Streetwise Professor

October 13, 2014

Russia in a Nutshell: Three Stories That Convey Important Truths About an Aggressive, Mendacious, and Economically Weak Empire

Filed under: Commodities,Economics,Energy,Military,Politics,Russia — The Professor @ 2:43 pm

A quick rundown on some Russia stories. Three stories that encapsulate important truths about an unhappy country that seems intent on forcing others to share in its unhappiness.

First, there was a lot of attention paid to Putin’s announcement that 17,000 soldiers would be withdrawn from Rostov, on the Ukrainian border, to return to their bases. The reactions are a combination of poor memory, ignorance, and wishful thinking. Poor memory because something similar happened in the spring, which didn’t preclude an invasion in the summer. Ignorance, because if you are aware of Russia’s conscription cycle, you are aware that the fall 2013 conscript class is due to be mustered out, and units must return to their bases to discharge last year’s class and induct and train this year’s. That’s what happened in the spring. This ignorance is inexcusable now, as it was written about in the spring, notably by Pavel Felgenhauer: I wrote about it here as well. Wishful thinking, because everyone is grasping at the hope that Putin will back down from the Ukraine battle. As if.

There is no news here. This is an artifact of Russia’s conscription system. Period. Watch for new training exercises in a few months, and the deployment of units to the Ukrainian border again, once the new conscripts are integrated into their units.

Second, Russia will sign several intergovernmental agreements with China when Premier Li visits next month. One of them is an agreement to export gas from Russia to China.

I know what you’re thinking: “Wait, didn’t they sign that deal to huge fanfare back in May?” Apparently not:

Russia has prepared intergovernmental agreements to sign during Chinese Premier Li Keqiang’s visit to Moscow next week including one on a $400 billion natural gas deal agreed in May, Russia’s deputy foreign minister said.

Russian gas exporter Gazprom and China National Petroleum Corp (CNPC) have agreed that Russia will supply China with 38 billion cubic metres of gas starting from 2019.

Yet on Friday Gazprom said an intergovernmental agreement between Russia and China required for the plan to come into force had not yet been signed.

Russian Deputy Foreign Minister Igor Morgulov told Chinese state news agency Xinhua that governmental agreements including one on gas were ready for signing during Li’s coming visit.

“They include an intergovernmental agreement on natural gas supplies via an “‘eastern’ route,” he said. [Emphasis added.]

Proving yet again that announcements from the Russians about any deal should be treated with extreme skepticism. They are the masters of vaporcontracts.

The Russians are touting various deals with the Chinese as proof of their invulnerability to western sanctions and pressure. The feebleminded believe this. In fact, Russian desperation is palpable: the fact that they hyped the gas non-deal is a perfect example of this. If you don’t think that the Chinese are aware that they have the whip hand here, and are flogging the Russians for all it is worth, please contact me. I’ve securitized some bridges, and I’m sure they’d be perfect for your portfolios!

Third, the Russians are in full paranoid mode over the decline in oil prices. Brent is down to $88/bbl, which puts Urals at about $86. Speaking of 86, they are having flashbacks to 1986, when the Saudis flooded the world with oil. This began the fatal crash of the Soviet economy (described well in Gaidar’s book, Empire).

The vice-president of Russia’s state-owned oil behemoth Rosneft has accused Saudi Arabia of manipulating the oil price for political reasons. Mikhail Leontyev was quoted in Russian media as saying:

Prices can be manipulative. First of all, Saudi Arabia has begun making big discounts on oil. This is political manipulation, and Saudi Arabia is being manipulated, which could end badly.

Er, this is way different from 1986. At most, the Saudis have increased output only slightly (about 100kbbl/day): in ’86, they more than doubled output. The Saudis are just acknowledging market reality. Demand is weak,  supplies from the US are growing, and Libya is coming back into the market. Put those  things together, and prices are inevitably going to fall. The Saudis can see the writing on the wall, and their market share is sufficiently small that unilateral reductions in their output are not economically rational. Funny, now that I mention it: Saudi market share is about the same as Russian market share. The Russians produce up to capacity, because that is profit maximizing. Yet they expect the Saudis to cut back output? Of course they do! The Saudis should sacrifice their own interests to bail out the Russians! Of course they should!

Leontyev seems to be vying with the Gazprom guy Komlev to see who can make the most idiotic statements about world energy markets. Something that commentor Ivan passed on suggests that as idiotic as Komlev was, Leontyev has him hands down. The Rosneft spokesman also blamed low oil prices on ISIS selling oil at a “triple discount.” Hilarious! World oil prices are determined in the world market. ISIS has to sell at a huge discount because it is politically radioactive, and because it cannot access world markets directly. Those to whom it sells pocket the discount to adjust for the risk of dealing with a political leper (a radioactive leper!-I’m not mixing metaphors), and sell at the world price. The world price is determined by world output, not the price of the first sale. If anything, ISIS is propping up prices by reducing output in Syria (not a big deal) and threatening output in Iraq (a bigger deal).

