Streetwise Professor

February 18, 2009

Enron on the Moskva

Filed under: Economics,Energy,Politics,Russia — The Professor @ 11:01 pm

Yesterday Rosneft and Transneft announced a deal with  China, whereby the Russian companies would receive a $25 billion loan to build a pipeline to  China.   In return, Rosneft promised to deliver 15 million metric tons/year of oil to  China  over the next 20 years.   Rosneft trumpeted the fact that the interest rate on the loan is a mere 6 percent—50 basis points over LIBOR.   That looks like a great deal, given Rosneft’s and Transneft’s current financial condition, until you consider the pricing of the oil, which is much less clear.  

The real pricing of the loan depends on the oil price agreed to in the contract.  It is VERY interesting that this rather important detail was not disclosed.  

One report puts the price at $20/bbl.   I’ve done a quick back-of-the-spreadsheet calculation.   Based on the current NYMEX forward curve (extrapolated beyond 2016), that represents a substantial discount.   Taking the discounted price into account, the true interest rate on the loan (if the $20/bbl figure is right) is 23 percent.   Even if you double the oil price to $40/bbl, the interest rate is still 14 percent.   Given Rosneft credit spreads (which were 1000 bp in the fall, if I recall), something in that 14-23 percent range seems to make sense.  

One thing is for sure, there is NFW Rosneft/Taftneft are borrowing at 50 bp over LIBOR for 20 years.  The oil price in the structure surely favors China in a way that makes the effective interest rate far higher than LIBOR.  Far higher.  

So, it is quite likely that the deal is not nearly as advantageous as the Sechinists would like you to believe.   Given the dire financial straits of Rosneft, and the strong Chinese bargaining position, and their reputation for hard-nosed negotiating, I would expect the Chinese to be able to extract a very nice deal.  

As an aside, this type of transaction structure brings to mind some of the deals Enron did as it neared collapse.   Enron engaged in some off-market swaps in which it received cash up front, in exchange for making off-market payments in the future.   These were called swaps, but they were really loans in drag.   The Russia-China deal seems to have the same characteristics; the loan “interest” payments understate the true interest cost, and the below market oil sales are effectively an interest expense.

Another thing to note is that this sets the stage for a huge pricing dispute down the line.   I would place a pretty large bet that when oil prices rise, and especially if they rise dramatically, Rosneft will renege, claim that it entered the contract under duress, or claim force majeure, or something, to force the Chinese to renegotiate.  

I would put that in the “when” column, not the “if” column.   And won’t that be interesting to watch?

February 17, 2009

Oy. Again.

Filed under: Economics,Energy,Politics,Russia — The Professor @ 9:10 pm

Not a good day for any market, but an especially bad one for Russia.  RTS index was down almost 10 percent. Micex was also down hard.  Sberbank is down to around 40 cents again; Gazprom down to $12.50.  The ruble, which had rallied last week, has given up almost all of those gains, losing more than 3 percent against the dollar today.  The basket is now only 1.1 percent away from the 41 level, putting the central bank on the hook again, forced to choose between burning reserves or raising interest rates. Or maybe to impose capital controls.  

Fundamentals are very weak.  Brent crude fell over 6.5 percent today, and is hovering at about $40.  The Russian government budget process is going painfully slowly, as every day’s news makes previous projections obsolete.  Economic forecasts are getting progressively more grim, with the government now predicting a GDP drop of 2.2 percent in 2009, vice its earlier -.2 percent forecast, which in turn had replaced a +1.6 percent forecast (if memory serves). Given the crash in manufacturing, and other evidence that suggests that services are reeling too, I’d put my money on the 2.2 percent figure being revised downwards soon too.  Especially if oil continues its drop.  That is quite possible given the profound shakiness of European banks, which, in turn are shaky in large part because of their outsized exposures to E. European and Russian debt.  

The world economy looks increasingly shaky, and Russia is (due to the oil price and credit channels) acutely vulnerable to further weakening.  Rather than being an island of stability, it is a vortex of trouble.  

And there are Russian-specific factors as well.  I would wager that some of the drop in the ruble reflects increased nervousness over the security of Kudrin’s status, given rumors swirling around in the aftermath of  Investigative Committee head Aleksandr Bastrykin’s statements about the criminality current and former Kudrin deputies.   There is widespread concern that this shot was really aimed at Kudrin.  People can see the dogs fighting under the carpet, but don’t know who is winning.  Even if Kudrin survives, such distractions in the face of existential economic crisis hardly provide confidence in the quality of the decision making.  That’s hardly a bullish factor for the currency.  

Like I’ve said, it stinks to be us; it stinks worse to be European; but it especially stinks to be Russian right now.

