will dominate:

“To a certain extent the Russian people are aware of their loss of liberties under Putin and Medvedev. To a degree, they have reconciled themselves to this because of the rising living standards,” Satter says. “Well, the living standards are very likely not going to keep rising under these circumstances. So there are enormous sources of potential tension in Russian society.”

But with a weak opposition and a public that has been politically passive for a decade, it remains unclear whether the hard economic times on the horizon will translate into demands for political change.

“If the government fails to keep its economic side of the bargain, I don’t think we know yet how the Russian public reacts. They haven’t shown themselves in the last 10-12 years to be an especially revolutionary group,” Pifer of the Brookings Institution says.

Satter predicts that internal tension will translate into international tension and Russian aggressiveness:

“I think if things get really bad, the regime will get more authoritarian, more fascistic, more brutal, and more anti-Western. And that will be the way in which they stave off internal turbulence,” Satter says, adding that he expects to see “an intensified search for foreign enemies” to explain the economic downturn to an increasingly restless public.

Brian Whitmore at RFE/RL provides more detail:

Boris Gryzlov, head of the party’s Supreme Council, announced on November 21 that it was cutting a quarter its staff positions. Gryzlov, who is also speaker of the State Duma, also announced that 10 percent of those working as aides for Unified Russia lawmakers in the lower house — where Unified Russia has a two-thirds majority of seats — will receive pink slips.

That sure is a lot of patronage to throw away. One way so-called managed democracies like today’s Russia keep themselves afloat is by buying off a critical mass of the elite with patronage, and placating enough of the general public with pork.

You can do a lot of that when oil is $150 a barrel. But what about when it is less than $50?

Well that’s when it is time to rely on that other — weaker — pillar of the authoritarian petrostate: coercion.

On November 21, Gryzlov also announced the creation of Unified Russia’s new Anticrisis Commission, which will monitor how state funds are being spent in Russia’s regions. “We must place the regional authorities under strict controls so they behave properly,” the daily “Gazeta” quoted him as saying.

A warning shot, perhaps, to keep regional elites in line. Keep your eyes open for some wayward governor or mayor to be made into a high-profile example.

Similar thoughts from Eurasian Daily Monitor:

Top Russian economists recently looked at five possible scenarios, Gontmakher says. All of them, except modernization and immediate reform, would lead to a catastrophe. This single solution that could still save this country is not, however, in the cards under the conditions of the existing state, which is afraid of losing its monopoly of power. “The consequences will be dire,” Gontmakher says. He believes that the country may pass the point of no return sometime in 2009.

Experts see a very serious possibility of an abrupt collapse of the living standard and economic disintegration leading to social unrest, eventually followed by political upheaval.

Gontmakher’s story in the daily Vedomosti (November 6) was pointedly titled “Novocherkassk-2009,” in an allusion to the major workers riots on June 1 and 2, 1962, in the city of Novocherkassk, which were suppressed by the Soviet Army; 23 people were killed and dozens jailed in the unrest (see V.A. Kozlov,   Massovye Besporadki v SSSR pri Khrushcheve I Brezhneve [Mass Riots in the USSR Under Khrushchev and Brezhnev], Sibirski Khronograph, Novosibirsk, 1999). The article raised quite a commotion by drawing a picture of a shaky social peace collapsing once the 1962 situation starts repeating itself with prices and tariffs increasing drastically, wages dropping, workers laid off in droves, and food disappearing from the shelves because of collapsing imports and inadequate domestic production. “Either we finally take an effort to reform, or else we will enter a crisis that cannot be resolved within the framework of the current constitutional order,” the story concludes. On November 22 Rosomsvyaznadzor, the government’s media watchdog, issued a warning to Vedomosti that Gontmakher’s article could be seen as inciting extremism (www.polit.ru/news, November 22). Both Vedomosti and Gontmakher protested against the admonition.

As Tayevsky put it, “There will not be a crisis in Russia. There will be something immeasurably worse. But decent words for what it will be have not yet been devised, at least in the Russian language.”

Paul Goble reports that Putin and Medvedev are attempting to preempt a challenge from the regions:

These arrangements, Kolesev concludes, point toward the replacement of a large number of regional leaders, including those who came to office in Yeltsin’s time, by people totally loyal to the United Russia party and its leader, Prime Minister Putin, and they suggest that the party will work to prevent divisions within regional elites and between them and Moscow.