Together, these three stories convey important truths  about Russia. And truth is ugly indeed. An aggressive, economically tottering empire dependent on commodity rents, and constitutionally unable to tell the truth or deal with reality.

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15 Comments »

  1. How do we know if Russians are not deliberately crashing the stock market these days?

    Comment by LL — October 13, 2014 @ 2:53 pm

  2. >This began the fatal crash of the Soviet economy (described well in Gaidar’s book, Empire)

    Gaidar’s fairy tales are first and foremost a maskirovka operation to deflect attention from this: http://www.wilsoncenter.org/event/putins-kleptocracy-who-owns-russia . What was crashing was not the economy as such, but rather that particular edition of the Moscow-centered extraction system, the hierarchy of kormlenie roughly based on CPSU rank. In response to which the nomenklatura hastily liquidated the assets and stashed the proceeds in the West so that it would have the means to preserve power and restore the kormlenie in a slightly different form later. Like now.

    The drift of Ukraine out of the newly consolidated hierarchy of kormlenie is an existential threat to this project, a very real possibility that the whole “geopolitical tragedy” will have to be played again – for the second time in one little Putin’s lifetime. So of course they are not very worried about losing some fish to sanctions when their fishing rod is at stake, especially while the West is making sure it is small fish indeed.

    On the other hand, to have the oil price or some such wind direction seal the fate of such a grandiose parasitic structure: truly infuriating 🙂

    Comment by Ivan — October 13, 2014 @ 4:11 pm

  3. I see that Gazprom has made bumper (rouble) profits this quarter – because the rouble has collapsed against the dollar. Vodkas all round!

    Comment by Tim Newman — October 14, 2014 @ 3:58 am

  4. Professor, I believe that Saudi Arabia has the ability to cut and restore production easily in contrast to Russia, where a meaningful cut in total output would require shutting down thousands of wells, which is not only costly but could harm long-term production profiles from some fields. I can’t be sure about KSA but I would guess the average flow rate is 5,000 bpd per well so they need to shut down 100 wells to cut by 0.5 mn bpd. With the average well producing at just 70-75 bpd, Russia would have to stop 7,000 wells. This is not to say that Russia would act as a global valve like KSA if it physically could – but it’s merely unable to.

    On Gazprom, I’m glad to see I’m not alone in sensing their hurt. It’s starting to look like (un)conditional surrender to the Chinese. Under the sanctions, Gazprom cannot borrow, cannot import equipment for LNG plants and cannot drill offshore. All that remains is to pledge future deliveries of piped gas against Chinese loans called “prepayment”.

    Tim, this time it’s the other way round. Gazprom is a net borrower in hard currencies. It reports in rubles under IFRS. When the ruble weakens, Gazprom must post a forex loss as its net debt grows in ruble terms. But the ruble actually strengthened in 2Q 14 so Gazprom reported a forex gain, in contrast to 1Q 14, when the ruble had indeed collapsed. (Or, rather, plunged; “collapsed” is what it’s done since mid-2014.) Anyway, backward-looking paper gains and losses aren’t very interesting. Look at what happened to gas exports in 3Q14… and is probably still happening.

    Comment by Alex K. — October 14, 2014 @ 6:55 am

  5. t reports in rubles under IFRS. When the ruble weakens, Gazprom must post a forex loss as its net debt grows in ruble terms.

    Ah, okay. I assumed that its sales are in USD but reports profits in rubles, so when the ruble weakens against the dollar its profits grow.

    Comment by Tim Newman — October 14, 2014 @ 7:52 am

  6. @Alex K. Good point. I was focusing on the demand side. Countries with similar market shares will face similar demand elasticities, and choose similar outputs if they have similar cost structures. However, it is costlier for the Russians to cut output (because they have to shut more wells, assuming a fixed cost element to a shutdown) their output will remain relatively constant even if demand declines, whereas it would be rational for the Saudis to cut. Got it. Thanks for the correction.

    The ProfessorComment by The Professor — October 14, 2014 @ 5:45 pm

  7. Tim your statement is correct: about 3/4 of Gazprom’s gas sales is in dollars, and probably over half of its overall revenue. At the top line, things look dandy: 2q14 revenue increased not only in rubles but also in dollar terms. Gas exports to Ukraine were the prime driver: they more than doubled in 2q14 on 2q13, and Gazprom also hiked the price by $100/1000cm (from 2q13) to $485/1000cm.

    Trouble is, Ukraine hasn’t yet paid a cent for 2q14 gas and who knows if they ever will. PWC must have warned Gazprom: you can only book that revenue if you impair the associated receivables. Which Gazprom did and wrote off 95% (maybe 100%) of 2q 14 Ukraine sales. That opex line canceled out 60% of the yoy revenue increment. There were two other opex items I don’t quite understand… anyway, EBITDA fell 36% on 19% revenue growth, yoy.

    Luckily for Gazprom’s PR effort, at the end of June the ruble firmed up – not for long – so below the EBITDA line, they recorded a forex gain almost equal to the impairment of Ukraine debt. Plus, back in 2q13 Gazprom had a large forex loss. The net effect was an increase in net income yoy.