Fool Me Once

Filed under: Energy,Politics,Russia — The Professor @ 8:47 pm

Russia’s sinister Deputy PM Igor Sechin announced that Russia is considering storing up to 16 mm tons of oil. More on the substance of that in a moment, but first there are some priceless parts of the Reuters article that are much more important/entertaining, and which confirm some of my December analysis of Russia’s strategy of whispering sweet nothings in OPEC’s ear and then producing and exporting to the max:

Deputy Prime Minister Igor Sechin, who oversees the oil and gas sector, said the move could help the Organization of Petroleum Producing Countries (OPEC) stabilize oil prices.

Sechin traveled to Algeria in December and told OPEC delegates that Russia, the world’s second-largest oil exporter and the biggest outside OPEC, could cut exports by 16 million tons, or 320,000 barrels per day, if oil prices fell further.

As oil prices have stabilized around $40 per barrel, Russian exports have instead risen to above 4 million bpd in the past two months in what traders said was further proof Russia will limit cooperation with OPEC to verbal pledges. (Emphasis mine.)

. . . .

Specifying a time period and elaborating on the means of stockpiling are key questions left unanswered by Sechin’s comments.

“He’s using all sorts of caveats. It’s a politically astute statement, and he’s not really committing to anything,” Mike Wittner of Societe Generale said.

“I’m skeptical that they’ll do this. The Russian economy continues to deteriorate and they need the money. I think they’ll sell every barrel they produce,” Wittner said by telephone in London.

Go on.  You mean that Sechin’s word isn’t gold?  I noted soon after Russia played Lucy to OPEC’s Charlie Brown, pulling the football of promised output cuts at the last moment, that the country’s behavior was inconsistent with any effort to reduce exports in order to help support oil prices.  The country cut export taxes dramatically, and as the article notes, its exports actually rose.

The only question is whether OPEC will be credulous–I mean dumb–enough to believe Sechin’s 16 million bbl pickup line again.  I’m sure they felt so used, so cheap, last time, and hopefully will be smart enough not to repeat the performance.  

If Russia does store oil, it will only be because it perceives that price structures make this a rational move, not because they are engaged in tacit cooperation with OPEC to cut output and raise prices.  Storage volumes are ballooning world wide as price taking producers with access to reasonably priced storage (and even storage that would have seemed unreasonably priced not too long ago) can make a good profit by storing into this huge contango (with the deferred futures price far above nearby prices.  That relationship went totally whack on the WTI last Thursday, but came back a bit the next day.)  

Given the inelasticity of Russian supply, arising from the technical rigidities associated with production in Siberia, storing into the contango could make sense if they have the storage capacity.  I’m not sure that they do, however.  (Anybody know the answer to that?  Past behavior suggests that storage capacity is limited.)  Maybe they’ll charter ships as North Sea producers, the Iranians, and others have done, if their onshore storage options are limited.  

But the point OPEC should remember is that if Russia decides to put supplies into storage, it’s not in the spirit of doing their part to keep oil prices higher.  It’s because it’s a profit maximizing move for a country that perceives itself as a price taker with an interest in letting OPEC do the heavy lifting and selling as much as it can at prevailing prices.  

In other words, the Saudis, etc. should invite Sechin to the Middle East to pound some sand, of which they have plenty.

February 16, 2009

Bad in Their Own Way

Filed under: Economics,Politics,Russia — The Professor @ 11:06 pm

I’ve mentioned at times the huge exposure of European banks to Eastern European (including Russian) debt.  Ambrose Evan Pritchard has the gruesome details.  Evans-Pritchard has a tendency towards hyperbole, so it’s probably not as dire as he makes it sound, but even if you discount his story substantially, there is still room for considerable concern.  Here’s just one of the most sobering grafs (ooh, don’t he sound so journalistic):

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.

They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico’s car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe’s financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus.  

I don’t want to focus on the specifics here, important as they are for the future.  I just want to point out that the agonies of European banks–continental European banks–have important implications for the debate raging over regulation.  

American and British banks have rightly been excoriated for their lending and risk management practices.   The US-centric commentary in particular has attempted to identify some specific regulatory failing in the US (repeal of Glass-Steagal, the Commodity Futures Modernization Act, the failure to regulate CDS, the SEC permitting IBs to inflate their leverage) as the root cause of all that ails.  

But the experience of continental banks, including the supposedly staid Swiss, makes it clear that the banking crisis is not peculiar to the “Anglo-Saxon model,” or solely attributable to some deficiency in American regulation.  It is a worldwide phenomenon, and European banks supposedly subject to greater regulatory restrictions than their American and British counterparts evidently took on even greater risks.  Note the 50 percent greater leverage.  The concentration of risk in particular markets.  (Shades of American banks’ near death experience with Latin American debt in the 80s.)  

So, we shouldn’t fool ourselves that some change in US regulation is sufficient to prevent the recurrence of such problems (in that perhaps distant future when we have recovered from our current travails.)  Put differently, given the substantial cross sectional variation in banking regulation across countries and regions on the one hand, and the striking lack of variability in their assuming massive risks and suffering the consequences on the other*, it seems foolish to attribute the banking crisis to any one country’s regulatory failings.  Instead, it is more plausible that some common factor is responsible. And the most plausible candidate for that common factor is, in my view, overly lax monetary policies in the 2000s.  