According to political analysts with whom Kolesev spoke, “very soon the role of the Control-Revision Commission of United Russia will grow sharply,” a development with disturbing parallels to the way in which the CPSU made use of its control-revision commission to keep party members and leaders in line.

But it was Yevgeny Minchenko who uttered the words that the leaders of Russia’s regions and republics most fear. “There will be purges,” he said, because “with the growth of social tensions [in the country] the leadership will need to seek out the guilty and punish them as examples” to others as to what Moscow or — more immediately — Putin wants.

But will the regional leaders submit without a fight?   With fewer resources at its beck and call, does the center have the ability to bribe, cajole, or force its will on the regions?   The fact that Putin appears compelled to take drastic measures suggests that he has serious concerns about his strength.   The regional leaders may sense this, and in any event, they may have little to lose by opposing him if it appears that they will be consigned to oblivion in any event.

The emerging situation is one in which there is a very real prospect of fierce internecine struggles within the elite who will battle over the diminishing resource rents, and attempt to exploit the financial weakness of those in control of desirable resources.   Moreover, the financial crisis threatens to weaken the center’s control over the regions.   The decline in resource rents alone threatens the stability and viability of the system, and even the potential weakening of the control of the power vertical can be a self-fulfilling prophecy.   The viability of a self-enforcing truce between contending factions depends on their time horizons.   Political and economic crisis tends to shorten time horizons, that undermines the viability of cooperation between the various factions.

Again, the wildcard is the popular reaction to intra-elite battles and broader economic decline.   The broader population appears uneasy, but largely quiescent.   That may last, but it may not.

And, BTW, despite a modest rally on Wall Street today, oil continued its decline–with Urals Med falling to $42 and change.   All the less glue to hold the whole contraption together.

Reuben Johnson writes a rather dismissive appraisal of Russia’s military “renaissance” in the Weekly Standard:

All signs suggest that the waste and neglect that made Belenko so disdainful of the political commissars were never dealt with. So, be on the lookout for more armed men in tennis shoes carrying stolen toilets in carjacked Humvees the next time Russia decides to make mischief beyond its borders. And don’t be surprised if the average Russian serviceman continues to risk being needlessly sent to an early grave.

Most of what Johnson says is familiar to SWP readers, but he does provide some very colorful details:

This is all just so much chest-thumping. The immense sums required to support these lavish promises will not materialize. You can’t get there from here, as the old aphorism goes. The price of oil (which Russia depends on for a great deal of its state revenues) has dropped to less than half its value from this past summer, the Russian stock market is in free fall, and foreign investment has fled Russia.

President Medvedev has announced an increase in military spending, but total outlays are still far less than the U.S. defense budget, and much of what has been allocated will have to go towards undoing the years of neglect and decay during the Boris Yeltsin presidency.

The performance of the Russian armed forces during the invasion of Georgia in August showed the dismal state of Moscow’s military machine. Some Russian soldiers went into battle wearing athletic shoes because there were not enough boots to go around. Russian troops stole everything they could lay hands on–particularly from the Georgian army facilities they overran. Uniforms, beds, U.S.-supplied Humvees, and toilets were even pulled off the walls by Russian forces. “They had everything; the most amazing f–ing beds, amazing f–ing barracks with sealed windows,” one Russian soldier was recorded saying in a short mobile phone video that was later broadcast–awestruck like Goldilocks when she stumbled upon Baby Bear’s boudoir. Apparently living conditions for soldiers have improved little in the decades since Belenko’s defection.

Russian forces were able to overcome Georgian forces because of sheer numbers, but in air operations the Russians had their proverbial head handed to them. A total of 12 Russian aircraft were lost to Georgian air defense units, including one Tupolev Tu-22M Backfire bomber. By the time hostilities ceased Russian pilots were being offered lavish bonus payments if they were willing to fly missions over Georgia, and still some of them turned the offers down, preferring to stay on the ground where it was safe.

The loss of the Tu-22M is symptomatic of the deep and pervasive ills of Russia’s military machine. There were no operational pilots with enough hours to fly the mission, so instructor pilots had to be press-ganged into service–only two of whom were able to eject safely. The fact that the aircraft–a medium-range strategic bomber that was originally designed to carry nuclear weapons–was misused for a reconnaissance mission is another source of embarrassment.

Think about that last statement–having to bribe Russian pilots to fly combat missions against a pipsqueak military force, and having many of the pilots respond “Nyet!”

