The Debate
Michel and Da Russophile are engaged in an interesting debate on Russia in the comments to Check Out Michel’s Comments. I’ll add my two cents (or should it be kopecs?) here.
The main issues in the colloquy between these two gentlemen are (a) the breadth of Russian prosperity, (b) its dependence on oil prices, and (c) the likely future course of oil prices.
With respect to (a), official statistics are not that illuminating, and anecdotal evidence is seldom conclusive. My one anecdotal data point is from a friend who recently returned to Russia (not Moscow or St. Petersburg, but a large city) after 2 years in the US. She said that yes, things had changed for the better but that “You live in a different world, and should be grateful for that.” In brief, things were better, but a long, long, long way from what Americans or Europeans take for granted.
I can speak with a little more authority on (b) and (c). I’ll start with (c). Insofar as the future course of oil prices is concerned, the price is effectively hostage to the strength of the world economy, and that is not a good place to be right now. All indicators are for a deep recession world-wide in the coming year. To the extent that emergency interventions in the banking markets work, they will primarily affect the depth and duration of the impending recession. Given the inelasticity of the demand and supply for oil, even a modest downturn in demand translates into a substantial decline in oil prices.
With respect to OPEC riding in to save the day (for those long oil, anyways)–don’t count on it. OPEC output restraints didn’t really contribute to the skyrocketing price over the last summer. Every OPEC producer was pumping flat out, with the exception perhaps of Saudi Arabia (which increased output some in the summer) and Nigeria (which is continuing to experience disruptions due to MEND and other anti-government groups.) When producers are operating at capacity, a cartel is having no effect. When demand falls, and OPEC faces an excess capacity situation, an effective cartel could prop up prices, and collectively its members would like to do so, but the incentives to cheat on any such agreement to restrict output are strong. Historically, OPEC members have cheated substantially on their quotas, and the cartel’s influence on prices has been sporadic at best during periods of excess capacity. I therefore wouldn’t count on OPEC to provide substantial relief to Russia by keeping the oil price from falling too low.
As to (b), in some respects whether the price of oil (Urals or REB) remains above $70/bbl is a secondary issue. (Tuesday’s price for Urals-Med was $73.44. Netting out transport costs, that is very close to the $70/bbl figure.) Certainly, the lower the price, the greater the budgetary pain, and a fall below $70/bbl will, per Kudrin, result in Russia running a deficit. Even if the price is substantially higher, however, there is considerable room for doubt as to whether the additional revenues will be directed to meet Russia’s most pressing needs, which include, to name but a few, public health, infrastructure, and pensions. Prices even in the $80s–which are very likely, and maybe even optimistic over the coming year given the bleak economic outlook–will allow Russia to avoid running a deficit, but are probably insufficient to go far in addressing Russia’s health and infrastructure capital deficits, especially given the, ahem, “leakage” of funds that pass through government hands.
Anyways, keep up the conversation, guys. I’m enjoying it.
SWP & Michel,
I think a good idea might be to break this down into 2 scenarios. What will happen if 1) there is a moderate recession in the West and continuing vigor in Asia, and 2) there is a prolonged depression in the West and a very substantial slowdown in Asia. Short-term = 0.5-2 yrs, Long-term = 2+ years.
1) Moderate recession in the West and continuing vigor in Asia
In the SHORT-term, as both of you agree, collusion could work, if imperfectly. Should demand fall (a questionable proposition, because new Chinese demand may cancel out falling American), supply can be decreased TEMPORARILY. Thus oil prices can be stabilized. Even if they stagnate somewhat, that’s exactly what the oil exporters’ foreign currency reserves are for.
In the LONG-term, there will be a recovery in the West and Asia gets a further boost to its growth, and demand increases rapidly. At this time, as you correctly said, cheating will be breaking apart collusive agreements. But it won’t matter. To meet demand oil producers will be free to fully unwind their spigots and reap in the benefits of 150$ (or 200$? 300$?) oil again and capital flows will resume to them.
2. Prolonged depression in the West and a very substantial slowdown in Asia
In the SHORT-term, oil prices free-fall and Russia and the oil producers are forced to burn through their reserves. The success of collusion is uncertain. On the one hand, the urgency of doing it for everybody is very high. On the other hand, some states might well be desperate for immediate funds and cheat straight away. Although, for reasons I lay out down below, I believe the chances of collusive success this time around, as opposed to previous attempts, are much higher.
In the LONG-term, oil producers get screwed. But by then the rest of the world is also screwed, by our initial assumption (global depression). Everybody is screwed. So I think it best that we all try to not let this happen since it’s not in anybody’s interest.
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“Given the inelasticity of the demand and supply for oil, even a modest downturn in demand translates into a substantial decline in oil prices.” – SWP
Given the ineslasticity of the SUPPLY of oil, even a modest downturn in supply can keep prices stable in the face of a modest downturn in demand. Hence where collusion however imperfect comes in. Actually, it’s not even necessary that OPEC as a whole co-operates. Since Russia and Saudi Arabia between them account for around 20% of world oil production (and Russia can presumably lean on Kazakhstan and Azerbaijan to toe the line too), basic co-operation just between them two may stabilize prices in the short term. I believe this is the game plan currently favored by the siloviki (as opposed to Kudrin and the liberals) and it seems quite rational.
I also believe that today the chances of success in collusion is much greater than it was in the 1970’s. Back then the equilibrium price for oil was very low, and it took a BIG leftward shift in supply to ratchet up oil prices. Nowadays, the equilibrium price is much higher and increases in supply are constrained by the geological realities of peak oil. It takes much more capital investment to increase supply – capital that the producers won’t have access to in a period of low prices and Western recession. Hence, with supply so tight, today it would take just a marginal contribution from each oil producer to stabilize prices. The pay-offs for individual cheating are for the above reasons much less than they were in the 1970’s, when collusion broke down. Hence the players are much more likely to all win this game this time around, should they decide to play it.
“Even if the price is substantially higher, however, there is considerable room for doubt as to whether the additional revenues will be directed to meet Russia’s most pressing needs, which include, to name but a few, public health, infrastructure, and pensions.” – SWP
I’ll remark that currently Russia has one of the world’s most liberal tax regimes. If Scenario 2 plays out I think we can expect to see the cancellation of the 13% flat tax in favor of a stepped income tax (a measure I believe is long overdue and support for both practical and ideological reasons).
Comment by Da Russophile — October 15, 2008 @ 12:51 am