So, perhaps we need somebody to update Friedman and Schwartz’s Monetary History of the United States.  Friedman and Schwartz laid the Great Depression at the feet of the Fed.  It is quite likely that their successors will do the same for the Great Whatever that is now impending.  The exact failings are quite different, but the results are sadly similar.  To paraphrase the first line of Anna Karenina, good central bankers are all alike; bad central bankers are bad in their own way.

* Though, as commentor Michel points out, Canadian banks appear to be an exception to this rule.

Sclerosis

Filed under: Economics,Politics — The Professor @ 10:35 pm

Felix Salmon has a nice piece on the banking system that includes this paragraph:

Still, he’s indubitably correct on the subject of the “Geithner plan” — which is one of those phrases that genuinely belongs in scare quotes:

As far as I can see there is no detail – and if you don’t have detail you don’t have a plan.

This is one of the reasons I’m becoming increasingly convinced that we’re turning Japanese: given how hard it is to do something bold, it’s always easier to faff about and do something woefully insufficient. Unless and until Geithner announces a plan worthy of the name, we’ll have to assume that to be the base-case scenario.

So why are we “turning Japanese”?  [And, if you know the rather vulgar origin of that phrase, you’ll know it works on several levels.]  

I think it boils down to something I wrote about in my post on Geithner’s public self-destruction: intense political battles between interested groups, namely politicians intent on getting their hands on the banking system to turn it into a literal piggy bank for funding their causes and pals, and incumbent bank managers who want to retain the status quo as long as possible.

That is, the inaction is a consequence of the kind of sclerosis that Mancur Olson identified as the bane of mature polities and economies in his Logic of Collective Action and The Rise and Decline of Nations.  

The impression that “leaders” are fiddling while the banks are burning is palpable.  The press is agog with stories of Obama playing hoops, or going to Chicago for a romantic dinner.  He is lionized for getting a stimulus bill passed by stoking fears.  BFD.  He gets a liberal Democrat Congress to spend money!  He peels off three of the wettest “Republicans” on the Hill!  Wow.  I’m so impressed.  What’s his next Herculean labor?  Getting hungry sharks to attack bleeding tuna?  

All the while, the bank problem festers and metastasizes.  Obama punts the problem to Wonder Boy–who flubs it.  Going on a week later, Geithner gets spanked by the G-7 finance ministers (well, at least he did better than the drunken Japanese guy), and still nothing.  

I think it’s because Obama and pretty much everybody else is a political animal (go figure), and the politics have seized up because of the distributive implications of any alternative that has a chance of mitigating the problems.   That’s what happened in Japan.  Political pressures from banks, and from the zombie firms that the banks kept alive, prevented the government from cutting the Gordian knot.  

So, what is going on now, to the best I can figure, is that we have clatches of squabbling interest groups and politicians arguing over just how best to untie the knot.  That’s not gonna happen, and it’s not gonna work.  Somebody has to cut the knot.  And I think that somebody is too much of a politician to do it.

More Russian Energy Fun!

Filed under: Economics,Energy,Politics,Russia — The Professor @ 7:36 pm

Two stop-me-if-you’ve-heard-this-before stories relating to Russian energy.

First, ExxonMobil is complaining that the Russian government was staging a holdup on the heretofore unscathed Sakhalin I project:

ExxonMobil complained Friday that the government was preventing its subsidiary from continuing to develop a multibillion-dollar project in the Pacific Ocean, just days before the ceremonial opening of production facilities at a Gazprom-led neighbor.

The operator of the Sakhalin-1 project has clashed with the government over the terms of its production-sharing agreement, which exempts the venture from restrictions on gas exports. Exxon Neftegas Limited has faced pressure from Gazprom to scrap plans to export the prospective gas to China in favor of selling it to the state-controlled company.

The Energy Ministry said late Friday that Sakhalin-1 must cut its budget by 15 percent to 20 percent, in line with reductions at other projects, including Sakhalin-2. The cuts must focus on optimizing costs — including for materials and services — rather than halting work, which would delay the project’s launch, the ministry statement said.

The conflict comes days after an Energy Ministry-led body approved the budget for Sakhalin-2, a rival multinational offshore project. The Gazprom-led Sakhalin-2, which operates under a PSA with Royal Dutch Shell, is preparing to launch Russia’s first liquefied natural gas plant on Wednesday.

After sustained pressure over purported environmental violations, Shell handed over control of the project to Gazprom in 2006.

Exxon Neftegas has “no choice but to implement a controlled and orderly suspension of work” on two fields off Sakhalin because the government has not approved its investment plan for this year or supplements to last year’s budget, ExxonMobil spokeswoman Dilyara Sydykova said Friday, before the ministry’s statement.

Sydykova could not be reached for comment Sunday.