The “chest thumping” that Johnson refers to is also quite familiar to those following Russian military developments (and economic developments, for that matter).   This brings to mind a story from the Economist, which ran a series on Russia that echoes many SWP themes (but of course, the Economist is just the house organ for Bourgeois Reactionaries;-).   Here’s the story:

One of the biggest pop hits in Russia a few years ago was a song called “I Was Made in the USSR”, first performed in 2005 in the Kremlin, in front of Mr Putin. “Ukraine and Crimea, Belarus and Moldova—it is my country…Kazakhstan and the Caucasus as well as the Baltics—it is my country…I was born in the Soviet Union; made in the USSR,” its lyrics go. As the audience rose to applaud, it was perhaps unaware that the tune was the same as Bruce Springsteen’s “Born in the USA”.

(And I bet that Springsteen didn’t see any royalties either.)

Reading Johnson’s article, along with the many other articles on the Russian military and imperial pretensions, makes me think that another Springsteen composition is far more apt: “Glory Days,” a song about how some people pathetically fixate on past glories (real or imagined) and ignore a far less glorious current reality.

Like a spoiled child who has lost a game at his birthday party, Vladimir Putin cries: “It’s NOT FAIR!“:

Prime Minister Vladimir Putin described the effect foreign markets have on domestic share prices as “unfair” during a government meeting Monday, saying the values of the securities do not accurately reflect those of the companies themselves.

Putin also spoke out against insider trading and again blamed the West for the country’s economic difficulties, adding that those trading on domestic exchanges would be compensated for financial losses, Interfax reported.

“Decisions concerning which securities to buy or sell on Russian markets are, for the most part, made abroad,” Putin said, the news agency reported. “Moreover, the criteria by which these decisions are made have very little connection to the actual state of our economy or Russian companies.”

At the same time, he was careful to point out that the country did not want to exclude foreign investors.

“No one is preparing to limit the activities of foreign capital in the Russian stock market — we welcome foreign investors,” Putin said. “But at the same time, the task lies in properly building a large class of domestic investors as a powerful and capable financial institution of its own.”

While the lack of domestic investors is clearly a problem and shares in Russian companies trade at levels below what might be expected given their fundamentals, said James Beadle, director of Pilgrim Asset Management, the blame for their performance should be shared around.

“On the face of it, Putin is completely correct — I think a lot of the market’s reaction has had nothing to do with the Russian economy,” Beadle said. “But Russia’s situation has been, as we know, worse than most emerging markets. I put that down to the weak economic environment, the political risk and a lack of domestic investors.”

While lashing out at the West, Putin said the government remained committed to turning Moscow into an international financial center.

“In the very near future, the government will examine a comprehensive plan regarding the financial center’s creation,” he said, adding that the financial crisis would perhaps change the global economic pecking order, affording Russia greater opportunity to achieve its goal.

Vladimir Milovidov, head of the Federal Financial Markets Service, followed Putin’s comments at the meeting by elaborating on the state’s plans for compensating investors for market losses, Interfax reported.

Milovidov explained that this would be achieved through a mechanism based on the Deposit Insurance Agency, which is designed to insure individual bank deposits.

“I don’t see any clear obstacles to the creation of such a system of compensation based on the idea of the Deposit Insurance Agency,” Milovidov said, although he added that the question would require further consultation with various ministries and departments.

There was skepticism over whether such a plan could work.

“It seems a little unrealistic to me,” said Tom Mundy, an analyst at Renaissance Capital. “Maybe it would be better to think about how Russia can restructure its financial institutions.”

While saying there was some truth to the charges Putin made, Mundy also said not all of the blame for weak domestic markets should be placed elsewhere.

“Russia’s financial institution did break down. The banks didn’t lend,” he said. “[The crisis] is an inherited problem, and I can understand why the market is frustrated. But it does not mean that Russia is completely blameless.

“There is a little bit of blame to be passed overseas, and there is some internal blame as well with these oligarchs who had [overleveraged their companies],” said Ronald Smith, chief strategist at Alfa Bank. “There’s blame all the way around.”

In line with Putin’s comments, the Presidium approved a strategic development project for Russia’s financial markets through 2020, Milovidov reported. He added that the Presidium also approved a draft law designed to combat insider trading.

