Streetwise Professor

And admits mistakes were made:

The Russian government overspent its vast oil revenues in recent years, fueling inflation, and did not do enough to reduce the economy’s reliance on oil, Finance Minister Alexei Kudrin said in an exclusive CNN interview.

“Of course, I too bear the responsibility for not managing to diversify the economy as much as we wanted,” Kudrin said. “We were spending more money than we could afford, which is why we had a rapid strengthening of the national currency [and] a high inflation rate.

“I think the government should have been more conservative in its financial policy and save more money that it received from the high global oil prices,” he said.

It is interesting, though, to look carefully at what mistakes Kudrin identifies.  This interview is really a shot at  Vladimir Yakunin and Yuri Luzhkov.  Those fierce Kudrin critics have argued that the Finance Minister was too stingy, and that rather than banking oil revenues, the government should have spent more on infrastructure, construction, etc.  Kudrin in effect responds that his only mistake was that he spent too much.  

An interesting glimpse at the infighting and recriminations currently going on between various factions in Putin’s Russia.

Speaking of Yakunin, and infighting, his Russian Railways is cutting back on infrastructure spending:

Plans to develop Russia’s railway system have been put into question as the government focuses on measures to combat the economic crisis, the head of the rail monopoly said on Monday, Interfax reported.

‘We are talking about the 100 billion roubles ($2.80 billion) meant for the development of infrastructure. This sum is now in question,’ the head of state-owned Russian Railways, Vladimir Yakunin, was quoted as sayingLast year, at the cusp of almost a decade of growth and high global oil prices, Russia laid out ambitious plans to overhaul its Soviet-era infrastructure over the coming decade.

The global financial crisis, however, is forcing the government to shelve many of these projects and spend its cash pile to prop up banks, support the value of the rouble and finance the social sphere.

And Yakunin is not happy about it.  And who does he blame?  That’s an easy one:

In the United States and parts of Europe, governments have taken a different approach, boosting infrastructure spending in an effort to create jobs and kick start the stalling economies. [In other words, the US is spending money it doesn’t have to build a lot of infrastructure it doesn’t need, and Russia doesn’t have the money to build the infrastructure it needs.  There are many ways to be screwed.]

Yakunin indicated that he would support this approach, but that bankers and financial experts are advising against it.

‘The approach of these financial experts is puzzling to us. Investment in infrastructure cannot cause inflation. It should be viewed as an instrument to avert the crisis, as a way of creating GDP growth, new jobs and a basis for future growth,’ he said, the news agency reported.

For “financial experts” insert “Kudrin.”  Note that Kudrin is supporting a more conservative government spending program that limits the deficit to 8 percent of GDP in order to prevent greater inflation.  Yakunin’s specific mention of inflation is clearly a direct response to, and attack on, Kudrin.  

Putin has come down on Kudrin’s side and against Yakunin’s in one area, at least for now: exchange controls.  Putin has come out publicly opposing them, and praised Kudrin’s exchange rate policy.  This is a slap at Yakunin, who openly advocated these controls.

But what’s interesting about this is that the disputes are becoming increasingly public.  The strains on the power vertical are showing.  And that bodes ill for Russia’s stability.  Along these lines, a Russian commentor, Dmitry Oreshkin, channels SWP too:

or most countries of the world, the global crisis is strictly economic. But Russia is experiencing two crises simultaneously — economic and political.  

Economic downturns, including the current one, come and go, but Russia’s political crisis will never go away. This is because Russia’s political model has always been deeply grounded in the myth of monism: one monolithic state, one party, one ideology, one national leader and one people. Those who lived during the Soviet period remember the ubiquitous overblown slogans of “the unity of all Soviet nationalities” or “the unified Soviet nation.”