The ExxonMobil subsidiary operates the Sakhalin-1 oil and gas project for an international consortium, which also includes a group of Japanese companies such as Itochu and Marubeni, a subsidiary of Indian state energy firm ONGC and two Rosneft units.

ExxonMobil says the delay is because of bureaucracy at the Authorized State Body, which approves budgets for projects operating under PSAs.  

The body includes officials from the energy, finance and natural resources ministries as well as local officials from Sakhalin.  

Exxon Neftegas was planning to start drilling production wells on its Odoptu field and continue building a gas pipeline from the field to the shore, the Sakhalin government’s industrial safety watchdog reported recently, Interfax said. The company was also preparing to halt unspecified work at another field, Arkutun-Dagi.

Chayvo, the third field, began producing oil in late 2005. Gas production followed, but the company needs to invest more to produce enough gas for exports.

Exxon Neftegas has “fully responded to all” information requests that is within the requirements of the project’s PSA, Sydykova said. The Sakhalin-1 development has provided the region with resources, jobs and revenue, she said.  

“The Sakhalin-1 future phases will significantly expand these benefits to the state and local communities, but we are concerned that the Authorized State Body’s failure to approve budgets may defer or limit these positive results,” she said.

Operators of PSAs have traditionally inflated costs to claim a greater share of the output, said Konstantin Simonov, director of the Fund for National Energy Security, a think tank. Exxon Neftegas may be trying to coerce the authorities into accepting its investment plan by threatening a scandal before the grand opening of the LNG plant, he said.  

President Dmitry Medvedev is expected to attend the opening, and Japanese Prime Minister Taro Aso has been invited.

The Industry and Trade Ministry, which used to oversee the project, approved last year’s budget for Sakhalin-1 in December 2007, striking down a proposal to start designing a pipeline to China.  

Gazprom deputy chief Alexander Ananenkov said at a government meeting earlier that year that the company wanted all Sakhalin-1 gas for domestic supplies.

ExxonMobil has a tentative agreement with China’s CNPC to sell the country 8 billion cubic meters of gas annually by pipeline. It is also supplying gas to the local market from its only operating field, Chayvo.

A Gazprom spokesman declined comment Friday. Simonov and Alexei Kokin, an oil and gas analyst at Metropol investment company, said they doubted Exxon’s problems were linked to the talks with Gazprom.

Now, perhaps XOM is engaging in ex post opportunism, in an attempt to extract rents from the PSA.  But I place very high weight on Russian shenanigans given: (a) the track records of the Russian government and Gazprom, and (b) Gazprom’s desperate need for gas to meet domestic demand and export needs in the face of declining output (down 10.5 pct year-on-year in January, although that reflects in part the gas war) and having to pay what are now above market prices for Turkmen gas (I’m sure it sounded like a good idea at the time).  I am metaphysically certain that it is stark raving nuts to dismiss out of hand, as Simonov and Kokin do (last paragraph), the possibility of any linkage between Exxon’s difficulties in Sakhalin with talks with Gazprom about which way the gas will flow.  

XOM is in far better shape to withstand Russian pressure than BP, or Shell for that matter.  Moreover, the company has told Venezuela to pound sand in response to expropriations, and may well send the same message to the Putinistas as it did to the Chavezistas.  Here’s hoping.  

Sure puts a different spin on Putin’s sweet words (delivered in Davos) about Russia’s desire to attract foreign investment, don’t it?  I also remember Putin saying late last year in the presence of Shell’s CEO that foreign oil investors had no reason to fear the safety of their investments in Russia.  Ha!  [And yes, that’s a laugh, not a stray Russian preposition.]

The second story is one of intramural rent wrestling:

Prime Minister Vladimir Putin agreed on Thursday to consider more incentives to reverse declining oil output, as the energy minister delivered the grimmest outlook yet for the industry.  

Crude output will drop by nearly 8 percent from last year’s level through 2013 if the government doesn’t provide further aid to producers, Energy Minister Sergei Shmatko said at a meeting that Putin convened at a refinery outside St. Petersburg to talk to oil executives.  

Any potential incentives would further dent federal revenues, which are already expected to contract drastically this year on the back of low oil prices and the global economic crisis.  

Putin announced that the government was willing to discuss lower export duties for oil that is flowing or will flow later from eastern Siberian green fields. These new fields must also enjoy lower taxes, he said.  

Existing fields in western Siberia have been depleting, forcing companies to venture out into wilder expanses to the east.  

“We know that transportation costs are high there and infrastructure is not developed,” Putin said to the chief executives of companies including Rosneft and LUKoil, the country’s biggest and second-biggest crude producers, respectively. “I believe it’s possible to support you.”  

In return, the companies will have to invest the money that they save on taxes in exploration and development, “not bonuses or other needs that are not of primary importance,” Putin said.  

Current taxes do not encourage companies to invest in new fields, Putin conceded. If introduced, the new incentives will come in addition to a package of tax breaks that was approved last year and went into effect in January.  