Mundy said the Kremlin’s focus on a global financial center pointed to a healthy desire for economic integration and that, in the end, the crisis might actually help push along Russia’s economic development.

“‘The next stage in Russia’s development is probably creating more transparency,” he said.

I especially like the part about insider trading.   I’m sure no silovik ever does that.

The prattle about Russia as a financial center is simply delusional.   No secure property rights, no credible policy commitments, no rule of law, corporate raiding, expropriation of foreign investors–yeah, that’s the foundation for a world financial center.   You betcha!

And what’s the deal about compensating those trading on domestic exchanges for their losses?   That’s the ticket, give investors a put paid for with government money.   No better way to encourage wild risk taking–private gains, socialized losses.   The proposal also smacks of a scheme to tunnel state assets and direct them to the pockets of political favorites.   We are repeatedly told that individual investors don’t play the Russian stock market–that it is the playground of a limited set of connected players, the oligarchs prominent among them.   So this seems like just another bailout.

Tom Mundy gets a nomination for the Understatement of the Year Award:

“It seems a little unrealistic to me,” said Tom Mundy, an analyst at Renaissance Capital. “Maybe it would be better to think about how Russia can restructure its financial institutions.”

Ya think?

Last week I linked to a Reuters story (one of many from a variety of news sources) that stated that Russia was backing away from liberalization of the power market.   (That’s the market for electricity, not the market for political power, which will remain illiberal for the foreseeable future;-)

Not so fast, says Vladimir Putin:

Prime Minister Vladimir Putin pledged Friday not to slow the development of the power industry, responding to concerns from Germany’s E.On, Russian news agencies reported Friday.

“All the plans that we set out for this sector, we will fulfill. We will not cut them back,” Putin said, RIA-Novosti reported.

On Friday, Putin received E.On’s chief executive, Wulf Bernotat, at the presidential residence in Novo-Ogaryovo. Bernotat was reported as saying the planned liberalization of the power market was a key factor in E.On’s $6 billion acquisition of power producer OGK-4 this year.

Since the acquisition, the global financial crisis has knocked Russian share price indexes down by some 70 percent, and many industries have begun to lobby against the full liberalization of electricity prices by 2011, which power firms like OGK-4 are counting on to make a profit.

“As far as we are being assured, nothing has changed,” Bernotat said, Interfax reported. “It is important to us to know that all obligations will be fulfilled. … It is important for us to have political support,” he was quoted as saying.

“We are conducting fruitful negotiations with [Deputy Prime Minster] Igor Sechin and [Energy Minister] Sergei Shmatko on this issue, but it is important for us to have political support,” Bernotat said.

This echoes Shmatko’s statement from last week:

The pace of the move toward market rates for electricity will not be slowed, Energy Minister Sergei Shmatko said Friday, dispelling fears that the liberalization might be delayed.

The Market Council, a state-controlled watchdog for the electricity sector, said Wednesday that the idea of slowing deregulation of power prices was being discussed.

“We have been getting a great number of requests from various sectors asking to freeze the tariff,” Shmatko said on the sidelines of a meeting with power industry executives devoted to preparations for the winter heating season. “But we suggest sticking to the decisions that have already been made.”

Under the liberalization plan, half of Russia’s electricity production is to be traded at market rates from July 1, 2009, while prices for the other half are to be set by the Federal Tariffs Service. Only 25 percent of the electricity trade is currently deregulated.

A delay “would affect the investment climate and investors’ activity in the sector,” Shmatko said, calling it “a very bad signal to the market.”

He also said for the first time that Russian power consumption had slowed and that there was a special team at the ministry to “react swiftly” to problems in the power sector.

“We know there will be problems between the wholesale and retail companies, between Gazprom and the generators … problems with payment delays,” Shmatko said. He added that companies shouldn’t bother asking the ministry for the help, including the financial support.

So what’s going on?   Who knows?   And that’s exactly the problem.   The fact that E.On felt compelled to genuflect to Putin personally tells you all you need to know about Russia’s politico-economic system.   Namely, that it is a personalized system of rule in which crucial decisions are the result of negotiations (and who knows what else) centering on Putin, the Godfather.

Investment and growth are crucially dependent on the existence of credible policy commitments.     Investors who have no confidence that the returns to their capital are secure from expropriation or radical policy shifts will not sink their wealth into immobile, specific assets–like power plants.   A stable political system that has mechanisms to make policy commitments credible is essential to providing investors with such assurances.   It is virtually impossible to make credible commitments in a highly personalized political system like Russia’s.   Especially since that system is extremely corrupt, lacking in a rule of law, and suffused with violence and the potential for violence.