    And then came 3q14: gas exports plunged and the rouble dropped from 33.6 to 39.6 to the dollar…

    Apologies for straying off topic for too long.

    Comment by Alex K. — October 15, 2014 @ 3:29 am

  8. The 1986 oil price collapse is well-discussed in US policy circles- although the motivation is controversial. http://www.politifact.com/punditfact/statements/2014/mar/13/michael-reagan/ronald-reagans-son-says-his-father-got-saudis-pump/

    but question for Prof, does the Russian elite view 1986 price collapse as a important variable in the fall of the soviet empire- or is it only Gaidar’s view? The devaluation of ruble in 1998/ bankruptcy and low oil prices is clearly imprinted in the russian mind? So what is the Russian counter-strategy if the Saudi’s push prices down 50%, or prices fall below $60/bbl for reasons beyond Moscow’s control. It must be in the forefront of the Russian mind, whereas barely evident in most minds on NYT and bloomberg

    Comment by scott — October 15, 2014 @ 4:04 am

  9. the counter strategy is probably what it has always been: find a scapegoat and start a war.

    Comment by Sotos — October 15, 2014 @ 8:24 am

  10. In other news, Rogozin the Ridiculous Rides to the Rescue and takes some attention off Vova the best way he knows how: by saying dumb things.

    http://www.ibtimes.co.uk/alaska-next-russias-deputy-pm-dmitry-rogozin-calls-annexation-russian-america-1470223

    Comment by Blackshoe — October 15, 2014 @ 1:16 pm

  11. @Blackshoe-I saw that, and sent the Moscow Times version of that article to a friend. He gets more ridiculous by the day. It would be like, what, having Alex Jones as SecDef?

    The ProfessorComment by The Professor — October 15, 2014 @ 1:38 pm

  12. @scott-I have long been fascinated by the 85-86 Saudi actions, and whether it was the result of a different sort of collusion that what Opec engages in: that is, collusion between the US government and KSA as a means of torpedoing the Russian economy. KSA probably had sufficient economic incentive to act as it did unilaterally, because demand for its oil was sufficiently elastic. But it is a fascinating question. The fact that it left a mark on the Russian mind means that even if the Saudis did this out of their own interest, we were sufficiently adept at spinning it that it made the Soviets wonder.

    I have little doubt that the current elite is very aware of the continued dependence of the Russian economy on the price of oil, and lives in fear of a repeat of the price collapse in the 80s.

    You mention 1998. That’s when oil tanked again, due to the Asian financial crisis. That only reinforces the fear. And 2008-2009 was a near death experience too.

    The only counterstrategy I can think of is for the Russians to sow chaos in the Middle East in an attempt to disrupt production. If you think along those lines, this means the Russians have no incentive for the completion of a deal with Iran that would result in it returning in full force to the oil market. It also means that the Russians have an incentive to hamper efforts to defeat ISIS, particularly in Iraq, and actually have an incentive to support it. Similarly, they have an incentive to stir trouble in Libya.

    They have an incentive to do these things even if the price stays where it is. Indeed, these strategies are overdetermined in the zero sum Russian mind. They think that any American setback is a Russian victory, even if it doesn’t boost the price of oil. So getting us bogged down with ISIS is definitely a plus for the Russians.

    The ProfessorComment by The Professor — October 15, 2014 @ 1:49 pm

  13. Ah, but SWP, in spite of all you say, President Obola, according to news reports that I’ve seen, seems to be thinking about backing off on sanctions against the Rasha “because the Rasha is needed for various things.”

    Comment by elmer — October 16, 2014 @ 11:35 am

  14. @elmer-I know. This is just another specific case of a general principle: Give Obama a choice, and he’ll make the wrong one.

    How can anyone, at this late date, think that Russia has the remotest interest in cooperating with the US? Talk about the Einstein insanity definition in action.

    Putin (and Russian decision makers generally) operate according to a zero sum mindset, and believe that the US is Russia’s enemy. Therefore, anything that helps the US hurts Russia, and anything that hurts the US helps Russia. The only way of getting them to do something that advances American interests is to deceive them as to what those interests are. That is, the US would have to play B’rer Rabbit to perfection, and the present Team of Retards is incapable of that.

    In other words, Getting to Yes with Russia involves doing things that Russia believes will damage US interests.

    The ProfessorComment by The Professor — October 16, 2014 @ 1:15 pm

  15. http://www.vox.com/2014/10/17/6989397/russia-mcdonalds-putin-ukraine-yolo

    Russia is conducting a massive McDonald’s purge

    In purely economic terms, the war on McDonald’s is, like so much of Russia’s recent lashing out at the West, mostly self-defeating. There are give-or-take 437 McDonald’s in Russia and they purchase about 85 percent of their supplies from Russian companies. So the anti-McDonald’s campaign is, in a way, a microcosm of Putin’s entire approach to the Ukraine crisis: damn the economic costs, full speed ahead on aggressive nationalist symbolic gestures.

    Comment by elmer — October 18, 2014 @ 8:20 am

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