Putin said at the meeting — held at the Kirishi refinery owned by No. 4 crude producer Surgutneftegaz — that the previous measures would help the industry to save 500 billion rubles ($14.3 billion).  

The easing of the tax burden coincided with the devaluation of the ruble, benefiting the oil industry by raising the amount of rubles being earned from exports.  

Despite that, Shmatko said oil companies might fall short of 200 billion rubles earmarked this year to invest in increasing output. Next year, the shortage may expand to at least 500 billion rubles, he said, citing data from oil producers.  

“The industry is stagnating,” he said.  

Should the government not -intervene, oil output will drop to 450 million tons per annum by 2013, he said. He said the forecast was based on an oil price of $60.  

Alternatively, production will grow to 511 million tons by that year if the state extends more tax breaks and state guarantees for loans, Shmatko said.  

Russia produced 488 million tons of oil last year, registering the first annual production drop in a decade.  

Shmatko’s estimate for output contraction is realistic only if the oil price falls further, said VTB analyst Svetlana Grizan. A barrel of the Russian export blend, Urals, has stabilized at about $40 in the past several weeks.  

As a way out, Shmatko offered a transition to a tax on excess profits for new fields, but it was unclear if the proposal received the green light from Putin at the meeting. Putin said any new taxes in the oil industry must be easy to collect.  

Analysts have warned that oil producers might want to inflate their costs to reduce tax payments in the event that an excess-profits tax becomes reality.  

The oil industry generated 43 percent of all federal budget revenues, or 4.4 trillion rubles, last year, Shmatko said.

Shmatko also warned that the transportation rate of $16 per barrel on the East Siberia-Pacific Ocean pipeline that Transneft plans to charge would make oil production unprofitable in eastern Siberia. The pipeline is scheduled to begin operating in December.

This could reflect an industry poor-mouthing in order to extract more from the government.  But, it must be recognized that the Russian oil tax regime is draconian, not to say punitive, and that it drastically reduces the incentive to invest, especially in low-to-moderate price environments like those of the present.  It should also be noted that some of the output declines reflect the inefficiency of Rosneft, a poster child for the economic consequences of Putinism.  

This is also just another illustration of the myriad Russian policy dilemmas.  The budget is heavily dependent on tax revenues from the oil sector.  The budget is deep in the red.  So, cutting taxes will exacerbate an already desperate budgetary situation–and put further pressure on the ruble.  The RF needs revenue today.  Lots of it.  But, the ability of the industry to generate revenues for anybody, including the government, in the future is threatened by the maturation, and outright decline, of existing fields and the tax-driven (and lack-of-property-rights-driven) lack of incentive to invest in new fields.  Russia must choose: money today, or money tomorrow.  Even though reducing taxes would be a positive net present value move (i.e., the present value of future taxes would almost certainly be greater than the value of the taxes foregone), the pressures of the short term crisis may well lead the government to choose to let the future take care of itself, and to attempt to maximize current revenues.

I especially liked Putin’s remark that any tax had to be easy to collect.  This speaks volumes about (a) his trust in the probity of Russian corporations, and (b) his stationary bandit mentality.

One last historical note.  Part of the discussion raging on SWP over the weekend focused on the role of the collapse of oil prices in the late-80s in causing the demise of the entire USSR.  I should note that not only did oil prices decline, but Soviet output plunged too.  The finances of the USSR were thus hit by the effect of selling smaller quantities at lower prices.   That’s exactly what Russia faces today.  It’s deja vu all over again.  

Apropos that earlier discussion, I agree that the structural defects of the Soviet economy, and the burdens imposed on it by a gargantuan defense establishment, were far greater than today’s counterparts.  That doesn’t mean, however, that the Soviet precedent is irrelevant.  Russia is unlikely to fall as far as fast as the USSR, but that is cold comfort.   If A died from falling from a 100 story window, should B take solace because he is plunging only from the 40th floor? I think not.  The RF’s economic problems aren’t as bad as the USSR’s, but they are of the same kind, and sufficiently severe to jeopardize the country’s short, medium, and long term economic health.

This is a Story About Something Russian that IS Crashing to Earth

Filed under: Economics,Military,Politics,Russia — The Professor @ 6:14 pm

Over the weekend numerous Texans reported a mysterious fireball in the sky.  Initial reports suggested that it was debris from a falling Russian satellite that had collided with an Iridium telcom satellite.  Subsequent investigation showed that the streaking object was in fact a meteor, and not Son of Sputnik falling to earth.

There is no uncertainty, however, about today’s news reports of the plummeting Russian manufacturing sector.  Bloomberg reports that Russian manufacturing suffered an “unprecedented” drop,  hard on the heels of a dismal December; an event that the government had promised would not be repeated.  Wrong:

Russian  industrial production  slumped more than economists expected in January as demand eroded for cars, trucks and construction materials.

Output shrank an annual 16 percent after falling 10.3 percent in December, the Moscow-based  Federal Statistics Servicesaid today. That was the biggest contraction since the service moved to a new methodology in 2003. The median estimate in a Bloomberg survey of 12 economists was for a 12 percent decline. In the month, production dropped 19.9 percent.