Russia under Vladimir Putin’s leadership is doomed by historical inertia and tradition to continue the Soviet monistic model. United Russia is Putin’s modern version of the Soviet Union’s “United U.S.S.R.” — that is, the Communist Party. Nonetheless, United Russia is not as unified as Putin would like. There is the United Russia faction loyal to State Duma Speaker Boris Gryzlov, and there is the one loyal to Mayor Yury Luzhkov. Luzhkov rigidly controls the party’s membership in Moscow and won’t let any federal functionaries get within a mile of holding power.  

. . . .  

Putin could have continued propping up his Potemkin power vertical and his Potemkin democracy for many more years if the petrodollars kept pouring in. That money was crucial to keep Putin’s “circus lions” — that is, the various elite surrounding him — well-fed and docile. But now the money is running out, and it is frightening to consider the consequences. It is well-known that even the best-trained circus lions have been known to turn on their trainers unexpectedly, even when they are well-fed. Just think of what could happen if those lions are hungry — and angry. We have already heard the first menacing roars from Putin’s lions. They are gritting their teeth and salivating at the mouth. I am sure that Putin sees and hears all of this.  

Putin’s Potemkin village is about to fall apart at the seams, but this is nothing to rejoice over. The only pluralism we will see as the result of this collapse will be “armed pluralism” — that is, widespread protests and violence on the streets. The government will respond by further strengthening its autocratic rule.  

There is an outside chance that the collapse of Putin’s model might end with a whimper, but it all likelihood it will end with a huge explosion — like the lid blowing off an overheated pressure cooker.  

That’s what I’ve meant by brittleness; the system appears strong, but is subject to complete collapse if the necessary condition for its continuance–copious quantities of red meat for the lions–disappears.   The Kudrin vs. Yakunin spat in the press is probably a tame and censored version of what is going on out of the public eye, but could be a harbinger of turmoil and conflict to come.

There has been a lot of effort spent trying to figure out what Russia’s goals are in Afghanistan in the aftermath of its bribing Kyrgyzstan to deny American access to the Manas airfield in that Central Asian country.   One commonly heard theme is that the Russians are of mixed minds; they don’t want a Taliban victory, but they don’t want a solid American presence in Central Asia.   Ariel Cohen presents a far gloomier scenario:

Medvedev has announced that the U.S. needs to come to Moscow – not to the capitals of Eurasian independent states – to ask for transit to Afghanistan. Thus, Russia can first create a problem, and then provide a solution – at a price.

This is only the best-case scenario. In the worst case, Russia would benefit from a U.S. defeat in Afghanistan. First, it would be payback for the Soviet fiasco in the 1980s; second, and more importantly, such a defeat would highlight the collapse of NATO power, and with it, America’s global dominance.

Russia may mistakenly believe that, together with China and Iran, it can pick up the pieces in Afghanistan and prevent the Taliban from extending its influence over allies in Central Asia and the Caucasus. However, radical Islamists – not America – are the long-term systemic threat toward the “soft underbelly” of Russia’s south – a threat for which Moscow lacks answers.

To me, it is all about priorities, and what choices reveal about priorities.   Yes, from the Russian perspective a Talibanized Afghanistan is hardly desirable.   But it survived a decade of that before, and it is likely that the Russian military and policy establishments view that as a nuisance that can be survived again.   They realize that Afghanistan’s ability to project power is nil, and likely calculate that an Islamist threat can be contained.

For Russia, the big issue is the US.   Part of the reason is psychological.   Part of the reason is payback.   Part of the reason is hardwired imperial ambition.   A big part of the reason is energy, and keeping the United States away from Central Asian energy resources–resources that Russia (and Gazprom) desperately need to meet export commitments and domestic needs, especially in light of decling production and financial-crisis-constrained investment in new fields.

In brief, given a choice between a resurgent Taliban, and a deep American presence in Central Asia, for Russia the choice is clear.   Moreover, Russia is probably figuring it can have its cake and eat it too, by allowing the US to resupply via Russian territory.   This is a three-fer: it puts pressure on the Taliban, ties up the US in a difficult commitment thereby limiting its freedom of action elsewhere, and gives Russia the option to cause the US major pain down the road by cutting off this route, or raising dramatically the price of using it.   (There might even be an economic payoff from collecting transit fees from the US, but that is less certain given that it will cost Russia dearly to buy off the Central Asians.   But even here there may be an attraction to those making the decisions, because the cost of buying off may come out of the budget, but a good portion of the fees collected from the US might well flow into well connected pockets rather than the Russian state budget.)