So, perhaps Putin made the right decision–today.   And regardless of the correctness of the decision, the process is far more problematic.   With such a process, in which CEOs of major companies must seek personal assurances from the nation’s prime minister, there is no assurance that today’s decision will survive until tomorrow.   And given the uncertainty which is inherent in a personalized system lacking the institutional mechanisms to make policy commitments credible, investors will be very wary about investing in Russia.

Today’s oil market, that is.   January Brent on ICE down 11.4 percent to $47.53/bbl.   January WTI on NYMEX down a mere 9.5 percent to $48.28/bbl.   And our favorite, Urals Med, down to $43.79/bbl in European trading.

The oil market continues its death ride strapped to the equity market.   This is historically unusual.   From 1985-2008, on average a 1 percent move in the SP500 was associated with a 0–yes zero–percent move in WTI.   That is, there is historically zero correlation between WTI and the SP.     In the summer of 2008, the correlation was negative–when the oil market went up, the stock market went down.   During this period, a 1 percent increase in the price of WTI was associated with about a .8 percent decline in the S&P.   This is consistent with supply shocks being the main driver of oil prices during that period.   An adverse supply shock raises oil prices and constrains economic activity, leading to lower stock prices.

What a difference a few months makes.   During October and November, oil and stock prices have been moving in the same direction, in a virtually unprecedented way.   A one percent change in the price of oil during these months is associated with a .85 percent change in the S&P   in the same direction, i.e., a one percent drop in the price of oil is associated with a .85 percent decline in the S&P.

In the past 20 years, the largest value of this coefficient is .4.   So, in the past two decades oil and stocks have never been even close to as highly correlated as they are now.

This all means that demand is now in the driver’s seat.   A decline in the S&P reflects bearish prospects for the economy.   Bad economy–low demand for oil–low oil price.

Today’s oil price bloodbath sure speaks volumes about the market’s assessment of the credibility of OPEC General Secretary al-Badri, who said today:

OPEC is ready to cut production by a significant amount when it meets later this month in Algeria, prompted by high oil inventories, the group’s secretary-general said on Monday.

“We are all geared toward a cut in Algeria,” Abdullah al-Badri told a news conference in Tehran, two days after the Organization of the Petroleum Exporting Countries decided at a meeting in Cairo to delay a decision on a new supply reduction.

Tell us another one, Abdullah!

Today’s plunge also speaks to those in Russia, and those bullish on Russia, who are counting on OPEC to ride to Russia’s rescue.   Don’t count on it, in other words.   To believe such is to grasp at straws in the tempest.

The market’s scoffing at al-Badri’s whistling-past-the-graveyard bravado reflects a clear-eyed appraisal of the realities facing OPEC.   As I’ve noted on SWP before, cartels in general, and OPEC in particular, face serious problems from cheating.   It is collectively rational to cut output to raise prices, but individually rational for each individual member country to produce more than its quota. This prisoner’s dilemma undermines cartel discipline, and means that cross-my-heart-hope-to-die promises to cut output are worthless.

Due to the sharp contraction in oil demand (as manifest in the decline in prices and the rapid growth of inventories), most OPEC countries are operating well below capacity.   This cushion would only increase were they to cut output in response to OPEC agreement.   They therefore have the ability and incentive to increase output beyond their quotas.   And believe me, they will.

This bodes ill indeed for Russia’s recovery.   The only somewhat gloomy World Bank report on the Russian economy, which predicted a slowdown in growth to 3 percent was predicated on an oil price of $74.45/bbl for 2009.   That is looking increasingly unlikely, meaning that the 3 percent growth number is similarly unlikely.

The first reliable indicators of damage to Russia’s real economy are also becoming available.   Manufacturing activity has declined more than in–wait for it–1998:

Russian manufacturing shrank more in November than during the 1998 financial collapse as the global economic crisis drove output and new orders to record lows and companies cut jobs, VTB Bank Europe said.

VTB’s Purchasing Managers’ Index fell for a fourth month to 39.8, its lowest level, from 46.4 in October, the bank said in an e-mailed statement today. The previous low was 43.2 in September 1998, a month after the government’s ruble devaluation and default on $40 billion of debt. A figure above 50 means growth, below 50 a contraction. The bank surveyed 300 purchasing executives.