. . . .

Manufacturing fell an annual 24.1 percent in January, compared with a 13.2 percent drop in December. Tire production plummeted 83.1 percent as car and truck output fell 79.7 percent and 76.4 percent, respectively. Output of cement fell 44.3 percent as builders struggled to find funds to complete projects.

AvtoVAZ, Russia’s biggest carmaker, idled its production line for a month on Dec. 29, while KamAZ, the nation’s biggest truck producer, resumed output on Feb. 12 after halting production in December.

“The car plants, the train car factories are at a standstill. The pipe makers are working part time, construction has stopped,” said  Alexander Mastruev, the personnel chief of OAO Magnitogorsk Iron & Steel, Russia’s third-largest steelmaker. Magnitogorsk had the biggest output cut in the fourth quarter among the country’s top six steel companies.

‘Don’t Believe This’

“To hope that we’ll return tomorrow or the day after to the volumes we had before, of course we don’t believe this will happen,” Mastruev said in an interview shown on state channel  Vesti-24 today.

Mining and quarrying contracted an annual 3.6 percent in January as iron ore output fell an annual 39.7 percent.

The contraction of industry contributed to joblessness surging by about half a million people in December, boosting the unemployment rate to 7.7 percent.

The WSJ added: “Industrial production fell 10% in December from a year earlier — a rate alarming enough to prompt assurances from the Kremlin that the numbers wouldn’t get worse in the coming months. Many officials even talked about Russia’s overall economy recovering somewhat by the end of 2009″ (emphasis mine).  I guess that assurance is no longer operative.

To put things in contrast, a 12.7 percent (annualized) drop in Japanese GDP–about half as much as the decline in Russian manufacturing output–drew gasps of shock from the world economic/financial community.  Now, manufacturing is more volatile than GDP, but nonetheless, a 24 percent annualized drop in any major sector is an economic disaster.  

Why is this happening?  Well, part of it is the world economic recession/depression, which is hitting manufacturers everywhere very hard.  But Russia certainly exacerbated this problem dramatically through its currency policy.  As I’ve written for months, keeping the currency artificially high would hammer Russian manufacturers.  Here’s the proof.  The currency chickens have truly come home to roost.  

Given the predictable effects of its currency policy, you wonder why the government would give assurances that happier days would arrive in January after a disastrous December.  Putin et al were trusting to luck, and counting on short memories if luck didn’t come through, I guess.

In response to the news, the ruble fell substantially relative to the both the dollar and the euro today, giving up a good chunk of the gains it clawed back last week.  The ruble was down about 1.7 percent relative to the dollar today, and about .5 percent relative to the euro.

Persisting in a defense of the currency will be a double whammy.  It will continue to throttle manufacturing by making domestic output uncompetitive.  Also, the current method of choice to support the currency–higher ruble interest rates–will also make credit for domestic firms more expensive.  As a result, the February bloodbath may not be as bad as January’s, but this month will almost surely show continued contraction of Russian manufacturing.  

And, obviously, this will not hit just billionaires and oligarchs.  Of course, their fortunes are imploding, and their numbers contracting  (pardon me while I wipe away a tear), but this manufacturing holocaust will hit ordinary Russians very, very hard.  Moreover, this, and the broader economic turmoil, is forcing an additional 15 percent cut in the RF budget in order to keep the deficit within 8 percent of GDP.  

This illustrates the severe constraints facing Russian policymakers.  If the budget blows out, the currency will collapse.  To prevent that, the government is cutting spending, and given the magnitude of the cuts, they will likely fall widely, and impact social and income support programs.

Which raises a question.  How will expenditures on the Russian Empire of Dreams fare?  The signals are conflicting.  On the one hand, as recently as last Wednesday Putin said that the planned increase in purchases of military hardware would not decline despite the rising budgetary pressures and existential economic crisis.  On the other, there are reports that defense expenditures will be cut by the same 15 percent as the overall budget.  So which is it?  Is Putin just lying?  Or is there disarray in the government?  Who knows?  And that’s as disturbing as anything, and another illustration of the maddening opacity of Russian governance, especially in the Age of the Dyarchy.  

And remember that just last week saw Russia make sweeping financial commitments to Belarus and the ‘Stans, all in an effort to keep out the Americans and advance imperial dreams.  

Interesting commentary on priorities, dontcha think?

February 13, 2009

Random Russian Stuff

Filed under: Economics,Energy,Politics,Russia — The Professor @ 4:56 pm

The ruble has rebounded strongly in the last week, despite no great strengthening in fundamentals.  Oil has been down/sideways during the period of the ruble rally.  News about the budget has been grim.  So what’s going on?  For one thing, the central bank is defending the band much more aggressively.  It’s reserves declined some last week (about $3 billion), but more importantly it cut the amount of liquidity it is supplying to the banks, jacking up interest rates, and the government is applying extraordinary (read–Chekist, the “All-Russian Extraordinary Commission etc.”) means to put pressure on banks not to sell rubles for dollars.  