The interesting thing to ponder is: What happens if Russia succeeds in keeping the US out of Central Asia?   As always, one should be careful what one asks for.   It will not be so easy to keep China out of Central Asia–because it’s already there.

China’s geographic position, unlike that of the US, is pretty symmetric to that of Russia.   China also has a great appetite for the region’s resources.   China also has substantial demographic advantages over Russia.   It also has economic leverage over Russia, and can put great pressure on Russia in other areas (e.g., Siberia). China is also not as constrained by diplomatic and civil niceties as the Americans (or the Europeans.)   Is Russia ready to go head-to-head with China if it succeeds in getting the US out of the way?   Methinks not.   But, in its myopia, its fixation on keeping the US out of its sandbox, Russia is (a) committing vast sums of money it doesn’t have, and (b) setting itself up for a confrontation in which the correlation of forces is not in its favor.

Good luck with that.

I should also note that there are reports that China is also attempting to pressure/cajole Central Asian states to give the US the cold shoulder.   Do you think that the Chinese are doing this, only to concede the region to the Russian orbit?   Methinks not again.

So, if China and Russia succeed in shutting out the US from the region–not a foregone conclusion–that merely sets up the final between these two countries.   I know who’d I put my money on.

So, contra Cohen, Islamism is not the main threat to Russia’s “soft underbelly.”   China is.   And China’s contact with Russia’s soft underbelly runs not just through Central Asia, but along the entire length of the Amur River to the Pacific.   And China is a full spectrum threat, whereas Islamists are not.   And, like Russia, China has a long memory, and an acute sensitivity to historical humiliations, many suffered at Russian hands.   Perhaps that is what should make Russia most nervous.

RIA Novosti reports that the Russian economy contracted 8.8 percent year-on-year in January.   That’s pretty bad, but in fact understates the steepness and intensity of the drop.

Consider the Russian economy was growing about 6 percent through August.   So, normalizing January 2008 GDP to 100, in August GDP was approximately 104.   Now, it’s 91.2.   This means that the drop from August to January is 12.3 percent.   Annualizing that gives an almost 30 percent per year rate of decline.

Economic Development Minister Elvira Nabiullina recently stated that the decline in January vs. December was 2.4 percent.   Annualizing that gives a 25 percent per year annualized decline.

To put things in perspective, the Japanese economy contracted at a 12.7 percent annualized rate in the fourth quarter of 2008.   The US economy contracted at a 3.8 percent annualized rate in the fourth quarter.   UK GDP fell at a 6 percent rate in that quarter.   For Germany, the figure is about 8 percent.   For the entire Eurozone, about 6 percent.   The OECD, 6 percent annualized.   Canada–can’t forget Canada!–well, didn’t forget, but can’t say, because its 4th quarter numbers are not out yet.   Ditto for Oz.

Given Nabiullina’s estimate of a 2.4 percent decline in January alone, it is heroic to put any faith in the government’s just revised estimate of a 2.2 percent drop in GDP for the entire year.   Given that the budget is based on a 2.2 percent number, that the projected deficit based on that number is 8 percent of GDP, and Kudrin has said that the country cannot afford a deficit of bigger than 8 percent of GDP without sparking greater than 14 percent inflation–well, draw your own conclusions.

For those (not naming names;-) who still believe that Russia is not among the nations hardest hit the global economic crisis, The Professor has some extra credit homework for you;-)   Find a country that has contracted more rapidly than Russia since August.

And, for those who persist in insisting that Russia is in better economic circumstances than the US, please choose a metric or metrics by which we can make the comparison.   Hint: Don’t use GDP growth.

In brief, the Russian economic condition is dire.