“The sense of doom and gloom was only deepening,” in November, Tatiana Orlova an economist in Moscow at ING Group NV said by telephone. “The mood isn’t getting any better.”

Industrial production has slumped and unemployment is rising as declining commodities prices and the seizure of credit markets prompt an outflow of capital. Investors withdrew $190 billion from the country since August, BNP Paribas SA estimates, as oil fell below the $70-a-barrel average needed to balance the 2009 budget.

“Driving the rapid contraction of the manufacturing sector in November was a record fall in incoming new work,” the bank said in the statement. New export contracts tumbled because of “fallout from the global financial crisis.”

(Not that things are rosy in the US.   Here manufacturing dropped by the largest amount in 26 years–that is, since the Reagan-Volker recession.)

But nonetheless, the Russia Central Bank continues its insane policy of supporting the ruble, thereby accelerating the erosion in its currency reserves:

Dec. 2 (Bloomberg) — Russia’s central bank probably doubled spending of foreign reserves to defend the ruble from its biggest weekly plunge against the euro in more than four years, according to the median of 10 analyst estimates.

Bank Rossii may have sold $5.75 billion of foreign currency last week, based on the average of predictions ranging between $2 billion and $6.5 billion. That’s likely to contribute to a decline of about $6.25 billion in Russia’s overall cash pool, compared with $3.6 billion in the previous week, the survey by Bloomberg shows.

Russia lifted interest rates twice last month and drained $148 billion from the world’s third-largest reserves since August to stem a 16 percent currency slide against the dollar. BNP Paribas SA estimates that investors withdrew $190 billion since August as oil prices below the $70-a-barrel average needed to balance the 2009 budget triggered Russia’s worst financial crisis since the government’s default a decade ago.

“The central bank is willing to use reserves daily to make sure the ruble falls at their pace,” said Elina Ribakova, chief economist in Moscow at Citigroup Inc., which forecasts a 15 percent fall in the ruble next year. “I expect continued declines in reserves until the end of the year and into the next.”

Bank Rossii buys and sells foreign currency to keep the ruble within a trading band against a basket comprised 55 percent of dollars and rest in euros. Policy makers widened the band three times last month as the ruble lost 3 percent versus the basket.

The Russian currency weakened 2.3 percent against the euro last week, its biggest plunge since August 2004. It traded near the weakest in 2 1/2 years against the dollar yesterday.

Currency Gains

The government may have deepened the reduction of its reserves from $449.9 billion last week by transferring cash to state lender Vnesheconombank, said Tatiana Orlova, an economist in Moscow at ING Groep NV.

A $1.8 billion loan to Evraz Group SA, Russia’s second- largest steelmaker, may also appear in the reserves data for last week, said Katya Malofeeva, an analyst in Moscow at Renaissance Capital.

An acceleration of purchases of rubles from the reserve combined with the fact that the ruble continued to fall last week suggests that a speculative attack against the currency is gaining speed.   And Russia is getting what for this, exactly?   Letting the ruble go to find an equilibrium level consistent with the dramatically weakening fundamentals (i.e., a plummeting oil price) would ease the drain on the reserves, and would also help the country’s increasingly desperate manufacturing sector.   But it would represent a very public repudiation of the Putin’s main economic argument.   So, expect speculators to make money at Russian expense, and for most Russians to see exactly bupkus from the summer’s oil windfall.   Easy come, easy go.

So, to tie everything together.   The price of oil is a hostage of the financial crisis in the West, with the linkage between the oil price and stock prices tighter than ever.   Russia’s economy is hostage to the price of oil, with the linkage again arguably tighter than ever.   With no end in sight to the West’s economic travails, this means that economic growth in Russia in 2009–even 1 percent–is likely a pipe dream, and that an economic contraction is far more likely.

The only question is what will be the broader fallout of a sharp decline in the ruble (inevitable, sooner or later) and a recession in Russia, against the background of unrealistic expectations stoked by a government controlled media.   Will Russians behave in the stereotypical, fatalistic fashion, and accept yet another disappointment with resignation?   Or will this spark another of Russia’s paroxysms of political chaos?   The latter is not a certainty, but it cannot be ruled out.   And the more severe the contraction becomes, the more likely that outcome.

Who would have believed that a devotee of enemas could be so full of crap?