The reduction in loans and the rise in interest rates have supported the ruble but has bad implications for the banks, and for borrowers.  Just an illustration of the Hobson’s choice the central bank/government face.  

Another factor in the rally is perverse, in a way, and actually reflects the bearish Russian outlook.  The odd announcement from the Russian Association of Regional Banks (subsequently sort of denied) that European banks were interested in restructuring their Russian loans due to their precarious condition spurred fears about the possibility that the banks had suffered severe losses on these loans (and others to emerging markets.) This contributed to a sharp drop in the Euro:

Speculation of European bank losses on Russian loans drove declines in the euro against the dollar and yen today. Russian President Dmitry Medvedev has pledged more than $200 billion in emergency funding to support banks and companies as the 62 percent decline in oil prices since August and the ruble’s 34 percent tumble against the dollar push the world’s biggest energy supplier into its worst economic crisis since the government defaulted on $40 billion of domestic debt in 1998.

. . . .

“People expect that part of these debts were from the European banking system,” said  Sebastien Barbe, a strategist at Calyon in Hong Kong, the investment banking unit of France’s Credit Agricole SA. “You already have a very weak banking system in Europe. If you have these Russian issues, the next step would be questions about whether similar problems will come out of other eastern European countries.”

Whereas subprime mortgage debt proved the Achilles heel of the US banking system, Europe binged on emerging market debt–including a lot to Russia.  That’s a major source of concern.  And given the interconnectedness of the European and North American banks, bad news for Eurobanks isn’t good news for American ones.

Another very peculiar story that may be freighted with serious implications–or not, as it’s always hard to tell in Russia–is the news that a Russian prosecutor accused current and past deputy finance ministers of fraud and corruption:

A senior Russian prosecutor accused past and present deputy finance ministers on Thursday of large-scale theft of state funds in signs of renewed pressure by hardliners on liberal Finance Minister Alexei Kudrin. The allegations coincide with a sharp economic downturn that has revived a long-running turf war between rival groups in the government over how Russia’s diminishing cash reserves should be spent.

“It would not be an exaggeration to say that some of the best specialists in finance and economics, including a former and a current deputy finance minister, have been involved in organising large-scale theft of state funds in recent years,” Alexander Bastrykin, the head of the investigative committee of the Prosecutor-General’s office, was quoted as saying.

Later the prosecutor narrowed his accusations to  Deputy Finance Minister Sergei Storchak and ex-Deputy Finance Minister Vadim Volkov, implicating no other officials.

Still, this is widely interpreted as an attack on Kudrin, most likely on Sechin’s behalf.  In the context of the immense challenges Kudrin faces in dealing with the financial crisis such a war would be extremely damaging to Russia.  Moreover, if Sechin gains the upper hand, it is likely that resources will be transferred to support state companies, or to facilitate increasing state control over other companies.  Given that these state companies–most notably Sechin’s own Rosneft–are notoriously inefficient, and likely serve as tunnels for smuggling wealth into the pockets of the connected, such a transfer would contribute to even more drag on the Russian economy.

The last item I have time for relates to something I blogged on a couple of days ago, namely the frantic Russian efforts to buy friends at a time when its financial resources are incredibly stressed.   Eurasia Daily Monitor Reports that Russia is planning to spend $7.5 billion to “bail out” former Soviet republics.  Belarus’s Lukashenko is asking for more and more money.  Russia just ladled out $2 billion to Kyrgyzstan.  

This is another example of the back-to-the-future nature of Russian policy.  As the Soviet economy imploded in the mid-to-late-1980s, the Soviet government felt compelled to support financially its similarly troubled Warsaw Pact allies in its bid to maintain its superpower status.  

The Soviet aid of decades ago, and the current Russian aid, is intended solely to buy geopolitical relevance.  In times of existential economic crisis, this is an expenditure that the USSR could not afford, and Russia cannot afford either.  But away they go.  

This is another illustration of the futile, learned nothing-forgotten nothing compulsion driving Russian policy.

What’s Really Going On?

Filed under: Derivatives,Economics,Politics — The Professor @ 12:16 am

The passage of a couple days since Treasury Secretary Timothy “Eraserhead” Geithner’s speech on the planless plan to heal the banking system has led me to the conviction that it was not just stupid and damaging (to Geithner, the administration, but most importantly the country), but it was just plain strange.  Passing strange.  Certainly Geithner and Obama, who didn’t want to “steal [Geithner’s] thunder” (no need to worry about that!), should have known that the release of the Treasury Term Paper would be an economic and political disaster given  the buildup for the speech, and the market’s near frantic desire for some indication that some resolution was in sight.  So why did it happen?

The speech was delayed one day as it was.  But the anticipation was so great that Geithner could not wait any longer.  So, even though he had nothing concrete to deliver, he was compelled to say something.  