Well before the financial crisis, back in fact when Russia was back!  off its knees! I wrote several extended posts identifying what I believed to be a key vulnerability of the country’s political system.  Applying the theory  advanced by North, Wallis, and Weingast (their book is forthcoming next month), I argued that Russia is a “natural state.”  Relatedly, I analogized the Russian state to a cartel of violence specialists.  Both approaches emphasize the vital role of rents in maintaining the stability of the system.  Competing cliques (or clans) of violence specialists maintain an uneasy peace only because this allows them to divide rents, rents that in Russia derive primarily from natural resources, especially oil and gas.  I noted that both theories predict that the stability of this type of system is quite precarious.  More specifically, declines in rents eliminate the “glue” that holds the system together.  Thus, even when oil was going from $80 to $100 to $140, I made the conditional predictions that when prices fall, the system would be subject to stress; that the stress would be greater, the greater the fall in resource rents; and that there was inherently a large probability that the system would collapse in a flurry of infighting in the event of a large decline of rents.  

At the time I made the predictions, the conditions under which its predictions would be testable seemed remote, so I cannot be accused of designing my theory to fit contemporary facts.  The conditions are remote no longer.  They have arrived, and in a more severe form than I would have thought reasonably likely.  

So, now Russia presents a natural experiment to test my theoretical predictions.  Of course the system has not collapsed, and ardent Russophiles (you know who you are!) derisively dismiss even the possibility.  We’ll see.  I have noticed in the past several days, however, an accelerating stream of stories that suggest that inter-clan conflict is heating up in Russia.  

In past days I linked to, and wrote about, stories regarding Kudrin’s increasingly tenuous position.  Today’s FT has another article that suggests that the heat on him is increasing dramatically.  Both Moscow mayor Luzhkov and Russian Railways head (and silovik)  Vladimir Yakunin have publicly and viciously excoriated Kudrin.  (Interestingly, Yakunin openly called for currency controls, something that I opined might be in prospect, but which had not received widespread attention.)  According to the FT:

A senior Russian official on Tuesday called for the immediate imposition of exchange controls to ensure the foreign currency spent supporting the rouble was not taken out of the country.

The remarks from Vladimir Yakunin, the head of state-run Russian Railways and a close associate of Vladimir Putin, the prime minister, were seen as a thinly veiled attack on Alexei Kudrin, the liberal finance minister and the man behind recent efforts to defend the rouble by drawing $200bn (€159bn, £141bn) from the country’s currency reserves.

Mr Yakunin said “temporary” restrictions should have been introduced when the central bank started defending the currency last year. Having failed to act then, the authorities should act now, he said in an interview with the Financial Times. “It’s never too late, and better late than never.”

While Mr Yakunin did not name names, he pointed the finger at Mr Kudrin saying such measures were the “responsibility of the fiscal authorities”.

Mr Yakunin’s comments come amid a growing dispute in Moscow about the huge sums lost slowing the decline in the rouble. With foreign exchange reserves plummeting from an August peak of $597bn to $383bn this month, there is spreading unease among officials about who might be held responsible for the losses.

There are also fierce arguments between liberals and conservatives over policy, with conservatives wanting more public spending in the economy and complaining that funds have been wasted on ill-judged currency interventions.

Luzhkov blamed Kudrin for amassing large reserve funds, rather than spending money on infrastructure.  

Relatedly, commentor Michel pointed me to this Forbes article:

The growing queue for state bailouts among businessmen and the resultant political infighting are the key reason why Russia has no new budget for 2009 almost two months into the year.

When the country’s main financial document is finally ready in two or three weeks, as the Finance Ministry pledges, Kremlin watchers will have a rare chance to identify favourites by looking for cash winners in often opaque budget books.

Should there be too many lucky cash recipients, the government will be left hoping the oil price does not come down further, pushing the deficit out of control and resulting in a further devaluation of the rouble and a spike in inflation.

‘The budget will give us an idea of who managed to win the race,’ said Audit Chamber member and former parliamentarian Vladimir Semago, who saw Russia cut budget spending many times in the 1990s.

‘And besides the wide road and front staircase (for money) to Prime Minister Vladimir Putin, we will see a narrow path, a small door and a short flight of stairs with no handrail yet to President Dmitry Medvedev,’ said Semago.

. . . .

Russian firms, which borrowed heavily to fuel growth and must redeem over $100 billion in foreign debt in 2009, were shocked when the government this month halted its $50 billion direct refinancing programme after disbursing only $11 billion.

They must go now to commercial banks. As some of the biggest lenders will enjoy support from the anti-crisis budget, the struggling empires of the likes of aluminium tycoon  Oleg Deripaska  still bear hopes they won’t be allowed to go under.

‘There is a lot of noise, but all the money that is being disbursed to fight the crisis ends up in 10-15 resource companies anyway,’ said Alexander Lebedev, a businessman rare in his willingness to criticise the Kremlin.

This suggests to me (and to Michel) that the Kremlin and the RF White House recognize that there isn’t enough money to go around.  The impending social demands arising from rising unemployment and the shrinking pool of rents to spread around to the violence specialists and favored oligarchs means that Putin et al have to make choices, to cut some people and companies loose.

Put differently, Russia’s governing elite is facing a classic lifeboat problem.  There’s not enough food and water for everybody.  For some to survive, others are going to have to perish.  But who?  And who decides?  

This is the situation in which cooperation turns to conflict and competition.  Nobody wants to go over the side willingly.  What is there to lose by fighting?  Passivity leads to certain doom.  Sure, conflict is costly, and dissipates rents, but its better to survive and get a piece of a smaller pool than perish and get nothing.  So, it becomes every man for himself, and devil take the hindmost.

In the past I likened Kudrin to Horatius at the Gate, and said that if he went, there would be a free-for-all among the siloviki to grab the monies he husbanded in the seven fat years.  That would represent the watershed, the event that would accelerate the slide into conflict and chaos, as silovik battles silovik, clan battles clan to grab as much as possible as quickly as possible.  

The very public attacks on Kudrin, heretofore considered a close ally of Putin suggest that day is approaching.  Now three major public attacks have been mounted against him, by the special investigator, by Yakunin, and by Luzhkov.  These people would feel bold enough to make these attacks against Kudrin unless they already sensed that he was extremely vulnerable, perhaps having lost Putin’s confidence.  For Putin, not one to take responsibility, a scapegoat is a necessity.  And Finance Minister Kudrin is a tailor made patsy for an economic and financial crisis that is swallowing Russia whole.  (The only other alternative explanation is that these are attacks on Putin himself.  The implications of that would be even more dire.)    

In sum, this is playing out pretty much as the natural state/cartel theory predicts.  Moreover, the attacks on Kudrin suggest that the climax is approaching.  Rapidly.

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?

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.

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.

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.

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.

Thanks to Translations Online is this translation of an editorial from Nezavisimaya gazeta, which reads in part:

The apotheosis of this extravagance could be the decision, announced on Tuesday, to give Kyrgyzstan a loan of $2 billion and $150 million in nonrefundable aid. For the sake of comparison, the entire budget of this small mountain country is just over $1.1 billion. In exchange, President Kurmanbek Bakiev of Kyrgyzstan promised to close the American military base in Manas, through which the United States delivers supplies to its contingent fighting the Taliban and Al-Qaeda in Afghanistan. This expensive exchange is dubious from the economic and geopolitical standpoints. If the Americans and their allies suddenly leave Afghanistan, Moscow might have to restrain the radical Islamists in that region again.

Even expenditures of that size on allies might be justified in some way if it were not for the financial crisis, which has drastically reduced Russia’s own economic potential. Now this money is needed within the country. The Ministry of Economic Development and Trade expects a decrease of 0.2 per cent in the GNP. The country is in danger of dropping out of the top 10 economies in terms of dollars. The exchange rate of the ruble to the dollar was more than 1.5 times the present figure in July, and gold-backed currency reserves have decreased by more than one-third. The federal budget for this year will be adjusted in line with an income projection of only 6.5 trillion rubles instead of the 10.9 trillion in the current budget. The plans for spending cuts are still unknown, but the projected expenditures in the current budget amount to 9.024 trillion rubles. The number of unemployed might also double and exceed 10 million.