Which raises the question: Why didn’t he have anything after Treasury had been working on things for months, and presumably the transition team had made the banking situation a priority?  (Remember Obama announced Geithner’s nomination days after the election.)  They had to have something much more detailed than what Geithner presented.  

This all leads me to believe that there is a vicious political battle over the banking plan going on at the very highest levels of the administration.  Note there were myriad leaks in the days running up to Geithner’s speech (most likely emanating from Geithner or his minions) to the effect that the Treasury Secretary had beaten back attempts by White House political types (Axlerod was named specifically) to impose much more draconian restrictions on the banking system.  But the fact that Geithner did not announce a credible, detailed plan means that even if Axlerod and his allies did not prevail, neither did Geithner.  In other words, there is a stalemate.  I don’t see any other way to explain why Geithner would essentially appear naked before a watching world.  

One of the President’s jobs is to break stalemates between his subordinates.  It is clear that Obama has not done so in this instance.  Given the gravity of the situation, that is a serious failure.  

And here is my most troubling concern.  Banking has long been considered one of the “commanding heights” of the economy.  (That’s Lenin’s term, which he used when defending a retreat from hardline Bolshevism in the New Economic Policy; he rationalized the tactical withdrawal by saying that the party still controlled the commanding heights, including the banks.)  Government power over the banking system gives it incredible power over the broader economy.  Hardcore political types (e.g., Axelrod, many people in Congress) no doubt understand the tremendous political and economic advantages to be gained by retaining pervasive government control over the banks.  (To paraphrase Rahm Emanuel, a banking crisis is a terrible thing to waste.) Just think how popular Fannie and Freddie were in Congress.  They were beholden to Congress and did its bidding accordingly.  Think of a quasi-nationalized banking system as Fannie and Freddie on ‘roids.  That would be a leftist/statist politician’s dream.  

So, one explanation of what is going on is that elements in the White House and the Congress want to exploit the crisis to strengthen their control over the banking system.  Treasury and the banks themselves are pushing back.  There is now a stalemate, and Obama has not intervened to break it.  This is very dangerous.

It is a matter of particular concern that politicization of the banking system and the capital markets is self-reinforcing.  Politicization can occur because the dire straits in which the banking system finds itself make it dependent on government support.  But this government support comes at a price, in terms of investment and lending decisions driven by political considerations, rather than economic ones.  Such decisions do further damage to the financial condition of the banks, perpetuating their dependence on the government.  

Maybe this is unduly alarmist, but I find it hard to explain otherwise why the administration was unable to unveil a more complete and credible response to the banking crisis.  It also comports with the leaks about the behind-the-scenes struggles between the more Bolshi elements of the administration and the finance/technocrat types.  

Whatever the cause, this limbo is unacceptable.  And if we are in limbo because of an internecine struggle, it is incumbent on Obama to intervene forcefully to put and end to it, and decide.  

He won, after all.  He told us so.  Well, with winning goes the duty to make the hard choices and live with the consequences.

February 12, 2009

Congress Shall Pass No Law

Filed under: Derivatives,Economics,Exchanges,Politics — The Professor @ 11:37 pm

There’s an old joke that the Founding Fathers should have ended the Bill of Rights after the first five words of the First Amendment.   The lunacy surrounding derivatives regulation suggests that there is more than a little wisdom in that witticism.  

The House Ag Committee first mooted a proposal that would have limited the trading of credit default swaps to hedgers (only those long bonds could buy protection; only those short bonds could sell it).  That proposal met with snorts of derision and bellows of outrage from many quarters (including hereabouts, where I voiced both), so committee chair Peterson soon backtracked on that.  Then it was reported that the bill would permit the CFTC to summarily stop trading in CDS products.  As I was quoted in Bloomberg, that was an improvement, but it was still horrible.  So, channeling Maxwell Smart, Rep. Peterson said “Check that.  Would you believe that what I really meant was that CFTC could stop trading in CDS by those without positions in the underlying security only on companies that were subject to an SEC short sale ban.”  

Given that the SEC short sale ban was arguably one of the most idiotic public policy moves of recent memory (and the competition is very stiff in that category, sports fans), House Ag’s new position appears to be that the CFTC has the authority to imitate the moronic moves of a thoroughly discredited agency.  Great.

The bill’s future is extremely uncertain.  You might think that’s good news, but the reason for its tenuousness just gives rise to other concerns.  Barney Frank is moving to get control of the bill shifted to his committee.  Yes, the Barney Frank who should not be allowed within several galaxies of any responsibility for regulation of anything related to the financial system.  The Barney Frank who, if he had a scintilla of shame (I know, I know), would have retired to a hermitage in the aftermath of Freddie and Fannie.  One can only imagine the mischief and mayhem he can create given control over derivatives market regulation.

Congress shall pass no law.  Sounds good to me.  But it will.  And, as the old saying goes, no man’s life, liberty, or property are safe while the Legislature is in session.  That mordant remark was never truer than today.

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