Even the United States, with the largest economy in the world, is tempering its geopolitical ambitions in the atmosphere of crisis. Barack Obama has announced the reduction of the contingent in Iraq and is urging Russia to reduce the nuclear potential of our country by 80 percent. Moscow, on the other hand, is eager to take advantage of the crisis to strengthen our position in the world and to restore and maintain our status as a great power instead of thinking of ways to solve its own socioeconomic problems. Furthermore, price is no object. In this sense, Russia is similar in some respects to the almost penniless Countess de Beauvilliers in Emile Zola’s novel  Money, who was willing to limit her daily diet to nothing but bread as long as she did not have to reduce her lavish banquet menu by a single dish, all for the sake of maintaining her image as a prosperous aristocrat. The sooner Russia gives up the great-power ambitions that are so inconsistent with the present state of its economy, the less the country, its population, and the physical production sector will have lost when the crisis is over. It would be regrettable if Russia were to make the same mistake as the USSR, wasting all of its resources on global confrontation with the West and trying to maintain its status as the world’s second superpower at any cost, to the point of the complete collapse of the economy and the disintegration of the country.

Emphasis mine.  

Politicians’ preferences are revealed by their choices.  Putin and Medvedev et al have made their choice very, very clear.  Theirs is to be Ozymandias, elevating their personal glory and dreams of imperial majesty, at the expense of a prosperous and decent society.  It is sickening, and as Penny suggests, sociopathic.  Why should we enable such behavior by bargaining with them over NATO, or missile defense, or anything else that the Putinists and chekists want?  

Remind me again.  Who is the Russophobe?  Only someone who has identifies the interests of Russians with the Russian state, who believes that Russians are state property only meant to serve the state, can consider such a deluded and inhumane agenda to be Russophilic.  

A couple of remarks re raining money on the ‘Stans, while offering to allow the US and NATO to transport supplies (non-military) to Afghanistan across Russian territory.  First, Ivanov and others in Russia have said–with straight faces–that there is no connection between Kyrgyzstan’s decision to close the Manas airbase to the US, and the financial largesse provided by Russia.  Please.  Don’t insult our intelligence.  Second, the Russians know that we know that they can allow the US supplies to reach Afghanistan via Russia today–but not tomorrow, on their whim.  Denying us use of Manas while providing access to Russian rails keeps their hand on our windpipe (to clean up the metaphor I was originally going to use).  Their grip is loose now, but it could tighten at any time.  There is no way that we can safely plan military operations on such an unreliable logistical foundation.  (Remember that military phrase: “Amateurs talk tactics.  Professionals talk logistics.”)  

This is just laying the trap for Russia to make demands on some other issues (missile defense, Ukraine, Georgia, gas pipelines) and threaten to withdraw the logistics route at a critical point in Afghanistan operations unless we cave to their demands.  And, at the time of such withdrawal, they will again insult our intelligence by claiming that it had nothing to do with negotiations over missile defense, or Ukraine, or whatever.  

Putin revels in playing hardball, being the tough guy, the gangsta.  This is just another one of his Sopranos tricks.  The question is, will we play hardball too?  “Reset relations” my a**.

Postscript.  The Kyrgyzstanis clearly realize that there’s a quid pro quo–Russian money in exchange for kicking out the US:

Kyrgyzstan officials have said they want the base closed, but lawmakers there said Monday that the parliament will delay voting on it until Russia provides $450 million in loans and aid it promised when Kyrgyz President Kurmanbek Bakiyev made the base announcement Feb. 3. “We have decided to wait until the Russians send the money,” Communist Party deputy Absamat Masaliyev, a member of the parliament’s coordinating body, told the Associated Press.